Taxing capital gains made during liquidation

Asset sales during a winding up, receivership or administration may give rise to a capital gain as defined in Australia’s tax laws (mainly the Income Tax Assessment Act 1997).

The possibility that a post-appointment tax debt may arise as a result, and that such a debt may have a right to payment ahead of other creditors (even secured and preferential creditors), is a cause for concern to insolvency practitioners.

I wrote a little on this subject in my article titled “Post-appointment income tax debts of liquidator”  (published on this blog on 10/10/2010).

At that time I was not sure whether revenue losses accumulated at the date of the liquidator’s appointment could be offset against a “net capital gain” made post-appointment.

I said:

“Ordinarily, an insolvent company would have revenue tax losses at the date of the liquidator’s appointment.  In most cases these would be available as a tax deduction against any net revenue income made during the liquidation period. But the same may not be true for net capital gains in this period.”

Since then I have obtained some expert advice, which is as follows:

1. A “net capital gain”  forms part of a company’s “assessable income”. (See ITAA 1997, Chapter 3, Part 3-1, Division/Section 102-5.)

2. An excess tax loss of an earlier year may be deducted from the assessable income of a current year. (See ITAA 1997, Chapter 2, Part 2-5, Division/Section 36-17.)

So it appears what I should have said is: revenue tax losses at the date of the liquidator’s appointment would be available as a tax deduction against any net revenue income made during the liquidation period and any net capital gains made during the liquidation period.

Although under these rules the chances of post-appointment tax debts arising would probably be reduced – as would the size of such a debt should it arise – it remains important that insolvency practitioners be aware of tax laws and the need to prepare income tax returns.

As to the remaining questions of  (a) where a post-appointment tax debt would rank in priority on the Corporations Act 2001, and (b) whether the insolvency practitioner may be held personally liable for it under Section 254 of the Income Tax Assessment Act 1936, we will have to await further developments.

The Insolvency Practitioners Association of Australia (IPA) has been discussing these issues with the Australian Taxation Office (ATO).  However, the correspondence between the two is not publicly available.

It appears that the ATO is seeking advice from Senior Counsel.

The IPA may also be considering running a test case in court.