Can the ATO take priority over a mortgagee?

02 October 2012

FCT V PARK – The Decision

You will have already heard about the Full Federal Court decision FCT v Park, in which the court determined that a “statutory garnishee notice” (a notice issued by the ATO under section 260-5 of the Taxation Administration Act 1953) took priority over secured creditors when the secured property is sold and settled by the mortgagor with the mortgagee’s consent.

The court also stated that a mortgagee could:

• Reject a sale if it was unhappy with the remaining sale proceeds after deducting the ATO debt; and
• Sell as mortgagee in possession, in which case the statutory garnishee notice would not take priority.

Look before you leap

The natural and immediate response of a mortgagee in similar circumstances would be to refuse to provide a discharge and proceed to sell as mortgagee in possession. The mortgagee would have to assess whether it is prepared to ride on the back of the mortgagor’s sale campaign and promptly exchange a fresh contract with the existing buyer or alternatively carry out its own sales campaign and only look to exchange contracts at the end of the sales campaign. Ultimately, though, it could mean that the existing buyer will be lost.

This is not a step to be taken lightly, without careful and close consideration of the risks, costs and benefits, namely:

• A mortgagee has a statutory duty to obtain “market value” when conducting a mortgagee sale (section 420A of the Corporations Act). Failure to do so can give rise to costly and protracted litigation with a borrower, loan guarantors or other interested parties. Upon taking possession the mortgagee assumes this statutory duty and would need to be satisfied that the property had been marketed professionally and that the sale was at arms-length;
• It would be prudent for the mortgagee to obtain a valuation to confirm that the sale price is representative of market value; and
• Other impositions on a mortgagee “taking possession” of its security that need to be considered, including:
  • notification of appointment to the ATO and ASIC;
  • insurance;
  • financial and performance reporting to ASIC and accounting for the sale transaction;
  • direct liability for the payment of GST collected on the sale to the ATO; and
  • a mortgagee bearing its own costs of realising its security (unless an agent is appointed to do so).

Mortgagees should only act only after weighing the facts up, which will be different in each case.

Will we see a rise in the issue of S260-5 notices by the ATO?

Are we going to see a rise in the number of “statutory garnishee notices” issued by the ATO? Possibly, but this is uncertain because the process is problematic at best. This is because the ATO must follow the following steps:

1. Establish that a defaulting taxpayer has real estate that they intend to sell;
2. Monitor the taxpayer’s sales efforts;
3. After contracts have exchanged identify the buyer; and
4. Serve a S260-5 notice.

Items 3 and 4 must occur within the settlement period.

The costs to the ATO may be high relative to any possible recovery. However, that is not to say that the ATO won’t have a go. It is important to note that the ATO has stronger investigative powers than ordinary creditors. The ATO can require taxpayers to inform them about the imminent sale of property by means which are not available to an ordinary creditor.

Could we see a rise in other creditors pursuing garnishee orders?

It is unlikely. The ATO’s position differs from other creditors. The ATO is exempt from challenge on “preference” grounds to its recovery in respect of “statutory garnishee notices”. Any other creditor that took the same steps would surely face a recovery claim by a subsequent liquidator or bankruptcy trustee.

Can I do anything to minimise this risk now?

When dealing with a distressed borrower, we would recommend that a mortgagee takes the following steps prior to consenting to the sale of its security:

1. Ascertain whether the mortgagor has outstanding liabilities with the ATO. This will confirm whether or not any risk relating to this issue exists. If the risk is present, you need to take a more active interest in the asset sale.
2. Review the sales agency agreement. This will identify the agent(s) and the commission payable on sale;
3. Review the contract terms, conditions and warranties. This will provide the basis for deciding whether to enter into an identical contract with the existing buyer if that is possible, after the original contract is rescinded;
4. Monitor the sales program. This will yield information concerning the depth of the market, the interested parties and the offer range; and
5. Make enquiries of an independent valuer in relation to market value in case you need to step in and exercise your rights, at which time you should obtain an updated valuation report.

If action by the ATO is looming, the appointment of an administrator or receiver may be advisable. This would likely render a later section 260-5 notice ineffective.

How can I avoid this risk in the future?

When providing new loans, we would recommend that a mortgagee satisfies itself in relation to ATO liabilities before advancing funds and imposes the following ongoing loan covenant, to enable monitoring of ATO liabilities:

“The borrower, mortgagor and guarantors must provide up to date financial statements, tax returns and business activity statements (if required) annually and within 14-days of any request.” This will identify any potential liabilities to the ATO (particular interest should be taken of the mortgagor’s position).

During the course of any loan it is important to monitor performance. Financial and tax information should always be obtained and reviewed and repayment of GST loan provisions should be monitored. Above all, stay close to your customer.

For more information please contact us.