Young & Anor v Commissioner of Taxation

LEGISLATION CITED : Corporations Act 2001 (Cth) - s 9, s 588FA, s 588FC, s 588FF, 588FGA(2).

David Gregory Young (First Plaintiff) PARTIES : Essential Outsourcing Pty Ltd a.t.f. for the D. Cain Family Trust (in liq) The Commissioner of Taxation (Defendant) Darren Cain (Respondent)

R.D. Marshall (Plaintiffs) COUNSEL : S. Golledge (Defendant) F. Austin (Respondent)

Gillis Delaney Lawyers (Plaintiffs) SOLICITORS : ATO Legal Services (Defendant) John Byrnes & Associates (Respondent)

2009/00289181 Young & Anor v Commissioner of Taxation

1 The Plaintiffs are a company in liquidation and its liquidator. They seek to recover from the Defendant ("DCT") an amount of $128,367.23 as an unfair preference pursuant to Corporations Act 2001 (Cth) s 588FA and s 588FF ("the Act"). The payment to the DCT was made, allegedly on behalf of the company, in satisfaction of its liability for PAYG withholding tax. The DCT disputes its liability to repay the money as a preference upon only one ground, to which I will come in a moment. However, in case it is found liable to the liquidator, the DCT claims indemnity from the company's sole director, Mr Cain, pursuant to s 588FGA(2). 2 It is not disputed that the company was insolvent at the time of the payment to the DCT. The sole issue is whether the payment of $128,367.23 on 2 August 2007 was "a transaction" for the purposes of s 588FA(1), s 588FC and s 588FF(1). 3 "Transaction" is defined in CA s 9 as: "in Part 5.7B, in relation to a body corporate or Part 5.7 body, means a transaction to which the body is a party, for example (but without limitation):

(a) a conveyance, transfer or other disposition by the body of property of the body; and

(b) a charge created by the body on property of the body; and

and includes such a transaction that has been completed or given effect to, or that has terminated. 4 The DCT and Mr Cain say that the payment was not a "transaction to which the company is a party" because the company did not make the payment to the DCT, and it was not party to any agreement, express or implied, resulting in the payment, even though the payment discharged its liability for withholding tax. They say that the payment was made by Mrs Fiona Cain, a former director and the former wife of Mr Cain, directly to the DCT in order to discharge what she perceived to be her own liability for the outstanding withholding tax as a former director of the company. 5 The liquidator says that the payment was made by Mrs Cain for the benefit of the company and pursuant to an express or implied agreement between Mrs Cain and the company that Mrs Cain's payment for the benefit of the company would be treated as a loan by her to the company repayable at some future time. Accordingly, the liquidator says, the company was a party to a borrowing transaction with Mrs Cain in order to procure discharge of its tax liability and that transaction resulted in a preferential payment to the DCT. Accordingly, the liquidator says, there has been a "transaction" falling within paragraphs (a), (e) and (g) of the definition. 6 The issue requires a finding as to the intentions of the parties at the time the payment was made: did Mrs Cain make the payment solely to discharge her own liability to the DCT and intending that she would have no recourse to the company to recoup the payment? If so, the company was not party to any transaction although it received an incidental benefit. Conversely, did Mrs Cain make the payment pursuant to an agreement with the company, express or implied, that she would be entitled to claim as a creditor for recoupment, so that the company was involved in a loan transaction resulting in the subject payment to the DCT? The parties are agreed that the issue is a pure question of fact. Facts

