The ATO ramps up its recovery of existing and anticipated tax debts

Articles Written by Stewart Grieve (Partner), Annemarie Wilmore (Partner), Jess Tsai (Senior Associate)
Cubed letters spelling tax on top of coins

Central to the Australian taxation system is the concept of self-assessment. Voluntary compliance for the payment of tax related liabilities is strong with Australian Tax Office (ATO) data indicating that approximately 90% of tax liabilities are paid by the due date.

Despite this, there are high numbers of collectable tax debt ($34.1 billion in FY 20), that the ATO is under some pressure to collect. COVID-19 saw a pause in ATO debt recovery activity; however, based on recent cases, it is apparent that the ATO has resumed its focus on recovery with increased vigour. Recovery actions have now been extended to both existing and future tax liabilities.

Freezing order against corporation: prospective liability

In remarkable circumstances, the Commissioner of Taxation (Commissioner) has successfully obtained a freezing order for approximately A$220m against a non-resident taxpayer in the recent decision of Deputy Commissioner of Taxation v State Grid International Australia Development Company Limited [2022] FCA 139 (State Grid Case). This is the largest freezing order application sought and obtained by the Commissioner against a corporate in the last 10 years. It is generally the case that income tax related liabilities are due and payable within 21 days from the lodgement due date or date of the notice of assessment. The Commissioner has an administrative practice of not commencing debt recovery action in circumstances where there is a dispute about the substantive taxation liability and certain conditions have been met. The Commissioner will, however, displace the administrative arrangements if there is a concern that there is a risk to the revenue. The Commissioner’s approach to risk management of tax debts is set out in Practice Statement Law Administration PS LA 2011/6. The evaluation of risk by the Commissioner is often a culmination of several factors including the taxpayer attributes (compliance history, behaviour and circumstances), the likelihood of payment and the size of the exposure. The Commissioner has a range of mechanisms that can be deployed in order to recover the tax debt, such as accepting securities (bank guarantees), payment arrangements, garnishee notices and freezing orders.

What is noteworthy about the State Grid Case is that the freezing order was obtained:

  • on the Commissioner’s assessment about a prospective tax liability, that, at the time of the hearing, was not yet the subject of any assessment. The Commissioner was aware that a capital gains tax (CGT) event was to occur on 16 February 2022, and sought urgent interlocutory relief on 15 February 2022;
  • in circumstances where State Grid was one of a number of shareholders that agreed to participate in a scheme of arrangement (Scheme) to dispose of its shares in an ASX listed entity; and
  • based on a difference in views as to whether the sale shares were taxable Australian property.

Recovery of tax liability twice

Perhaps the only limitation on the ATO’s ability to recover tax debts is when it is oppressive to do so. The 22 March 2022 decision of the Federal Court in Hyder v Commissioner of Taxation [2022] FCA 264 (Hyder) reveals that the ATO wanted to recover twice the taxation liability arising from the same source in the same year. The case of Hyder involved a trust, with distributions to Screaming Eagle Pty Ltd (SEPL) and Mr Hyder. SEPL had paid the amount of tax in relation to its distribution to the ATO (approximately $5.3m).

The ATO sought to include that same distribution recorded by SEPL as Mr Hyder’s income. The tax liability (to Mr Hyder, or alternatively to the trustee) in relation to the distribution recognised by the ATO was not reduced to reflect the tax already paid by SEPL. The ATO’s position was that Mr Hyder had entered into a contrived arrangement through a purported partnership with a private company (SEPL) as a partner, and then utilised the company’s profits for private purposes or retained the profits for working capital purposes.

The Federal Court found that the ATO had acted oppressively in Hyder by seeking to enforce the payment of total debt from the taxpayers in the period from May 2020 to July 2021.

Freezing order against two individuals, ex parte

On 22 March 2022 the ATO sought and obtained, on an ex parte basis, freezing orders against two individuals (Deputy Commissioner of Taxation v Williams [2022] FCA 263). Assessments had issued on 21 March 2022 for $7.7m and $3.9m. Both cases involved UK citizens having migrated to Australia with poor compliance history. In granting the freezing and ancillary orders the Court found that there was a risk of dissipation of the assets and non-payment of the taxation debt.

State Grid Case

Corporate taxpayers may be interested in the background circumstances to, and the reasons for, the Court granting the freezing orders. We set these out below, together with some considerations for buyers and sellers contemplating similar transactions.

