Focus: Safe from the Tax Office?
22 october 2012
In brief: A recent Federal Court case serves as a warning that mortgagees should take into account any garnishee notice issued in relation to a mortgagor's tax debt before agreeing to release a mortgage to facilitate a sale by the mortgagor. Partner John Gallimore (view CV) and Law Graduate Andrew Shetliffe report.
How does it affect you?
- In certain circumstances, a section 260-5 notice under the Taxation Administration Act 1953 (Cth) may, in practice, be effective for the Australian Taxation Office (the ATO) to achieve priority over a secured creditor in relation to proceeds of the sale of secured property.
- A mortgagee should consider the existence and effect of any tax debt that a mortgagor owes before agreeing to release a mortgage before sale by the mortgagor.
- Where appropriate, mortgagees may consider taking a security interest under the Personal Property Securities Act 2009 (Cth) (the PPSA) over proceeds of any sale of land by the mortgagor, in addition to a registered mortgage.
In Commissioner of Taxation v Park1 , the Federal Court considered the operation of a notice served by the Commissioner of Taxation under s260-5 of Schedule 1 of the Taxation Administration Act and its interaction with the rights of a registered mortgagee regarding a sale of land by the mortgagor.
The case involved the sale of land over which two mortgages had been registered. It was clear that the proceeds from the mortgagor's sale would be insufficient to discharge the total amount secured by both mortgages. The second mortgagee had, nevertheless, indicated its willingness to release its mortgage in exchange for the balance amount remaining after discharge of the first mortgage and sale expenses.
Before settlement, the Commissioner served notice under s260-5 on the purchasers, demanding that they pay $75,508 from the sale price owed to the vendor when that purchase price became payable. The second mortgagee initially refused to release its mortgage unless it was paid the full amount of the agreed purchase price remaining after satisfaction of the debt to the first mortgagee. However, the sale eventually settled on the basis of an undertaking by the solicitors for the second mortgagee not to release the $324,146 they received from the proceeds from their trust account without the ATO's consent. The second mortgagee eventually received the balance of this amount after it agreed to pay $75,508 into court, at which time it assigned all of its right and title to the $75,508 to the trustee in bankruptcy appointed to the seller's estate.
The majority, Justices Jessup and Katzmann, decided the case on the following bases:
- each registered mortgagee's interest was in the land, and not in the proceeds arising from sale of the land by the mortgagor;
- the balance of the purchase price at settlement was payable to the mortgagor/seller at the time it provided unencumbered title to the buyer; and
- the s260-5 notice imposed an obligation on the buyer to pay $75,508.64 of the purchase price to the Commissioner, instead of the mortgagor/seller (or at the mortgagor/seller's direction to the mortgagees), immediately that the purchase price became payable to the seller.
The majority noted that the mortgagor/seller's obligation to pay out a mortgagee is not part of the 'mutually dependent obligations' that arise at settlement of the sale of land. The mortgagee is not obliged to release its security over the land before being paid any amounts secured, and the seller is not obliged to use the money paid by the buyer at settlement in order to do so:
...there was never a point at which ... the amount to be received from the purchasers was 'no longer in reality owing to the taxpayer but to the [mortgagee]'
A voluntary release by a mortgagee of its security without full payment of the debt secured does not result in a charge over any proceeds of the sale in favour of the mortgagee:
...a mortgage of Torrens system land relates not to moneys owed by third parties but to the land itself: Land Title Act 1994 (Qld), s 74. Moneys owed by a third party even someone who had contracted to purchase the land are not the subject of the security.
The majority described the operation of the s260-5 notice as follows:
The silent premise on which the trustee's argument is based is that the Commissioner's rights under a s 260-5 notice are somehow derivative apropos those of the vendor/taxpayer in a situation in which the purchase moneys were notionally paid to him or her. Such an approach, however, implicitly mischaracterises the way that s 260-5 operates. A notice under s 260-5 (which this one was) imposes an obligation on the addressee immediately money becomes owing to the taxpayer. The money must be paid to the Commissioner instead of being paid to the taxpayer. There would, therefore, never be proceeds in the hands of the errant vendor which might be the subject of a charge in favour of the mortgagee.
