New South Wales Supreme Court Hamilton & 2 Ors v DCT [2005] NSWSC 229 CITATION : This decision has been amended. Please see the end of the judgment for a list of the amendments. HEARING DATE(S) : 3 November 2004 JUDGMENT DATE : 23 March 2005 JURISDICTION : Common Law Division JUDGMENT OF : Master Harrison DECISION : (1) The appeal is dismissed; (2) The decision of Magistrate Price dated 23 April 2004 is affirmed; (3) The summons filed 21 May 2004 is dismissed; (4) Costs are reserved CATCHWORDS : Appeal decision of Local Court Magistrate - s 588FG(2) Bankruptcy Act 1966 (Cth) Corporations Act 2001 (Cth) - s 588FG(2)(b)(i) Income Tax Assessment Act 1936 (Cth) - ss 222ALA, 222AOB(1), 222AOC, 222AOE, LEGISLATION CITED : Local Courts (Civil Claims) Act 1970 (NSW) - s 69(2) Supreme Court Rules - Part 51A r 13 Allen v Kerr & Anor (1995) Aust Torts Reports 81-354 Azzopardi v Tasman UEB Industries Ltd (1985) 4 NSWLR 139 Carr v Neill (1999] NSWSC 1263 Cussen v Commissioner of Taxation (2004) 51 ACSR 530; [2004] NSWCA 383 D'Aloia & Anor v Federal Commissioner of Taxation (2003) 203 ALR 609; (2003) 48 ACSR 204 CASES CITED : Devries v Australian National Railways Commission (1993) 177 CLR 472 Deputy Commissioner of Taxation v George (2002 55 NSWLR 511; [2002] NSWCA 336 Deputy Commissioner of Taxation v Woodham (2000) 199 CLR 370 Keith Smith East West Transport Pty Ltd v ATO (2002) 42 ACSR 501 State Rail Authority of New South Wales v Earthline Constructions Pty Ltd (in Liq) (1999) 160 ALR 588 Queensland Bacon Pty Limited v Rees (1966) 115 CLR 266 William James Hamilton (First Plaintiff) Pino Fiorentino (Second Plaintiff) PARTIES : Harmonious Landscapes Pty Ltd (in liquidation) (Third Plaintiff) Deputy Commissioner of Taxation (Defendant( FILE NUMBER(S) : SC 11484/2004 Mr J Hmelnitsky (Plaintiffs) COUNSEL : Mr P Rodionoff (Defendant) Mr K Harkness, K M Harkness & Co (Plaintiffs) SOLICITORS : Mr E Chiaw, ATO Legal Practice (Defendant) LOWER COURT JURISDICTION : Local Court LOWER COURT FILE NUMBER(S) : 128/2004 LOWER COURT JUDICIAL OFFICER : Magistrate Price IN THE SUPREME COURT OF NEW SOUTH WALES COMMON LAW DIVISION MASTER HARRISON WEDNESDAY, 23 MARCH 2005 11484/2004 - WILLIAM JAMES HAMILTON & 2 ORS v DEPUTY COMMISSIONER OF TAXATION JUDGMENT (Appeal decision of Local Court Magistrate - s 588FG(2) Corporations Act 2001 (Cth)) 1 MASTER: By summons filed 21 May 2004 the plaintiffs seek firstly, an order that the determination of Magistrate Price dated 23 April 2004 be set aside; secondly, an order that the payments in respect of its taxation liabilities made by Harmonious Landscapes Pty Ltd (in liquidation) that the defendant on or about 7, 13 and 19 March 2003 be avoided; thirdly, an order that the defendant repay to the first and second plaintiffs the amount of the said payments being $13,742.00. The first plaintiff is William James Hamilton, a liquidator. The second plaintiff is Pino Fiorentino. The third plaintiff is Harmonious Landscapes Pty Ltd (in liquidation) (Harmonious). The defendant is the Deputy Commissioner of Taxation (DCT). I shall refer to the parties by name in this judgment. 2 At the outset, it may be helpful to make some brief comments concerning the remedy pursued by the plaintiffs. Section 69(2) of the Local Courts (Civil Claims) Act 1970 (NSW) (LCCCA) permits a party who is dissatisfied with a judgment as being erroneous in point of law to appeal to this Court. The onus lies on the plaintiffs to demonstrate that there has been an error of law. What is a question of law (as opposed to a question of fact) was considered, inter alia, in Allen v Kerr & Anor (1995) Aust Torts Reports 81-354 and Azzopardi v Tasman UEB Industries Ltd (1985) 4 NSWLR 139 at 155-156 and two more recent cases, namely Carr v Neill [1999] NSWSC 1263 and R L & D Investments Pty Ltd v Bisby [2002] NSWSC 1082. It cannot be said that the Tribunal member acted on evidence inconsistent with facts incontrovertibly established by the evidence - see Devries v Australian National Railways Commission (1993) 177 CLR 472 per Brennan, Gaudron and McHugh JJ at 479 and State Rail Authority of New South Wales v Earthline Constructions Pty Ltd (in Liq) (1999) 160 ALR 588. Section 69(4) of the LCCCA provides that the court may determine an appeal by either (a) setting the judgment or order aside or (b) by varying the terms of the judgment or order or (c) by setting the judgment or order aside and remitting the matter for determination in accordance with the court's directions or (d) by dismissing the appeal. Grounds of appeal and notice of contention 3 The plaintiffs appeal the whole of the decision of Price LCM dated 23 April 2004. The grounds of appeal are that the Magistrate erred in law in firstly, applying the wrong test in considering s 588FG(2)(b)(i) of the Corporations Act 2001 (Cth) (the Act); secondly, by failing to consider whether the defendant had no reasonable ground for suspecting that Harmonious would become insolvent pursuant to s 588FG(2)(b)(i) of the Act; and thirdly, by failing to correctly apply s 588FG(2)(b)(ii) of the Act. By a notice of contention the DCT seeks that the decision of the Magistrate be affirmed on the basis that the liquidator failed to prove that Harmonious was insolvent at the time of making the alleged preferential payments. Local Court proceedings 4 On 7 August 2003 Mr Hamilton as the liquidator of Harmonious commenced proceedings seeking to recover from the DCT the amount of $13,742.00 which it alleged had been paid to the DCT by Harmonious pursuant to s 588FF of the Act as being voidable transactions. The relevant payments to the DCT were all made immediately after the DCT had issued a notice to the Harmonious directors pursuant to s 222AOE of the Income Tax Assessment Act 1936 (Cth). 