GST and Insolvency

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Introduction

The introduction of GST added extra tax obligations to both taxpayers and insolvency practitioners appointed to those taxpayers. This paper explains the more common issues arising from the appointment of external administrators and GST. It deals with who is responsible for any GST liability and when that liability will arise. However, the technicalities of GST are best left to tax accountants.

The insolvency of an entity, particularly the vesting of assets in a bankruptcy trustee, does not automatically give rise to any GST consequences or liabilities as there has been no "taxable supply" by any party. But, the appointment of an external administrator does change the status of the entity for GST purposes, and the practitioner will assume some of the taxpayer's responsibilities. They also must start reporting for GST in his or her own right.

These rules are governed by the A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999.

The Incapacitated Entity

What is an incapacitated entity?

An entity (the taxpayer) becomes an incapacitated entity and an external administrator becomes a "representative of the incapacitated entity" upon any of the following types of appointments to the taxpayer:

Bankruptcy
Controlling Trusteeship
Liquidation
Receivership (even if only appointed over some of the assets)
Voluntary Administration
Executing a Deed of Company Arrangement

An incapacitated entity is defined (section 195-1 of the Act) as:

incapacitated entity means:
(a) an individual who is a bankrupt; or
(b) an entity that is in liquidation or receivership; or
(c) an entity that has a representative.

The catch all part of that definition is 'an entity that has a representative'. This effectively includes all other insolvency type appointments that are not bankruptcies, liquidations or receiverships. A 'representative' of the incapacitated entity is also defined in section 195-1 as:

representative means:
(a) a trustee in bankruptcy; or
(b) a liquidator; or
(c) a receiver; or
(ca) a controller (within the meaning of section 9 of the Corporations Act 2001 ); or
(d) an administrator appointed to an entity under Division 2 of Part 5.3A of the Corporations Act 2001 ; or
(e) a person appointed, or authorised, under an Australian law to manage the affairs of an entity because it is unable to pay all its debts as and when they become due and payable; or
(f) an administrator of a deed of company arrangement executed by the entity.

Nearly all formal appointments over the financial affairs of a person or company are likely to convert that entity into an incapacitated entity and require the registration of the representative with the Australia Taxation Office. The appointment makes the representative (the practitioner) a new entity for GST purposes. Registration of the representative for GST purposes will be required if the incapacitated entity is, or was required to be, registered for GST purposes.

Two registrations

There are two parts to the registration process. The first is the registration of the representative of the incapacitated entity to advise the ATO that a representative has been appointed. The second is registration of the representative for GST if that is required. Registration for GST is necessary regardless of whether the entity is expected to exceed the turnover limits after the appointment, if the entity was or should have been registered before the appointment.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.20
Representatives are required to be registered
(1) A representative of an incapacitated entity is required to be registered in that capacity if the incapacitated entity is registered or required to be registered.
(2) This section has effect despite section 23-5 (which is about who is required to be registered).

The representative may not have any GST responsibilities if the incapacitated entity did not have any - for example: a consumer bankruptcy. If there is a requirement to for the representative to register for GST, the representative must lodge returns in their own right and report various matters to the Australia Taxation Office.

In fact, if the ATO must cancel the representative's GST registration if they believe that they do not need to be so registered: section 58.25 "The Commissioner must cancel the registration of a representative of an incapacitated entity if the Commissioner is satisfied that the representative is not required to be registered in that capacity".

In summary, if the entity becomes incapacitated

(a) The practitioner becomes the representative of the incapacitated entity, and becomes a new tax entity in his or her own right. They must register with the ATO as the representative of the incapacitated entity;
(b) If the incapacitated entity was or should have been registered for GST, the representative must register for GST.

The registration as a representative of the incapacitated entity ends when the appointment ends. The practitioner (the liquidator or trustee etc.) simply has to notify the Commissioner to cancel the registration. The practitioner must notify the commissioner within 21 days after ceasing to be a representative.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.30
Notice of cessation of representation
A representative who ceases to be a representative of an incapacitated entity must notify the Commissioner of that cessation, in the approved form, within 21 days after so ceasing.

Tax Periods and Lodgements

How does the appointment of a representative affect tax periods?

Most insolvency appointments happen during a financial year, not June 30. The current tax period for the incapacitated entity is deemed to have ended on the day before the appointment. A new tax period commences on the day of the appointment.