In the majority opinion, the decision did not amount to priority being given to a s260-5 notice over a registered security interest. At no time did the s260-5 notice restrict the second mortgagee's right to enforce its security by exercising its power of sale. Had the second mortgagee done so, no money would ever have been payable to the seller and, accordingly, the buyer's obligation to pay the amount stated in the s260-5 notice to the Commissioner would not have arisen.
The second mortgagee's position had been weakened at the time it agreed to release its mortgage before receiving payment of all amounts secured. It was further weakened when the second mortgagee finally agreed to give up any claim to the $75,508 that had been held in trust following completion of the sale, although it is unlikely the mortgagee would have found itself better placed in this regard than the trustee in bankruptcy, who argued the case before the court, had it not done so.
Justice Siopis, in dissent, found that the second mortgagee held an equitable charge over the proceeds of the sale. Referring to s88 of the Property Law Act 1974 (Qld), which provides that the mortgagee holds proceeds of a mortgagee sale on trust, his Honour held that:
...where land the subject of an existing equitable mortgage is sold, the charge under the equitable mortgage over the land converts to an equitable charge over the proceeds of the sale. I do not accept, as the Commissioner contended, that this principle is confined only to circumstances where the funds comprising the proceeds of the sale, have been generated by the exercise of a mortgagee's power of sale.
In the circumstances, Justice Siopis held that the seller never held a beneficial interest in the proceeds of the sale to which the s260-5 notice could attach. He relied on the High Court's reasoning in Bruton Holdings Pty Ltd (in liq) v Commissioner of Taxation2 , in which the Commissioner's position under a s260-5 notice was equated with that of a garnishor under a garnishee notice. Arising from that principle:
...the debt the subject of the demand made in the s 260-5 notice, is subject to the rights and equities which already exist in respect of the debt[.]
How the courts would approach the Commissioner's rights under a s260-5 notice if there were a perfected security interest over proceeds of the sale remains to be seen.
Neither judgment took into account previous authorities considered at first instance, such as Re Octaviar Ltd (No. 8)3 , which describe the operation of a s260-5 notice in terms of a statutory charge. Section 73 of the PPSA purports to deal with priorities as between statutory charges and security interests under it. However, s1.4(1) of the Personal Property Securities Regulations 2010 (Cth) expressly states that the PPSA does not apply to a right or interest in property mentioned in s260-5 of Schedule 1 of the Tax Administration Act.
The High Court's view in Bruton Holdings was that a s260-5 notice does not give rise to any proprietary interest in the debt.
Passages throughout the majority decision appear to suggest that such a security interest, taken in addition to the real property mortgage, may at least present an additional argument that the Commissioner would be required to overcome in order to obtain payment ahead of a secured creditor in similar circumstances.
The outcome would have been different had the second mortgagee simply refused to release its mortgage without being paid out the full amount it had originally required. Perhaps the sale by the mortgagor would then have fallen through, and the first (or second) mortgagee would have been able to sell the property. In that case, it seems that the mortgagees would have had a clear prior right to share all sale proceeds.
The decision is likely to affect a mortgagee's commercial decision whether or not to release a mortgage to enable a sale by a mortgagor to go ahead. Lenders may wish to consider taking additional PPSA security over the proceeds of any sale of land by the mortgagor in designing their security package.
-  FCAFC 122.
- (2009) 239 CLR 346.
-  QSC 202.
- John GallimorePartner,
Ph: +61 7 3334 3135
- Karla FraserPartner,
Ph: +61 7 3334 3251
- Nicholas AdkinsPartner,
Ph: +61 2 9230 4592
- Warwick NewellPartner,
Ph: +61 3 9613 8915
- Ben FarnsworthPartner,
Ph: +61 8 9488 3877