5 On 4 March 2003 the DCT sent a notice pursuant to s 222AOE of the Income Tax Assessment Act to Mr Carlson (DPN). Mr Carlson was a director of Harmonious. On 28 March 2003 the directors resolved to appoint the first and second plaintiffs as administrators. The creditors resolved that Harmonious be wound up in insolvency on 2 May 2003. Thus it was shortly after the 14 days from the date of the issue of the DPN that the creditors made their resolution to begin to wind up the company. It is common ground that five payments were made after the DPN notice was issued and these payments all fall within the "relation back" period. Issue of Director Penalty Notices [DPN] 6 Before I come to s 588FG of the Act, it is perhaps helpful if I briefly refer to the issue of a Director Penalty Notice [DPN]. The DPN was issued pursuant to s 222AOE of the Income Tax Assessment Act. That provision occurs in Part VI, Division 9, Subdivision B of the Income Tax Assessment Act, which is headed "Company failing to remit deductions, amounts withheld etc". 7 Subdivision B creates a regime for the imposition of penalties on company directors when the company fails to remit PAYG tax. The subdivision requires directors of such companies to either remit the tax due, come to a particular agreement pursuant to s 222ALA of that Act, to appoint administrators or to begin a winding up of the company – see s 222AOB(1). 8 Section 222AOC prescribes automatic penalties for any director in office at the date the tax was due who fails to cause the company to do one of the things mentioned in the previous paragraph. The amount of the penalty is equal to the amount of the unpaid tax. 9 However, before that penalty may be recovered, the Commissioner is required to serve a notice [DPN] on the director pursuant to s 222AOE. 10 Section 222AOE provides: "Commissioner must give 14 days' notice before recovering penalty The Commissioner is not entitled to recover from a person a penalty payable under this Subdivision until the end of 14 days after the Commissioner gives to the person a notice that: (a) sets out details of the unpaid amount of the liability referred to in subsection 222AOC(1), (1A) or (2) (whichever relates to the penalty); and (b) states that the person is liable to pay to the Commissioner, by way of penalty, an amount equal to that unpaid amount, but that the penalty will be remitted if, at the end of 14 days after the notice is given: (i) the liability has been discharged; or (ii) an agreement relating to the liability is in force under section 222ALA; or (iii) the company is under administration within the meaning of the Corporations Act 2001; or (iv) the company is being wound up." 11 The penalty is imposed on the director by the statute automatically. It is only where the Commissioner proposes to take action to recover that penalty from the director that a notice under 222AOE is required.– see Deputy Commissioner of Taxation v Woodham (2000) 199 CLR 370 and Deputy Commissioner of Taxation v George(2002) 55 NSWLR 511; [2002] NSWCA 336. The purpose of the DPN is to prompt the director to take action as set out in s 222AOE(b). 12 The DCT in its defence pleaded that it acted in good faith in receiving the payments, at that time had no reasonable grounds for suspecting that Harmonious was insolvent at those times, or would become insolvent and that a reasonable person in DCT's circumstances would have no reasonable grounds for suspecting that Harmonious was insolvent or would become insolvent. The "good faith" issue can be put to one side as it is not the subject of challenge in this appeal. The balance of the defence raised by the DCT arises pursuant s 588FG of the Act. 13 Section 588FG reads: "Transaction not voidable as against certain persons (1) … (2) [Transaction not an unfair loan] A court is not to make under section 588FF an order materially prejudicing a right or interest of a person if the transaction is not an unfair loan to the company, or an unreasonable director-related transaction of the company, and it is proved that: (a) the person became a party to the transaction in good faith; and (b) at the time when the person became such a party: (i) the person had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent as mentioned in paragraph 588FC(b); and (ii) a reasonable person in the person's circumstances would have had no such grounds for so suspecting; and (c) the person has provided valuable consideration under the transaction or has changed his, her or its position in reliance on the transaction. 