Final returns should be lodged for GST purposes as at the date of the appointment and the ATO will calculate the outstanding debt, if any. The new tax period (deemed to have started at the date of the appointment) will end on the date that the normal tax period would have ended and returns will have to be lodged separately for that period. That is, the tax period is divided into two periods at the date of appointment.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 27.39
Tax periods of incapacitated entities
(1) If an entity becomes an incapacitated entity, the entity's tax period at the time is taken to have ended at the end of the day before the entity became incapacitated.
(2) If a tax period (the first tax period ) ends on a particular day because of subsection (1), the next tax period starts on the day after that day and ends when the first tax period would have ended but for that subsection.

The representative also has a tax period. It begins on the date of appointment (the date of the new divided tax period described above)and each period has the same start and end dates as the incapacitated entity - so the initial tax period is likely to be shorter than a normal tax period unless the appointment happened to occur on the first date of a tax period..

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.35
Tax periods of representatives
(1) If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity.
(2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply).

The obligations of the representative end when the appointment ends, but the entity may or may not continue in existence after that date. The Act provides that the entity will have a concluding tax period (its tax obligations will end) when it dies (in the case of a person) or ceases to exist (in the case of other business entities).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 27.40
An entity's concluding tax period
(1) If:
(a) an individual dies; or
(b) another entity for any reason ceases to exist;
the individual's or entity's tax period at the time is taken to have ceased at the end of the day before the death or cessation.
(1A) If an entity ceases to carry on any enterprise, the entity's tax period at the time is taken to have ceased at the end of the day on which the cessation occurred.
(2) If an entity's registration is cancelled, the entity's tax period at the date of effect of the cancellation (the cancellation day) ceases at the end of the cancellation day.

It is unlikely that this provision will have much effect on a bankruptcy trustee (even if they are required to be registered for GST purposes) as the bankrupt is likely to survive the bankruptcy process. Companies in liquidation on the other hand, usually are deregistered upon the cessation of the liquidation.

Who must lodge the BAS?

The Act provides that the representative (who is registered for GST) must lodge returns in each tax period regardless of whether there has been any activity or any amount of GST to pay or refund to be received.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 31.5
Who must give GST returns
(1) If you are registered or required to be registered, you must give to the Commissioner a GST return for each tax period.
(2) You must give the return whether or not:
(a) your net amount for the tax period is zero; or
(b) you are liable for the GST on any taxable supplies that are attributable to the tax period.

The practical effect is that the representative will usually control the financial affairs of the incapacitated entity after the appointment and will report the GST consequences on transactions done after that appointment. The intention is to pass any post-appointment GST responsibility to the representative while they are in control. Some appointments (for example: administrator of a deed of company arrangement) do not leave the representative in control of the entity and it may have a requirement to do its own reporting. In these cases, the entity will have to lodge a BAS itself and the representative will lodge one for his transactions.

If the entity or representative is required to be registered for GST purposes, an obligation to commence lodging returns commences on the appointment, regardless of how the representative has been appointed.

Who is liable for the GST?

The Act was altered to clarify who was responsible for GST debits and credits and whether the entity or the representative would be liable for the GST payable. The short answer is that the representative is liable for the tax consequences of transactions that were entered into during their appointment, regardless of the capacity of their appointment.

Unfortunately and adding some confusion, in describing the position the Act refers to the representative (the insolvency practitioner) as 'the entity' and the incapacitated entity as 'the other entity'.

This is achieved in a two step process. The first step is making the entity responsible (deem the transactions were done by the entity) for all supplies and acquisitions etc. The intention is to ensure that the GST consequences that arise while the representative is acting are the same as consequences as if they were done by the entity.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.5
General principle for the relationship between incapacitated entities and their representatives
(1) Subject to this Division, any supply, acquisition or importation by an entity in the capacity of a representative of another entity that is an incapacitated entity is taken to be a supply, acquisition or importation by the other entity.

The section will continue to apply if the entity ceases to be an incapacitated entity and the representative resigns meaning that the incapacitated entity will be liable for further GST liabilities based on transactions that occurred while it was incapacitated.

(3) To avoid doubt, if the other entity ceases to be an incapacitated entity, this section continues to apply in relation to the supply, acquisition or importation, or to the act or omission, after the other entity ceases to be an incapacitated entity.

A further effect of the section is to ensure that the entity will be liable for, or entitled to, any GST consequences of transactions entered into during the period of the representative's appointment.

The second step is to make the representative liable to pay the GST that the entity would be liable to pay - as far as that liability "is within the scope of the representative's responsibility or authority for managing the incapacitated entity's affairs".

