Re Clarke, Bernard Edmond Ex Parte Deputy Commissioner of Taxation v The Official Receiver (as trustee of the property of Bernard Edmond Clarke, a bankrupt)
[1981] FCA 95
•01 JULY 1981
Re: BERNARD EDMOND CLARKE
Ex parte: DEPUTY COMMISSIONER OF TAXATION; THE OFFICIAL RECEIVER (as trustee o
the property of Bernard Edmond Clarke - a bankrupt) (1981) 51 FLR 220
No. 107 of 1971
Bankruptcy
COURT
IN THE FEDERAL COURT OF AUSTRALIA
GENERAL DIVISION
BANKRUPTCY DISTRICT OF THE STATE OF VICTORIA
C.A. Sweeney, J.(1)
CATCHWORDS
Bankruptcy - property recovered or preserved by means of an indemnity for costs of litigation given by creditors other than the Deputy Commissioner of Taxation - Whether the power of the Court under s.109(6) of the Bankruptcy Act 1966 to make an order with respect to the distribution of the proceeds of that property with a view to giving the indemnifying creditors an advantage over other creditors is subject to ss. 221P and 221YU of the Income Tax Assessment Act 1936.
Bankruptcy - Litigation of bankrupt continued by virtue of indemnity - Indemnity provided by certain creditors only - Litigation successful - Deputy Commissioner of Taxation not indemnifying creditor - Claim of Deputy Commissioner to priority - Whether discretion of court subject to statutory priority - Bankruptcy Act 1966 (Cth), s. 109 (1), (6) - Income Tax Assessment Act 1936 (Cth), ss. 221P, 221YU.
HEADNOTE
The official receiver was trustee of the property of the bankrupt. Early in the course of the bankruptcy six creditors, not including the Deputy Commissioner of Taxation, provided the official receiver with indemnities in respect of the costs of certain litigation already commenced on behalf of the bankrupt prior to the bankruptcy, without which it would not have been possible to continue the litigation. Subsequently the action was settled and after the deduction of certain costs and expenses the sum of $1,732.80 remained available for distribution to creditors.
By application dated 14th August, 1980, the official receiver sought directions and orders pursuant to s. 109 (6) of the Bankruptcy Act 1966 as to the manner of applying the proceeds recovered by means of the indemnity for costs. The Deputy Commissioner gave notice that he intended to oppose the making of the orders sought on the grounds that he had a statutory priority pursuant to s. 221P (2) of the Income Tax Assessment Act 1936 which could not be displaced by order of the court. Further by application on 22nd October, 1980, the Deputy Commissioner sought orders in relation to the net proceeds resulting from the litigation; the official receiver gave notice of opposition to the orders sought by the Deputy Commissioner.
Held, that the statutory priority granted to the Deputy Commissioner of Taxation pursuant to s. 109 (1) of the Bankruptcy Act applies only to the distribution of proceeds pursuant to that section. It does not affect any distribution made pursuant to an order of the court under s. 109 (6) of the Act. In the present circumstances, having regard to the facts of the case, it was appropriate to give the indemnifying creditors the advantage over other creditors of having the whole of the sum recovered by means of their indemnity distributed amongst them in proportion to the amounts of their respective debts.
Orders accordingly.
HEARING
Melbourne, 1980, October 27; November 12; 1981, June 1; July 1. #DATE 1:7:1981
APPLICATIONS.
Application and cross application relating to the distribution of certain funds obtained by the official receiver as a result of certain litigation continued by him after the date of the sequestration order.
N. A. Moshinsky, for the official receiver.
G. Griffith, for the Deputy Commissioner of Taxation.
Cur. adv. vult.
Solicitor for the official receiver: G. T. Bigmore.
Solicitor for the Deputy Commissioner of Taxation: B. J. O'Donovan, Commonwealth Crown Solicitor.
D. LEVIN
ORDER
1. That the following creditors, Messrs. Hargrave Box Woods and Curtis-Smith, Dr. F. X. Lyons, Reinehr Industrial Lease & Finance Pty. Ltd., Mr. R. I. Menzies by his Attorney, T. N. D. Stevens, A. M. & E. T. Barnes, and L. M. Clarke be given the advantage over other creditors of having the whole of the nett proceeds of the property recovered by means of the indemnity given by them distributed amongst them, in proportion to the amounts of their respective debts.