14 Thus, s 588FG(2)(b) contained both a subjective and objective test which needs to be satisfied. Hamilton submitted that the Magistrate erred when applying the second limb of s 588FG(2) namely s 588FG(2)(b)(ii) in that the Magistrate focussed his attention only upon the subjective test. Alternatively Hamilton submitted if the Magistrate did consider the objective test, he failed to consider the particular circumstances of the ATO. At the outset of his Honour's reasons he correctly set out the tests in s 588FG(b)(i) and (ii). (J [4]). 15 I shall refer to the test set out in s 588FG(2)(b)(i) as being the "subjective test"). Ms Karen Yankus (aff 25/2/04 at para 11) deposed that in her work as an ATO officer and she issued the DPN her decision to issued a DPN [Director Penalty Notice] to the company director had nothing to do with any view of the solvency or insolvency of the company. This subjective test was satisfied. 16 The second test is whether a reasonable person in the person's circumstances would have had no such grounds for suspecting that the company was insolvent at the time or would become insolvent as mentioned in s 588FC(b). (I shall refer to this as being the "objective test"). Alleged failure to apply correct test 17 The Magistrate when considering both tests contained in s 588FG(2) stated: "What the Plaintiff submits is that the Court ought to look cumulatively not individually at these various circumstances that were known to the ATO. Whatever view might have been expressed on behalf of the company the situation might have been radically different if the writer, the company accountant, had "waded in" and supported the optimism or view apparently being held by the director of the company. On the insolvency issues or aspects, it submitted the company pay its debt when and as they fall due or can the company realise its assets to pay its debts. What the facts do establish and which was or ought to have been known to the ATO is that the company had not paid twenty seven thousand odd dollars in outstanding taxes. As of the 30 June 2002, its taxation debt was of the order of thirty eight thousand dollars. In its profit and loss statement the company's assets were in the negative. Those factors, it is submitted, clearly established insolvency. What was known to the ATO was the tax payments since April 2002 to the extent of twenty seven thousand were unpaid. The Business Activity Statement had not been filed, the company had approached the ATO seeking time to pay its liabilities, there was an unexpected debt of some ten thousand dollars for workers compensation payments, the company had lost a significant proportion of its business, the company was experiencing cash flow problems, the company was exploring or investigating outside funding sources, the directors were looking to raise finance for the company. At the very least there should, in the Plaintiffs submission, have been a suspicion. An organisation such as the ATO ought to be sceptical, even cynical in such circumstances, all the tell tale signs were there. Alarm bells should have been ringing. The Court is asked to determine or find that there was a subjective belief in the mind of the ATO. Would a reasonable person have a reasonable suspicion, this is answered by the Plaintiff in the affirmative." The Plaintiff company might well have been insolvent. In retrospect, at the time of the payments being made to the ATO that view might well have been founded on a balance sheet as distinct from a cash flow analysis of the companys situation. The Keith Smith decision referred to earlier would require a finding on the latter rather than the former. In any event looking at the reasonable person entertaining a reasonable position [suspicion] as distinct from perhaps the specialised, perhaps even unique position that an officer of the ATO might find him/herself in, and even putting to one side that these particular officers of the ATO do little else than deal with tax payers who may be slow in meeting their obligations under the taxation legislation, what the objective reasonable person has in this case is essentially an unprogrammed or an unexpected payment, that's the workers compensation payment, which arose and which was discharged by instalments. A stated resource available to the company to secure funding irrespective of whether in the judgment of its directors it was appropriate to secure funds on terms In the market place. The tenor of communications and the assurances given by the company could not lead a reasonable person to conclude that the company lacked the capacity to pay its debts when and as they fell due. The Defendant, the ATO satisfies the Court that no reasonable person in a position of its office, sees with the material which quite clearly