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.10
Circumstances in which representatives have GST-related liabilities and entitlements
General rule
(1) A representative of an incapacitated entity:

(a) is liable to pay any GST that the incapacitated entity would, but for this section or section 48-40, be liable to pay on a taxable supply or a taxable importation; and
(b) is entitled to any input tax credit that the incapacitated entity would, but for this section or section 48-45, be entitled to for a creditable acquisition or a creditable importation; and
(c) has any adjustment that the incapacitated entity would, but for this section or section 48-50, have;

to the extent that the making of the supply, importation or acquisition to which the GST, input tax credit or adjustment relates is within the scope of the representative's responsibility or authority for managing the incapacitated entity's affairs.

Appointments that do not give the representative the "responsibility or authority" to make transactions, like a deed of company arrangement appointment that does include such powers, will not give rise to personal liability for GST transactions. But if the representative enters into the transaction, they will be liable for the GST consequences.

The representative is not liable when the supply or acquisition occurred before the representative became the representative of the incapacitated entity.

(2) This section does not apply to the GST payable on a taxable supply to the extent that one or more of the following apply:

(a) the incapacitated entity received the consideration for the supply before the representative became a representative of the incapacitated entity;
(b) if, under Division 83 or 84, the GST is payable by the recipient of the supply--the incapacitated entity provided the consideration for the supply before the representative became a representative of the incapacitated entity;
(c) if:

(i) the supply is a supply for which a voucher to which Division 100 applies is redeemed; and
(ii) the incapacitated entity supplied the voucher before the representative became a representative of the incapacitated entity;

the consideration for the supply referred to in subparagraph (i) does not exceed the consideration provided for the incapacitated entity's supply of the voucher.

(3) This section does not apply to an input tax credit for a creditable acquisition to the extent that the incapacitated entity provided the consideration for the acquisition before the representative became a representative of the incapacitated entity.

These provisions end the argument of who is responsible for GST transactions. The entity is responsible, but the representative is liable if they entered into the transaction. The representative has to lodge returns at the same time as the entity, but the commencement date of the first period will depend on the appointment date.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.35
Tax periods of representatives 
(1) If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity.
(2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply).

It is possible that two BASs should be lodged for an entity. Take, for example, a deed of company arrangement where the deed administrator files a BAS for tax consequences under the administration of the deed, and the company trades under its own right and lodges its own BAS each period. Each entity will only report its own transactions on their own BAS.

Adjustments to Pre-Appointment GST Liabilities

Adjustments to pre-Appointment GST Liabilities

In many insolvent estates, the ATO has an outstanding debt for GST. Some adjustments may be required to the GST consequences of pre-appointment transactions that may cause the ATO to increase or decrease their outstanding debt. These are called "increasing" or "decreasing" adjustments.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 19.10
Adjustment Events
(3) An adjustment event:
(a) can arise in relation to a supply even if it is not a taxable supply; and
(b) can arise in relation to an acquisition even if it is not a creditable acquisition.

The two most common adjustments under accrual accounting relate to the GST consequences from;

(1) the non-collection of debtors where GST has been paid before the appointment (decreasing adjustment); and
(2) adjustments to taxable credits due to the non-payment of creditors through a dividend where GST has been claimed pre-appointment (increasing adjustment).

Further, if a representative accounts on an accrual basis, the GST effects of transactions entered into by the entity that occurred before the appointment of the representative may be attributed to the first tax period of the representative.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.40
Effect on attribution rules of not accounting on a cash basis
(1) If:

(a) a representative of an incapacitated entity does not account on a cash basis; and
(b) because of section 58-10, all or part of the amount of GST payable on a taxable supply is payable by the representative, or the representative is entitled to all or part of the input tax credit for a creditable acquisition

then, to the extent that, but for this section, the GST or input tax credit would be attributable to a tax period that ended before the representative became a representative of the incapacitated entity, the GST or input tax credit is instead attributable to the first tax period applying to the representative in that capacity.

(2) This section has effect despite sections 29-5 and 29-10 (which are about attribution of GST on taxable supplies and of input tax credits for creditable acquisitions).

Writing off bad debts

It is not uncommon for practitioners to write off pre-appointment debtors as uncollectable. There can be numerous reasons for this to occur. It is also possible that the insolvent entity has accrued these debts before the appointment and may have paid or accrued GST on them. If these debtors are written off, the GST on those debts should in theory be refunded. In practice they are deducted off the GST debt outstanding.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 21.5
Writing off bad debts (taxable supplies)
(1) You have a decreasing adjustment if:
(a) you made a taxable supply; and
(b) the whole or part of the consideration for the supply has not been received; and
(c) you write off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more.

The amount of the decreasing adjustment is 1 / 11 of the amount written off, or 1 / 11 of the amount that has been overdue for 12 months or more, as the case requires.