2. That the costs of the Official Receiver of and incidental to his application be taxed and paid by the Deputy Commissioner of Taxation.
3. That the application of the Deputy Commissioner of Taxation be dismissed.
4. That the costs of the Official Receiver of and incidental to the application of the Deputy Commissioner of Taxation be taxed and paid by the Deputy Commissioner of Taxation.
5. That there be a stay of proceedings in respect of these orders for 21 days from this date.
6. That both parties have general liberty to apply.
JUDGE1
By application dated 14 August 1980 the Official Receiver in and for the Bankruptcy District of the State of Victoria, as trustee of the property of Bernard Edmond Clarke (the bankrupt), sought directions and orders pursuant to section 109(6) of the Bankruptcy Act 1966 (the Act) as to "the manner of applying proceeds of the property of the bankrupt, namely the sum of $2,474.47 recovered by means of an indemnity for costs of litigation given by certain creditors of the bankrupt."
This application was supported by an affidavit of the Official Receiver sworn 7 August 1980, in which he deposed that on or about 4 January 1973 notice of first meeting of creditors of the bankrupt was given to the 23 known creditors of the bankrupt, including the Deputy Commissioner of Taxation. In that notice the Official Receiver referred to an action for damages arising out of a motor collision which had already been commenced on behalf of the bankrupt, which his solicitors considered to have good prospects of success. He pointed out to the creditors that, as there were no funds in the estate and no assets available for realisation, the action could proceed only if indemnities were provided by them, or some of them, in the event of the action being unsuccessful. He stated that if indemnities were given, and the action were successful, he intended to apply to the Court for an order that the indemnifying creditors be given preferential treatment over other creditors in the distribution of the fruits of the action.
Six creditors, not including the Deputy Commissioner of Taxation, provided the Official Receiver with indemnities. The action was finally settled on a basis which resulted in a payment to the Official Receiver of the amount of $2,474.47. From that sum has been deducted the amount of the Official Receivers's remuneration, namely $591.67, and the sum of $150.00 has been refunded to one of the indemnifying creditors, Reinehr Industrial Lease and Finance Pty. Ltd., which it had advanced in respect of Counsel's fees. The sum of $1,732.80 remains available for distribution to creditors.
The Official Receiver estimated that a dividend of 39.2371 cents in the dollar would be payable to the six indemnifying creditors if an order were made by the Court giving them preferential treatment over other creditors. If no such order were made, the whole amount available would be paid to the Deputy Commissioner of Taxation by virtue of the priority enjoyed by him under section 109(1) of the Act.
By Notice dated 8 September 1980, the Deputy Commissioner stated that he intended to oppose the making of the orders sought by the Official Receiver on the following grounds: -
"1. The priority given to the Commissioner of Taxation by sub-section 221P(2) of the Income Tax Assessment Act 1936 cannot be displaced by an order of the Court made under sub-section 109(6) of the Bankruptcy Act 1966.
2. The amount available for distribution to creditors is insufficient to pay the amount payable to the Commissioner of Taxation in respect of tax instalment deductions and therefore by virtue of the operation of the said sub-section 221P(2) there is no sum available to the indemnifying creditors in respect of which an order under the said sub-section 109(6) can be made."
By application dated 22 October 1980 the Deputy Commissioner of Taxation sought the following orders: -
"1. An order declaring that the amount of $1,732.80 available for distribution to creditors is payable to the Commissioner of Taxation of the Commonwealth of Australia pursuant to section 221P of the Income Tax Assessment Act 1936.
2. An order that, subject to any order for costs of this application and of the application of the Official Receiver herein dated the 14th August 1980, the said amount of $1,732.80 be paid to the Commissioner of Taxation of the Commonwealth.
3. An order directing that this application be heard together with the application of the Official Receiver herein dated the 14th August 1980.
4. Such further or other order or orders as the Court thinks fit."
The Official Receiver by Notice dated 5 November 1980 stated that he intended to oppose the making of the orders sought by the Deputy Commissioner of Taxation on the following grounds: -
"1. The Court lacks jurisdiction to decide the questions raised by the applicant in his application.