it had available to it, could come to the view that the company was insolvent and the Defendants succeeds on the statutory defence to the action brought by the Plaintiff and there would be a verdict in favour of the Defendant." [my emphasis added] 18 In relation to the objective test, in Cussen v Commissioner of Taxation (2004) 51 ACSR 530; [2004] NSWCA 383 Spigelman CJ (with whom Handley and Tobias JJA agreed) held that the words "a reasonable person in the person's circumstances" in s 588FG(b)(ii) require an objective "reasonable business person" test to be applied and do not require the court to take into account the acumen, perspicacity and resources of the particular creditor. Where the defendant is the ATO, the objective test requires the court to consider not only what the plaintiff's circumstances might have prompted the reasonable business person to suspect but also requires the court to consider what those circumstances would have prompted a reasonable business person with the knowledge and qualifications of a person within the ATO to suspect. 19 The meaning of the word "suspicion" is well settled. In Queensland Bacon Pty Limited v Rees (1966) 115 CLR 266 at 303 Kitto J stated: "A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to "a slight opinion, but without sufficient evidence", as Chambers's Dictionary expresses it. Consequently, a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence. The notion which "reason to suspect" expresses … is, I think, of something which in all the circumstances would create in the mind of a reasonable person in the position of the payee an actual apprehension or fear that the situation of the payer is in actual fact that which the subsection describes — a mistrust of the payer's ability to pay his debts as they become due and of the effect which acceptance of the payment would have as between the payee and the other creditors." 20 The Magistrate referred to Rees. At the beginning of his judgment the Magistrate and later in the judgment to the correct objective test. However, later the Magistrate referred to the objective test as being the reasonable person in the person' circumstances would have had no such grounds for so concluding instead of "no such grounds for suspecting". The Magistrate found that the major debt was an unprogrammed or unexpected payment, namely the workers compensation payments which arose and was discharged by instalments and that stated resource available to the company was to secure funds on terms in the market place. It is my view that, when the whole passage quoted is considered, the Magistrate's addressed his mind and applied the correct objective test even though he inadvertently referred to the word "conclude" when he meant to say "suspect". He specifically says "the ATO satisfies the court that no reasonable person in a position of its office, sees (sic) with the material which quite clearly it had available to it, could come to the view that the Company was insolvent" used the correct objective test and correctly applies it to the facts. It is my view that there is no error of law. 21 Hamilton submitted that the objective test required the court to consider whether the service of a DPN, which is a matter peculiar to the business of tax collecting, evidences a suspicion of insolvency. It is my view, that the service of a DPN is a factor which may be considered in determining whether the objective test applies. 22 In the Local Court Hamilton pleaded nor argued that Harmonious Landscapes became insolvent as a result of paying the ATO the argument raised in D'Aloia & Anor v Federal Commissioner of Taxation (2003) 203 ALR 609; (2003) 48 ACSR 204. This argument cannot be raised now. Actual or suspected insolvency The Notice of Contention 23 The DCT contends that plaintiffs failed to prove that the company was in fact insolvent at the time of making the payments. The DCT further contends that it is crucial to the plaintiffs' claim to prove that at the time of receipt of each payment Harmonious was in fact insolvent or became insolvent as a result of the payment and that it is clear law that the statutory test of solvency looks at matters on a "cash flow" basis rather than a simple "balance sheet" basis – Keith Smith East West Transport Pty Ltd v ATO (2002) 42 ACSR 501 (Keith Smith) at 513. 24 Hamilton submitted that Part 51A r 13 of the Supreme Court Rules (SCR) requires an error of law to be demonstrated by the Notice of Contention rather than inviting the Court to find a different conclusion on the evidence. Further, "it cannot be contended that there was no evidence upon which that finding was based" (point 5 of Hamilton's submissions). "In the absence of any identifiable legal basis upon which to disturb the Local Court's finding on the question of insolvency, Hamilton submitted that the notice of contention should be dismissed". 