CGT and Insolvency
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Overview
One of the roles of an external administrator is the realization of asset owned by the insolvent. The sale of some of these assets could create a liability under the Capital Gains Tax legislation when they are sold. This is a factor that the external administrator will be concerned about, at least to a limited extent.
There are three main issues with Capital Gains Tax and Insolvent estates:
1. Who is responsible for Capital Gains realized after the appointment of an external administrator?
2. What happens to Capital Losses available at the date of the appointment?
3. Holding companies when a solvent wholly-owned subsidiary is wound up
This paper contains links to legislation. These will open in a separate window. Most of the legislation shown in this paper is only a summary or extract of the entire section. The links go to the entire section.
1. Who is responsible for Capital Gains realized after the appointment of an external administrator?
The Income Tax Assessment Act 1997 (ITAA (1997)) includes provisions that deal with insolvent estates and capital gains, at least where the estate is a bankruptcy, a liquidation or a secured creditor taking action under a security.
These provisions state that any actions or realizations taken by:
(a) bankruptcy trustees and Part X trustees;
(b) liquidators; and
(c) other people formally acting under a security;
that lead to a capital gain tax liability are deemed to have been done by the company, bankrupt or debtor; and not by the external administrator. This means that the external administrator is not made personally liable for any CGT liability. It places that liability on the entity that originally owed the asset.
This process starts by looking at the 'vesting' or otherwise of the asset. The legislation states that the vesting of assets in a bankruptcy or liquidation, or the providing or redeeming of a security is not a disposal of a CGT asset and the beneficial owner (the estate) does not change. This is set out in section 104.10.
INCOME TAX ASSESSMENT ACT 1997 - SECT 104.10
Disposal of a CGT asset: CGT event A1
(7) CGT event A1 does not happen if the disposal of the asset was done:
(a) to provide or redeem a security; or
(b) because of the vesting of the asset in a trustee under the Bankruptcy Act 1966 or under a similar foreign law; or
(c) because of the vesting of the asset in a liquidator of a company, or the holder of a similar office under a foreign law.
Bankruptcy
The ITAA (1997) confirms that the "the vesting of the individual's CGT assets in the trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored" in relation to CGT. The provisions related to bankruptcy are:
INCOME TAX ASSESSMENT ACT 1997 - SECT 106.30
Effect of bankruptcy
(1) For the purposes of this Part and Part 3-3, the vesting of the individual's * CGT assets in the trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored.
(2) This Part and Part 3-3 apply to an act done in relation to a CGT asset of an individual in these circumstances as if it had been done by the individual:
(a) as a result of the bankruptcy of the individual by the Official Trustee in Bankruptcy or a registered trustee, or the holder of a similar office under a foreign law;
(b) by a trustee under a personal insolvency agreement made under Part X of the Bankruptcy Act 1966, or under a similar instrument under a foreign law;
(c) by a trustee as a result of an arrangement with creditors under that Act or a foreign law.
This section has two effects for CGT and bankruptcy.
Firstly the vesting of property in the trustee is not deemed to be a disposal of the asset, so there is no capital gain tax liability automatically formed from the vesting of assets. Secondly, any acts of the trustee under a Part IV bankruptcy, Section 73 arrangement or Part X Personal Insolvency Agreement that give rise to a CGT liability are deemed to have been done by the individual (the bankrupt or debtor) and not the trustee.
Liquidations
This section provides that any act by a liquidator that accrues a capital gain is deemed to be an act of the company and not the liquidator, therefore no personal liability will pass to the liquidator.
INCOME TAX ASSESSMENT ACT 1997 - SECT 106.35
Effect of liquidation
This Part and Part 3-3 apply to an act done by a liquidator of a company, or the holder of a similar office under a foreign law, as if the act had been done instead by the company.
Secured Creditors
This section deems that acts done by people appointed under security documents, or that hold and act under security documents, that accrue a capital gain are done by the entity that gave the security, not the entity that exercises the security or an controller appointed to assist the mortgagee.