2. Even if the Court has jurisdiction, the questions raised in reality amount to an action by the applicant against the respondent for moneys had and received, which action should be brought in a State Court of competent jurisdiction.
3. This application (if competent to be brought before the Court at all, which is not admitted) amounts to an action pursuant to Section 147 of the Bankruptcy Act, 1966 and, that being so, the applicant has failed to make out a case that the respondent has refused or neglected to pay any dividend to the applicant. Moreover, the property which the applicant seeks to have paid out to him is property which is vested in the Official Receiver in Bankruptcy, and not property in respect of which the respondent has given notice of intention to declare dividend.
4. Even if the Court is disposed to deal with the application herein, the orders sought by the applicant ought not to be granted for the reason that:
(a) Firstly, the claim by the applicant pursuant to Section 221P of the income Tax Assessment Act, 1936 has been converted into a right to prove in the administration of the bankrupt estate of the bankrupt and cannot be enforced against the property claimed in the application; and
(b) secondly, the property claimed is not the same as the property which originally vested in the Official Receiver in Bankruptcy (i.e. a chose in action being the right against Pavlovic), but is rather the proceeds of certain legal action which have been paid to the Official Receiver in Bankruptcy subject to constructive trusts in favour of such indemnifying creditors as the Court may appoint pursuant to sub-section (6) of Section 109 of the Bankruptcy Act, 1966, that is to say the property claimed has not yet become vested in the Official Receiver in Bankruptcy or alternatively has not yet passed under the control of the respondent within the meaning of the said Section 221P."
By consent of the parties, the application of the Official Receiver and that of the Deputy Commissioner of Taxation have been heard together.
Prior to 1 February 1981, when the amendments made to them by section 51 of the Bankruptcy Amendment Act 1980 came into operation, the provisions of sub-sections (1) and (6) of the Bankruptcy Act 1966 were as follows:
"109.(1) Subject to this Act and to sections 221P and 221YU of the Income Tax Assessment Act 1936-1965, the trustee shall, before applying the proceeds of the property of the bankrupt in making any other payments, apply those proceeds in the following order:
(a) first, in payment of an amount to the petitioning creditor equal to so much of the amount lodged by the creditor under section 48 of this Act as has been used for meeting the expenses referred to in that section;
(b) second, in the order prescribed by the rules, in payment of the taxed costs of the petitioning creditor and the costs, charges and expenses of the administration of the bankruptcy, including the remuneration and expenses of the trustee;
(c) third, in payment of liabilities incurred in good faith before the date of the bankruptcy by a controlling trustee in exercise of the powers conferred on him by Part X. and any remuneration due to that controlling trustee;
(d) fourth, in payment of liabilities, commitments, expenses or remuneration referred to in section 114 of this Act;
(e) fifth, in the case of the estate of a deceased debtor whose estate is being administered under Part XI., in payment of proper funeral and testamentary expenses;
(f) sixth, in payment of amounts (including amounts payable by way of allowance or reimbursement under a contract of employment, or under an award or agreement regulating conditions of employment, but not including amounts in respect of long service leave, annual leave, recreation leave or sick leave), not exceeding in the case of any one employee the sum of Six hundred dollars, due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of services rendered to or for the bankrupt before the date of the bankruptcy;
(g) seventh, in payment of amounts, not exceeding in any individual case Two thousand dollars, in respect of compensation, being compensation the liability for which accrued before the date of the bankruptcy, under any Act or State Act or Ordinance of a Territory of the Commonwealth providing for compensation for personal injury arising out of, or in the course of, employment;
(h) eighth, in payment of all amounts due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of long service leave, annual leave, recreation leave or sick leave in respect of a period before the date of the bankruptcy;
(i) ninth, in payment of any sum payable under section 113 of this Act;
(j) tenth, in payment of assessed income tax or income tax and social services contribution, being tax or tax and contribution assessed under any Act or State Act or Ordinance of a Territory of the Commonwealth before the date of the bankruptcy, not exceeding in the whole one year's assessment; and
(k) eleventh, in payment of -
(i) such preferences, priorities or advantages in favour of any creditor or group of creditors as regards any other creditor or group of creditors; and
(ii) such costs, charges and expenses incurred in the interests of creditors before the date of the bankruptcy,
as a general meeting of creditors, by special resolution, resolves.