25 Part 51A r 13 of the SCR states that a notice of contention requires the respondent to seek to affirm the decision on different grounds relied on by the tribunal. It does not necessarily mean that an error of law must be demonstrated. Insolvency 26 The DCT submitted that prior to a consideration of the defences available under the Act, it is necessary for the plaintiff to prove insolvency of Harmonious at the time the payments was made or that the payments made the company insolvent under sections 588FA and 588FE. 27 In relation to insolvency, the Magistrate referred to Keith Smith at 513.5-15 where it was restated that the statutory test of insolvency looks at matters on a "cash flow" basis rather than a simple "balance sheet" basis. 28 Price J stated in his judgment "[t]he company might well have been insolvent" (at page 5), however he was silent as to whether or not the plaintiff had established a claim under sections 588FA and 588FE of the Act that was successfully defended by the defendants under section 588FG. 29 Insolvency is defined by Chapter 1; Part 1.2 Interpretation; Division 7 Interpretation of Other Expressions, subsection 95A(2) of the Act as: "(1) A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable (2) person who is not solvent is insolvent". 30 The defendant has made submissions regarding the presumption of insolvency under section 588E (3) of the Act. Section 588E (3) states: "If (a) the company is being wound up; and (b) it is proved, or because of subsection (4) or (8) it must be presumed, that the company was insolvent at a particular time during the 12 months ending on the relation-back day; it must be presumed that the company was insolvent throughout the period beginning at that time and ending on that day". 31 Thus for this section to apply, the insolvency of Harmonious must have been proved in the Local Court. 32 As evidence of insolvency, in particular the Liquidators Report to Creditors (Schedule "A" of Annexure "M" aff William James Hamilton). Paragraph 11 of this Report states: "11.1. The accounts at 30 June 2001 being the financial reports prepared by the accountant of the Company show that there was no working capital, the current liabilities being shown at $42,171 and the current assets $15,675. However there is a surplus of net assets (ie shareholders funds $13,320). However, the Company is clearly undercapitalised at this date the position worsens at 30 June 2002 where the total shareholder's equity has deteriorated to a deficiency of $23,600.76 and current assets have no ability to pay the current liabilities. However, this set of accounts is simply an extract of MYOB balances and may not be reliable in so far as the [sic] may be book debts not taken up in respect of the accounts receivable and creditors accruals. Nevertheless the position does not look healthy from this date. At that date there is a debt due to the Australian Taxation Office in the sum of $38,028 and there does not appear to be any means of the Company satisfying that as it has grown over the nine months to the date of winding up 28 March 2003 to $39,303.44. 11.2 There is therefore the possibility that the Directors have breached s588G of the Corporation Act in incurring debts after 30 June 2002." 33 From this paragraph, the liquidator stated, "it is my opinion that the Company has been insolvent since at least 1 July 2001 or earlier" (Point 3.3 of the Executive Summary of the Liquidators Report to Creditors). The report does not include any information based on a cash flow assessment. It simply relies on the balance sheet and profit and loss statements which does not satisfy the test referred to in Keith Smith. 34 Hamilton submitted that the service of the penalty notice and some of the options available to Harmonious under the notice pointed to insolvency. DCT in turn submitted that the penalty notice must be served and the due date listed to pass without the options listed being taken, before the Australian Taxation Office Commissioner can collect money. It is true that in some cases the issuing of a penalty notice, when examined in the factual context may point to insolvency. However, this is not the norm. The issue of a penalty notice does not immediately indicate that the receiver is insolvent, rather it is a catalyst for the director to consider taking action in accordance with s 222AOB(1). 35 The debts of Harmonious crystallise at winding up. There is no other evidence that Harmonious could not pay its debts when they fell due, taking into consideration payment agreements that were in place. The evidence in this case does not establish that this is the case. The onus of insolvency was upon Hamilton and this onus was not discharged. 36 The appeal is dismissed. The decision of Magistrate Price is affirmed. The summons filed 21 May 2004 is dismissed. Costs are reserved. The court orders (1) The appeal is dismissed. (2) The decision of Magistrate Price dated 23 April 2004 is affirmed. (3) The summons filed 21 May 2004 is dismissed. (4) Costs are reserved. ********** 07/04/2005 - Incorrect citations and typos - Paragraph(s) para 5 11, 12, 18, DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.