1.1 Background facts

The key facts of the case are as follows:

  • In late 2021, Australian Energy Holdings No 4 Pty Ltd, a company controlled by Brookfield Asset Management, Inc proposed to acquire all of the shares in AusNet Services Ltd (AusNet) under the Scheme. State Grid International Australia Development Company Limited (State Grid), a private company incorporated in Hong Kong, was a minority shareholder in AusNet and intended to participate in the Scheme.
  • On 16 December 2021, AusNet published a Scheme Booklet on the ASX, which set out the details of the proposed transaction. It appears from the case that this was how the ATO became aware of the transaction.
  • In January 2022, the ATO held discussions with AusNet, where it advised AusNet of its “likely view” that Division 855 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) would not apply to disregard any capital gain made by State Grid (and another shareholder) on the basis that the shares in AusNet constituted indirect Australian real property interests within the meaning of section 855-25 of the ITAA 1997. While no assessment or position paper was issued by the Commissioner at this stage, this was nonetheless the Commissioner’s “considered view at the time”. AusNet’s position was that the shares in AusNet should not give rise to an indirect Australian real property interest.
  • On 28 January 2022, AusNet shareholders approved the Scheme and AusNet notified the ASX that the Scheme would be implemented on 16 February 2022 (Implementation Date).
  • At the Implementation Date, State Grid owned 762,162,932 shares in AusNet, which represented approximately 20% of the total shares on issue. As part of the Scheme, State Grid would receive approximately A$1.98b sale proceeds in consideration for the sale of all of its shares in AusNet.
  • Other than its shares in AusNet, the Commissioner had a concern that State Grid had no other substantial assets in Australia. This concern arose from correspondence provided to the ATO by State Grid’s solicitors (although the ATO understood that it was part of a group which owned assets in Australia and had a global reputation to maintain).
  • The Commissioner determined that State Grid would make a capital gain of approximately A$737m and would be required to pay income tax at the corporate tax rate of 30%, resulting in an anticipated tax liability of approximately A$220m.
  • To protect its ability to collect the anticipated tax debt, on 15 February 2022 the Deputy Commissioner requested State Grid to provide a security for 50% of the tax liability by way of bank guarantee (ie A$110m). This request was not accepted by State Grid.
  • Also on 15 February 2022, at 4:15pm, and ahead of the Scheme being implemented the following day, the Commissioner applied to the Federal Court for freezing orders over bank accounts held by State Grid and AusNet. The application by the Commissioner had only been filed 30 minutes prior to the hearing, and State Grid had limited opportunity to read the documents and obtain advice and no opportunity to brief counsel.

1.2 The decision

The Federal Court granted the freezing order against State Grid and AusNet on the basis that the Commissioner established that:

  • It had a “good arguable case”, evidenced in this case by the special assessment. In this context it was irrelevant to consider whether the substantive arguments the Commissioner had with respect to Division 855 of the ITAA 1997 were correct;
  • There was a danger that a prospective judgment would be wholly or partially unsatisfied; and
  • The balance of convenience supported the freezing order being granted.

The matters the Court took into account in evaluating the second and third elements included that:

  • The prospective CGT liability was substantial;
  • State Grid is located offshore and accepted the Commissioner’s concern that it would have no substantial assets or residual business in Australia following the disposal of its shares in AusNet; and
  • Any prospective judgment would be difficult to enforce in China or Hong Kong having regard to China’s reservations regarding assistance with recovery of tax claims under the Convention on Mutual Administrative Assistance Matters in Tax Matters.

1.3 How might a tax liability arise in the ordinary course

Residents and non-residents alike will need to consider whether they are liable to CGT where a CGT event happens in relation to taxable Australian property. A capital gain realised by a non-resident on exit from its investments (such as a sale of shares in a company) may be disregarded under Division 855 of the ITAA 1997 if the asset disposed of is not Taxable Australian property (TAP). TAP is a defined term, and broadly includes both direct and indirect interests in Australian real property. The test in Division 855 requires both a categorisation of assets within the relevant categories, and an evaluation of how the market values the assets with a view to ascertaining whether 50% of the value is attributable to Australian real property.

In terms of the circumstances in State Grid, there were two ways in which the tax liability contended for by the Commissioner could arise:

  • State Grid would lodge its tax return in the ordinary course (presumably, without accounting for an amount of CGT in reliance on AusNet’s view that the shares in AusNet should not give rise to an indirect Australian real property interest). The Commissioner would review the lodged return and on forming a differing view, would issue an amended assessment, to include a capital gain (which may result in an additional tax liability). Any tax liability arising from the amended assessment would be due and payable within 21 days from the date of the amended assessment; or
  • As was the case in State Grid, the Commissioner could issue a special assessment (pursuant to section 168 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), which it intended to do on 16 February 2022, at which point the CGT event would have occurred. The tax liability arising from the special assessment would become due and payable on 1 December 2022. Notably, at the time of the hearing, no assessment had been issued by the Commissioner.

The cases of FCT v Resource Capital Fund III LP [2010] FCA 1247 (RCF) and FCT v Regent Pacific Group [2013] FCA 36 (Regent Pacific) show that the Commissioner is prepared to use freezing orders to secure payment for a tax liability. Both cases involved taxpayers based in the Cayman Islands, tax assessments already in existence and applications put on by the Commissioner for freezing orders even though the time for the payment of the tax debt had not yet occurred. Aspects of the RCF case also involved a CGT event, and whether Division 855 of the ITAA 1997 applied.