. . . . . . . . . .
(6) Where property has been recovered or preserved by means of an indemnity for costs of litigation given by any creditor or creditors, the Court may, upon the application of the trustee or a creditor, make such order as it thinks just and equitable with respect to the distribution of the proceeds of that property with a view to giving the indemnifying creditor or creditors an advantage over other creditors in consideration of the risk of giving them the indmenity."
Section 221P of the Income Tax Assessment Act provides as follows: -
"221P.(1) Where an employer makes a deduction for the purposes of this Division, or purporting to be for those purposes, from the salary or wages paid to an employee and fails to deal with the amount so deducted in the manner required by this Division, or to affix tax stamps of a face value equal to the amount of the deduction as required by this Division, as the case may be, he shall be liable, and where his property has become vested in, or where the control of his property has passed to, a trustee, the trustee shall be liable, to pay that amount to the Commissioner.
(2) Notwithstanding anything contained in any other Act or State Act, an amount payable to the Commissioner by a trustee in pursuance of this section shall have priority over all other debts, whether preferential, secured or unsecured.
(3) Where a trustee, being the trustee of the estate of a bankrupt or the liquidator of a company that is being wound up, is liable to pay an amount to the Commissioner in pursuance of this section, the last preceding sub-section does not operate so as to make that amount payable in priority to any costs, charges or expenses of the administration of the estate or of the winding-up of the company (including costs of a creditor or other person upon whose petition the sequestration order or the winding-up order, if any, was made and remuneration of the trustee) that are lawfully payable out of the assets of the estate or of the company except where, in the case of the winding-up of a company, the Crown in right of a State or any other creditor is entitled to payment of a debt by the liquidator in priority to all or any of those costs, charges and expenses and has not waived that priority."
In the Bankruptcy Act 1924, section 84 dealt with the priority of debts. It provided by sub-section (1) that the estate of a bankrupt should be applied in the order therein prescribed. Sub-section (2) read as follows: -
"(2.) Where assets in any estate have been recovered by means of an indemnity for costs of litigation given by certain creditors, the Court may make such order as it deems just with respect to the distribution of those assets with a view to giving the indemnifying creditors an advantage over others in consideration of the risk run by them in giving them the indemnity."
In 1942 section 221 of the Income Tax Assessment Act was introduced and obliged a person who was a trustee within the meaning of the Bankruptcy Act to apply the estate of the bankrupt in payment of tax due thereunder (whether assessed before or after the date on which he became a bankrupt) in priority to all other unsecured debts other than debts of the classes specified in paragraphs (a), (d) or (e) of sub-section (1) of s.84 of that Act.
The operation of section 221 was considered in the 1962 Report of the Committee appointed by the Attorney-General to Review the Bankruptcy Law of the Commonwealth, under the chairmanship of Sir Thomas Clyne, Federal Judge in Bankruptcy.
The report included the following passages (at pages 35-39) : -
"The enactment of this overriding priority came into force in 1942 and was then expressed to be what might be described as a war measure. It is now an enactment expressed to be for the better securing to the Commonwealth of the revenue required for the purposes of the Commonwealth.
There are innumerable instances where creditors have taken steps to obtain sequestration orders against debtors only to find that such assets of the debtor as have been realized have gone to the Commissioner of Taxation. An outstanding illustration of the effect of section 221 is afforded by Re Redman: Ex parte the Official Receiver (1948) 16 A.B.C. 90. In this case, the only asset in the estate of the bankrupt was one that had been recovered by means of an indemnity for costs of litigation given by certain creditors other than the Commissioner of Taxation. Two creditors had given unlimited indemnities for the costs of proceedings by the Official Receiver to recover the asset concerned and had paid 60 towards costs. Proceedings were commenced, but the claim of the Official Receiver was settled and he was paid 300 and costs. The Official Receiver applied under section 84(2.) of the Bankruptcy Act for an order to distribute the balance, after payment of the costs of the petitioning creditor and of the administration, between the indemnifying creditors. It was held that, by virtue of section 221(1)(b)(i) of the Income Tax and Social Services Contribution Assessment Act the asset had to be applied in payment of tax due under that Act in priority to the debts of the indemnifying creditors.