INCOME TAX ASSESSMENT ACT 1997 - SECT 106.60
Acts by security holders
This Part and Part 3-3 apply to an act done by an entity (or an agent of the entity) in relation to a CGT asset for the purpose of enforcing or giving effect to a security, charge or encumbrance the entity holds over the asset as if the act had been done instead by the person who provided the security.
One further point is that exercising a security or the appointment of a receiver or agent does not change the ownership of the asset and does not accrue a CGT liability as ownership of the asset does not change. Controllers of property usually only act as agents as the owner of the assets, with powers to sell under the security. The only thing that does change is the right of the security holder to actually sell the asset on behalf of the debtor. It is only the disposal (sale) of that asset that may create a CGT liability.
Summary
Two points are relevant to the external administrator:
1. The appointment of an liquidator, trustee, or controller; or the vesting of property; or the exercising of a security does not create a deemed acquisition or deemed disposal of a CGT asset. Without another disposal of the asset, no CGT liability will accrue to any party.
2. The eventual disposal of the CGT asset does not create a personal liability for the external administrator. The liability will accrue to the individual or company.
Where a capital gain arises that would lead to a tax liability, the insolvency practitioner will advise the ATO. The ATO will then lodge a proof of debt in the estate for that liability.
What about Voluntary Administrators?
The position is slightly different legally, but ends with the same result. The Corporations Act provides that a voluntary administrator acts as the agent of the company and not, effectively, in his own right. Any CGT debt arising during that period will be a company debt, not a debt of the Administrator. Any CGT liability is not a debt incurred by the Voluntary Administrator, so they are not personally liable for it. This position is very similar to that of entities holding security over assets.
CORPORATIONS ACT 2001 - SECT 437B
Administrator acts as company's agent
When performing a function, or exercising a power, as administrator of a company under administration, the administrator is taken to be acting as the company's agent.
Administrators of deeds of company arrangements are also usually protected. Most deed administrators simply act as a manager of a bank account and enforcer of the provisions of the deed. Rarely will a deed administrator control the trading and other actions of a company under a deed that lead to realizations.
Trading is generally done directly by the company, or with the deed administrator acting as agent of the company under the provisions of the deed.
2. What happens to Capital Losses available at the date of the appointment?
The procedure for calculating capital gains for tax purposes for individuals is set out in section 102-5 of the ITAA(1997). Two events occur that eliminate past CGT losses:
1. A person is not entitled to bring forward any capital losses from prior years into a year in which he or she became a bankrupt or was released from their debts or later year. This only relates to people becoming bankrupt, not to companies.
But the provision works twice, once when the person is made a bankrupt, and then again usually three years later when they are released from their debts at discharge.
2. A person is not entitled to bring forward any capital losses into a year in which another event occurs when they are released from their debts under a law relating to bankruptcy. This will occur at the end of the bankruptcy or the end of a Part IX, Part X or section 73 arrangement.
Any capital losses accrued before the bankruptcy or other appointment will be lost at the end of that administration.
The timing factor of either becoming a bankrupt (the commencement of the bankruptcy) and the release of debts (usually at the end of a bankruptcy or the agreement) may have to be taken into consideration.
(a) you became bankrupt; or
(b) you were released from debts under a law relating to bankruptcy;
any net capital loss you made for an earlier income year must be disregarded in working out whether you made a net capital gain for the income year or a later one.
Annulments of bankruptcies eliminate the bankruptcy. Annulments obtained by payment of debts (section 153) or through the Court will reinstate these losses as there is no bankruptcy and no release of debts - they are paid. Annulments obtained through section 73 proposals and the release of debts attached to the through section 74 are excluded as there still is a release of debts, and the CGT losses will be lost.
INCOME TAX ASSESSMENT ACT 1997 - SECT 102.5
Assessable income includes net capital gain
(3) Subsection (2) applies even though your bankruptcy is annulled if:
(a) the annulment happens under section 74 of the Bankruptcy Act 1966 ; and
(b) under the composition or scheme of arrangement concerned, you were, will be or may be released from debts from which you would have been released if instead you had been discharged from the bankruptcy.