1.4 Seller’s considerations

This case illustrates the extent to which the Commissioner will go to protect the Australian tax base and ensure recoverability of tax debts, including seeking enforcement of a last minute freezing order a day before a major transaction is expected to occur. As emphasised in the case and extracted from Deputy Commissioner of Taxation v Wang [2020] FCA 1711, “a freezing order is a ‘drastic remedy’ which should not be lightly granted”. Despite this, the case also illustrates the readiness of the Court to find in favour of the Commissioner in relation to risks concerning the recoverability of tax debts. The Courts recognise that there is a separate mechanism by which a taxpayer can contest the substantive tax question (via Part IVC).

Of note, in relation to the first requirement (that there must be a ‘good arguable case’):

  • As at the date of the hearing, the Commissioner had not yet issued State Grid with an assessment notice. The Commissioner, however, had produced evidence that it intended to issue a special assessment upon completion of the transaction the next day (at which point its powers to issue such an assessment would manifest). As such, the Court was effectively ruling on freezing assets to which there was not yet any real cause of action; and
  • Even if a notice of assessment had already been issued, the conclusive evidence provisions of the tax laws would effectively operate to establish that the Commissioner had a good arguable case, regardless of the Commissioner’s substantive arguments in relation to the calculation and imposition of any tax liability.

Interestingly, this case is one of two cases in the last 10 years that involved a freezing order being granted in relation to a prospective tax liability. On the other occasion, in 2013, a freezing order in relation to a prospective tax liability was granted in the context of the Binetter litigation, against an individual for approximately $1.2m. Based on a search of Federal Court judgements from the past 10 years, it is clear that the ATO does not shy away from seeking freezing orders as a means of securing its tax debts, having sought and successfully obtained freezing orders on 20 occasions. However, in most of those cases, subsequent litigation revealed the cause for the Commissioner’s concern, in that there were subsequent findings of fraudulent or evasive behaviour on the part of the taxpayer (eg Binetter v Federal Commissioner of Taxation [2016] FCAFC 163). Based on the information available about the State Grid case the freezing order appears to have been sought in very different circumstances to those granted to the Commissioner over the last 10 years.

1.5 Buyer’s considerations

While this case provides an example of the ATO exercising its powers as against the taxpayer with the primary tax liability, it is important not to forget a buyer’s obligations in the context of share disposals and the potential alternate routes available to the ATO.

It seems that a purchaser of shares would be required to withhold and remit to the ATO an amount under the foreign resident CGT withholding (FRCGTWT) regime, usually 12.5% of the purchase price (unless a valid clearance certificate or declaration is provided) on or before the day the buyer provides the ‘financial benefit’ (i.e. purchase price). The purpose of FRCGTWT is to remedy the low level of compliance with the foreign resident CGT regime. It is intended to be a non-final withholding tax, and operates by compelling the non-resident to file an income tax return for the year in which the CGT event occurred, disclosing the capital gain and claiming the 12.5% as a tax credit. The difference between the 30% tax on the capital gain and the 12.5% already paid would need to be paid by the non-resident following lodgement of the tax return.

Buyers may also wish to consider the pros and cons of relying upon another’s assessment of whether or not the sale will give rise to an indirect Australian real property interest, as well as the utility of obtaining an independent assessment of risk. Opinions regarding classification as between TARP and non-TARP and valuation will have important consequences in determining any taxation liability, and are matters that continue to be contentious.

Additionally, the terms of any withholding and gross-up clause will need to be considered carefully from the buyer’s perspective to ensure that it operates in the manner that the parties anticipate. It would be prudent to have regard to the range of possible approaches to enforcement that the ATO might take.

1.6 Final comments

Taxpayers should be aware that Australia has a highly proactive revenue authority. These cases, and others like the DPT case (see our insight from February), are prime examples of the breadth of the Commissioner’s powers and the persistent approach which the Commissioner takes to collecting taxation revenue. It would be prudent for taxpayers to keep in mind the ATO’s perspective on the risk to the revenue, and the potential consequences that could occur if the ATO is not comfortable with the level of perceived risk.

In both the State Grid and Hyder cases, the ATO approached the respective taxpayers with offers to enter into a 50/50 arrangement. Under a 50/50 arrangement, the taxpayer pays at least 50% of the disputed primary tax amount plus any other outstanding undisputed tax debts. The taxpayer agrees to provide information that is needed to resolve the dispute in a timely way. In exchange, the ATO agrees to defer recovery action on the debt until the conclusion of the substantive dispute. A concessionary general interest charge remission is also provided over the term of the dispute.

Given the significant implications of recovery action, taxpayers may want to consider a proactive ATO engagement strategy designed to provide the Commissioner with a degree of assurance regarding the tax technical position and risk to the revenue. Such assurance measures could include:

  • early engagement discussions with the ATO to put them on notice about the prospective transaction and anticipated consequences; and/or
  • robust opinions supported with evidence (including expert evidence where necessary) regarding the tax implications and taxpayer position at an early stage (well ahead of settlement of the relevant transaction) inviting dialogue with the ATO regarding its perceived risks and concerns, with sufficient opportunity to consider the appropriate steps to put in place to provide assurance.
Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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