Section 84(1.)(h) of the Bankruptcy Act has been the subject of judicial consideration. In Deputy Federal Commissioner of Taxation v. Stranger (1934) 50 C.L.R.468 the High Court held that, where there are unpaid assessments for more years than one, the priority of payment conferred by section 84 (1)(h) extends to an amount equal to but not exceeding the amount of the largest of such assessments.
Under a corresponding provision in the English Act of 1914 the Court of Appeal came to a similar conclusion. In Re Pratt: Ex parte Inland Revenue Commissioners v. Phillips, (1951) Ch.225; (1950) 2 All ER 994, the Court of Appeal held that the Crown was entitled to select any fiscal year before the date of the receiving order and to claim priority for taxes assessed in respect of that year. The Court of Appeal reversed the decision of the Divisional Court, which had held that the only right of priority given to the Crown was in respect of the last appropriate fiscal year immediately before the receiving order.
The provision in the English Act corresponding to section 84 (1.)(h) has been the subject of adverse comment. It has been said that the Crown, by putting forward a large unpaid assessment several years old, may deprive the ordinary creditors of any dividend and that where this arises ordinary creditors tend to lose interest in an administration from which they cannot benefit. It is also said that the Crown's privilege may be regarded as unfair in that the bankrupt has been permitted to enjoy 'false credit' in respect of the arrears of tax. The United Kingdom Committee, in its report, after referring to the fact that many witnesses were in favour of the total abolition of priority for taxes and rates said -
'Whilst there is much to be said for that view, we appreciate that, since both taxes and rates are in effect debts due to the community, there is some justification for claiming that they should take priority over debts due to the individual. We are however greatly impressed by the unfortunate position that often arises in bankruptcy where an unsuspected and large claim for income tax incurred during some year prior to the bankruptcy is established by the Revenue and is so great as to swallow the whole of what was considered by the creditors to be a satisfactory sum available for distribution amongst them.'
Many schemes were suggested to and considered by the United Kingdom Committee for reducing, but not abolishing, the priority of the Inland Revenue for the preservation of which in some shape or form there was, in the opinion of the Committee, a good case. The Committee ultimately reached the conclusion that the simplest and best method of dealing with the matter would be to retain the Inland Revenue's right in its existing form but to limit its choice to one of the last two complete fiscal years preceding the receiving order, thus giving effect, with that important limitation, to the views of the Divisional Court in Pratt's Case.
Upon this question of priority for tax the Committee considered it advisable to have the benefit of a discussion with a senior officer of the Treasury and a senior officer representing the Commissioner of Taxation. Mr. Hewitt of the Department of the Treasury and Mr. Cain, a Second Commissioner of Taxation, attended before the Committee for this purpose. Mr. Hewitt considered that whatever priority the Crown now had should be retained. Mr. Cain said that his experience and the inquiries he had made showed that the position would be little, if any, more favorable to the general body of creditors if the Commissioner's priority were restricted to the one allowed under section 84(1)(h) of the Bankruptcy Act. There had been an attempt to estimate the amount of money the Commissioner received by the operation of section 221 of the Income Tax and Social Services Contribution Assessment Act over and above what he would have received if that section had not been enacted, but it was practically impossible to give any figure. The effective value of the section 221 priority in terms of cash was thought by the Commissioner to be comparatively small. Mr. Cain expressed the view that the greatest value of the section 221 priority was its moral value.
Mr. Cain was fully aware of the difficulty that the creditors of a debtor were faced with in obtaining information from the Commissioner of Taxation concerning the liability of the debtor for tax, which the Commissioner is forbidden by law to divulge, and of the fact that a petitioning creditor frequently discovers too late that the debtor has a substantial liability for income tax that brings section 221 into operation.