There appears to be no such provision for a company entering into liquidation. There is generally no real need for these provisions as the life of the company will come to an end at the conclusion of the liquidation and there will be no chance to use any accrued CGT losses 'after a liquidation'.
There is no statutory provision dealing with the availability of losses to a company that is subject to a deed of company arrangement, so it is expected that any losses would be available to offset against any capital gains made by the company realizing assets (or by the deed administrator acting as agent of the company).
It is possible that the ATO will argue the same policy as the bankruptcy provisions set out above, if the company will continue in existence after the conclusion of the deed of company arrangement, or will only allow losses in the same percentage as dividends paid to the ATO and a release of some of that debt.
3. Holding companies when a solvent wholly-owned subsidiary is wound up
The first thing to note is that the subsidiary being would up must be solvent. The ITAA(1997) gives specific tax relief in the case of a holding company receiving an asset (a roll-over of an asset) from the liquidator of a subsidiary that is in a Members Voluntary Winding Up. That relief may only be a reduction of the CGT, not an entire exemption.
This is partially due to the fact that, as the liquidated company is solvent, the ATO will be paid all outstanding tax liabilities by that company and there will be no release of debts. This CGT relief only applies if the roll-over of the asset was transferred in relation to the cancellation of the shareholding in the 100% owned subsidiary that is being wound up. The holding company get the asset in consideration for the cancellation of the shares.
INCOME TAX ASSESSMENT ACT 1997 - SECT 126.85
Effect of roll-over on certain liquidations
(1) A capital gain a company (the holding company ) makes because shares in its 100% subsidiary are cancelled (an example of CGT event C2: see section 104- 25) on the liquidation of the subsidiary is reduced if the conditions in subsection (2) are satisfied. The reduction is worked out under subsection (3).
The capital gain that a holding company makes from the roll-over of the asset because post-CGT shares in its 100% owned subsidiary are cancelled on the liquidation of the subsidiary is reduced only if certain conditions are satisfied.
These conditions are:
(a) There must be a roll-over of at least one "CGT asset" (i.e. acquired on or after 20 September 1985) and the asset must be being disposed of (transferred) by the subsidiary to the holding company in the course of its liquidation;
(b) The disposal must either be part of one of the liquidator's distribution in the course of the liquidation; or have occurred within 18 months of the dissolution of the subsidiary (if they are part of an interim distribution);
(c) The liquidated company must be a 100% owned subsidiary from the time of the disposal until the cancellation of the shares;
(d) The market value of the asset(s) must comprise at least part of the capital proceeds for the cancellation of the shares;
(e) One or more of the shares that were cancelled must have been acquired by the holding company on or after 20 September 1985, that is, they must be post-CGT shares.
The mechanics to calculate this relief is summarized below. Refer to section 126-85 of the ITAA (1997) for complete details.
INCOME TAX ASSESSMENT ACT 1997 - SECT 126.85
Effect of roll-over on certain liquidations
(3) The reduction of the capital gain is worked out in this way.
Method statement
Step 1. Work out (disregarding this section) the sum of the capital gains and the sum of the capital losses the holding company would make on the cancellation of its shares in the subsidiary.
Step 2. Work out (disregarding this Subdivision):
(a) the sum of the capital gains the subsidiary would make on the disposal of its CGT roll-over assets to the holding company; and
(b) the sum of the capital losses it would make except for Subdivision 170-D on the disposal of its CGT assets to the holding company;
in the course of the liquidation assuming the capital proceeds were the assets' market values at the time of the disposal.
Step 3. If, after subtracting the sum of the capital losses from the sum of the capital gains, there is an overall capital gain from step 1 and an overall capital gain from step 2, then continue. Otherwise there is no adjustment.
Step 4. Express the number of post-CGT shares as a fraction of the total number of shares the holding company owned in the subsidiary.
Step 5. Multiply the overall capital gain from Step 2 by the fraction from Step 4.
Step 6. Reduce the overall capital gain from Step 1 by the amount from Step 5. The result is the capital gain the holding company makes from the cancellation of its shares in the subsidiary.
Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information
provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.
Last Updated: 19.04.2011
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