(2) However, you cannot have an adjustment under this section if you account on a cash basis.

The Act clarifies that the adjustment cannot be made if the representative accounts on a cash basis.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 58.15
Adjustments for bad debts
(1) For the purposes of determining whether an adjustment arises under section 21-5 or 21-15 for the whole or a part of a debt relating to a taxable supply or creditable acquisition for which a representative of an incapacitated entity is liable to pay GST, or is entitled to an input tax credit, under section 58-10:

(a) the adjustment cannot arise if, when the whole or part of the debt is written off, or has been overdue for 12 months, the representative accounts on a cash basis; but
(b) it does not matter whether the incapacitated entity accounts on a cash basis at that or any other time.

(2) This section has effect despite subsections 21-5(2) and 21-15(2) (which preclude adjustments for bad debts when accounting on a cash basis).

Non-payment of creditors

Unless there are sufficient assets to pay all creditors in full - which is a rarity - there will be some part of creditor's debts that will go unpaid. If the insolvent entity has claimed the GST on these creditor amounts before the appointment, they will in theory have to be refunded to the ATO to the extent that the creditors were unpaid. In practice the GST liability to the ATO increases.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 21.15
Bad debts written off (creditable acquisitions)
(1) You have an increasing adjustment if:
(a) you made a creditable acquisition for consideration; and
(b) the whole or part of the consideration is overdue, but you have not provided the consideration overdue; and
(c) the supplier of the thing you acquired writes off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more.

The amount of the increasing adjustment is 1 / 11 of the amount written off, or 1 / 11 of the amount that has been overdue for 12 months or more, as the case requires.

(2) However, you cannot have an adjustment under this section if you account on a cash basis.

The two most common adjustments under cash reporting system relate to the GST consequences from;

(1) the collection of debtors where GST has not been paid before the appointment (increasing adjustment); and
(2) adjustments due to the payment of creditors through a dividend where GST has not been claimed pre-appointment (decreasing adjustment).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 19.40
Where adjustments for supplies arise
You have an adjustment for a supply for which you are liable to pay GST (or would be liable to pay GST if it were a taxable supply) if:
(a) in relation to the supply, one or more adjustment events occur during a tax period; and
(b) GST on the supply was attributable to an earlier tax period (or, if the supply was not a taxable supply, would have been attributable to an earlier tax period had the supply been a taxable supply); and
(c) as a result of those adjustment events, the previously attributed GST amount for the supply (if any) no longer correctly reflects the amount of GST (if any) on the supply (the corrected GST amount ), taking into account any change of circumstances that has given rise to an adjustment for the supply under this Subdivision or Division 21 or 134.

Collection of debtors

Sometimes practitioners will collect amounts from debtors that were billed before the appointment. Under a Cash Accounting system, no GST would have been paid on these amounts. In practice, this payment of the GST is an increasing adjustment to the liability to the ATO.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 19.50
Increasing adjustments for supplies
If the corrected GST amount is greater than the previously attributed GST amount, you have an increasing adjustment equal to the difference between the corrected GST amount and the previously attributed GST amount.

Payment of dividends to creditors

Under the Cash Accounting system, GST is not claimed on supplies from creditors until the payment is made to the creditor. No GST credit will have been allowed for outstanding creditors at the time of the appointment, but will be allowed when a dividend is paid to those creditors. The practitioner will be able to claim the GST on dividends paid by way of a decreasing adjustment to the ATO liability for the amount of the dividend paid to relevant creditors.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECT 19.55
Decreasing adjustments for supplies
If the corrected GST amount is less than the previously attributed GST amount, you have a decreasing adjustment equal to the difference between the previously attributed GST amount and the corrected GST amount.

Summary of Adjustments

The following table sets out the general adjustments required for adjusting events occurring after the appointment for pre-appointment transactions.

Representatives must notify the ATO of increasing adjustments or the representative may become liable for the lost dividends that should have been collected by the ATO. The ATO will then adjust their proof of debt to better reflect their debt on pre-appointment transactions once they know the final result of those transactions.

Summary

The following points provide a summary of these provisions:

(i) The appointment of an external administrator requires that administrator to register as a Representative of an Incapacitated Entity;
(ii) If the incapacitated entity is required to be registered for GST, the representative will be required to register for GST;
(iii) The incapacitated entity's tax year will end on the date of the appointment and a final BAS will have to be filed;
(iv) The representative registered for GST purposes has a responsibility to file BASs during their administration;
(v) The representative will have to notify the ATO of any increasing adjustments due to collection of debtors and payment of partial dividends.

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: 06.05.2011

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