It appears that, while comparatively little advantage accrues to the Revenue under section 221(1.)(b)(i) of the Income Tax and Social Services Contribution Assessment Act the section can work unfairly against individual creditors. The Committee, therefore, desires to express the strong opinion that the priority for income tax should be only such as is at present provided by section 84(1)(h) of the Bankruptcy Act, and that therefore section 221(1.)(b)(i) of the Income Tax and Social Services Contribution Assessment Act should be repealed."
Despite the strong opinion of the Committee, section 221 was to live on until, in Act No. 134 of 1980, it was repealed by section 5 with effect from 1 November 1979. The Bankruptcy Amendment Act 1980, No. 12 of that year, provided by section 51 for the repeal of section 109 of the Bankruptcy Act 1966 and the substitution of a new section 109 from which the Crown priority in respect of income tax and social service contribution was omitted.
However, section 221P, which was introduced by Act No. 63 of 1947, is still with us. As has been noted, sub-section (1) of section 109 of the Bankruptcy Act 1966 is expressed to be "subject to this Act and to sections 221P and 221YU of the Income Tax Assessment Act 1936-1965". Sub-section (6) of section 109 is not so expressed.
Section 109 lays down an order of priority for payments which, in the main, it characterises by reference to the circumstances in which the proposed recipient himself made a payment, as in the case of the deposit lodged by a petitioning creditor (see sub-section (1)(a) and section 48), or incurred a liability, as in the case of a controlling trustee (see sub-section (1)(c)), or had a claim upon the bankrupt (see, for example, sub-sections (1)(f), (g) and (h)). In the main, section 109(1) looks back to situations preceding the date of the bankruptcy.
An exception to this general scheme of the sub-section is found in paragraph (k) which confers upon the creditors in general meeting a power to authorize by special resolution payment of preferences, priorities or advantages and certain costs, charges and expenses. The power so conferred is made subject to review by the Court. Its inclusion in sub-section (1) makes it subject, by the opening words of the sub-section, to sections 221P and 221YU of the Income Tax Assessment Act. Had the legislature intended to make the power of the Court to give indemnifying creditors an advantage over other creditors also subject to those sections, it would have been simple to deal with in the same way as the power in sub-section (k) and include it in sub-section (1) or include the appropriate words in sub-section (6). However, it has chosen not to follow either of these courses. Sub-sec. (6) speaks simply of the Court's being able to make an order "with a view to giving the indemnifying creditor or creditors an advantage over other creditors in consideration of the risk run by him or them in giving the indemnity."
The ordinary and natural meaning of the words of section 109, in my opinion, justifies the conclusion that the power of the Court to give an advantage to indemnifying creditors, unlike the power conferred upon the creditors by sub-section (1)(k), is not subject to sections 221P and 221YU of the Income Tax Assessment Act.
There being, in my opinion, no legislative bar to the application by the Official Receiver, it seems to be a proper case in which to order that in respect of the nett proceeds of the property recovered by means of the indemnity given by the creditors, the indemnifying creditors should be given the advantage over other creditors of having the whole of that sum distributed amongst them, in proportion to the amounts of their respective debts.
It was not necessary for the Deputy Commissioner of Taxation to make his own application, as he was free to raise all his arguments in answer to the Official Receiver's application and obtain the relief he sought in that application, but in any event I would dismiss his application for the reasons already given.
The orders of the Court are :
1. That the following creditors, Messrs. Hargrave Box Woods and Curtis-Smith, Dr. F. X. Lyons, Reinehr Industrial Lease & Finance Pty. Ltd., Mr. R. I. Menzies by his Attorney, T. N. D. Stevens, A. M. & E. T. Barnes, and L. M. Clarke be given the advantage over other creditors of having the whole of the nett proceeds of the property recovered by means of the indemnity given by them distributed amongst them, in proportion to the amounts of their respective debts.
2. That the costs of the Official Receiver of and incidental to his application be taxed and paid by the Deputy Commissioner of Taxation.
3. That the application of the Deputy Commissioner of Taxation be dismissed.
4. That the costs of the Official Receiver of and incidental to the application of the Deputy Commissioner of Taxation be taxed and paid by the Deputy Commissioner of Taxation.
5. That there be a stay of proceedings in respect of these orders for 21 days from this date.
6. That both parties have general liberty to apply.