7 The company carried on the business of providing labour to the printing industry. Mr and Mrs Cain were the directors until September 2006, when Mrs Cain resigned. Thereafter, Mr Cain was the company's sole director. 8 In the first half of 2006 the company began to experience financial difficulties. By 2007 the company's debts had increased and it was unable to pay PAYG withholding tax as it became due. 9 By 2007 the company's director, Mr Cain, was endeavouring to sell the company's business. He believed that if he were able to sell it for what it was worth, the company would be able to pay all of its creditors in full. 10 The company's day to day financial management was left by Mr Cain, and by Mrs Cain while she was a director, to Mrs Cain's father, Mr Knott. Mr Knott had conducted his own business as a bookkeeper and from about 2000 onwards he assisted in running the company's business. However, as conceded by Mr Cain, Mr Knott in fact acted as financial controller of the company as well as keeping the books. 11 Mr Cain undertook negotiations on behalf of the company with the DCT resulting in various agreements to pay outstanding withholding tax by instalments. However, by mid-2007 it became obvious that there was a large liability to the DCT which the company could not meet from its own resources. 12 Mr and Mrs Cain had a meeting with the company's accountant, Mr Green, who advised that the company's most significant and pressing debt was the outstanding PAYG withholding tax. Mr Green said that if the tax was not paid there was a strong likelihood that the DCT would prosecute both Mr Cain, as the present director, and Mrs Cain as a director during the time a large part of the tax liability was incurred, and that it was possible that they would receive gaol sentences. 13 Mrs Cain says, and I accept, that she was panic-stricken by this advice. She was aware that she was already a creditor of the company for advances made in the past but she knew that the company had no money to pay the withholding tax. She discussed the matter with her father but he could not provide financial help. She approached her aunt, who agreed to lend her $130,000. She left the negotiations for the loan and the arrangement of the whole transaction to her father. 14 On 2 August 2007, a loan agreement was executed by Mrs Cain as borrower, her aunt as lender, and her parents as guarantors. The principal of the loan was $130,000. Recital A of the loan agreement stated that Mrs Cain "requires capital for business purposes". 15 Mr Knott ascertained from the DCT the precise amount required to pay the outstanding withholding tax liability, namely $128,367.23, and arranged for a bank cheque in that amount, being part of the proceeds of the loan from the aunt, to be delivered to him. On receipt of the cheque, Mr Knott arranged for it to be deposited with the DCT and the company's tax liability was reduced accordingly. 16 Mr and Mrs Cain each said in evidence that, in accordance with their usual practice and in accordance with Mr Knott's usual role in the company's affairs, they left it entirely to him to document the transaction by which the withholding tax had been paid. 17 After payment had been made, Mr Knott made an entry in a document forming part of the company's financial records entitled "Account Transaction Accrual". The entry created a loan account showing the company as indebted to Mrs Cain for the amount of $128,367.23. In a separate document entitled "Cash Receipts Journal" Mr Knott made the entry "Directors' payment of PAYG withhold" showing extinguishment of the PAYG debt to the DCT and a loan from Mrs Cain of the corresponding amount. 18 The company was wound up on 14 December 2007. In January 2008, Mr Cain provided to the liquidator a Report as to Affairs. Amongst the creditors of the company appeared Mrs Cain in an amount of $236,599. It is common ground that that amount comprises the sum of $128,367.23 which Mrs Cain paid to the DCT and other amounts lent by her to the company from time to time. 19 On 20 March 2009, Mrs Cain signed a Proof of Debt which was sent to the liquidator. The Proof of Debt form was filled in by Mr Knott, who explained it to Mrs Cain before she signed. The amount claimed by Mrs Cain in the Proof of Debt is $236,599. Again, it is common ground that that amount includes the sum of $128,367.23 paid to the DCT together with other loans made by Mrs Cain to the company. The particulars of the debt given in the Proof of Debt form are: "Funds advanced to [the company] to assist in working capital requirements." 20 Mrs and Mrs Cain both say that they did not give any direction to Mr Knott to make the entries in the company's accounts showing Mrs Cain as a creditor for the amount paid to the DCT. Mr Knott said in his evidence in chief: "Q. You have given evidence to the effect that you created that account 2 2515 after 2 August 2007. Do you recall the date when you created it? A. No, I can't remember.

Q. And when you used the words 'Fiona loan', what did you intend? A. To give me an indication of the corresponding entry to the Tax Office. The dilemma is you have to have a debit and a credit. My intention was to reduce the Tax Office's liability and I needed somewhere to put the other entry. … I had the dilemma of having to pass a debit and a credit entry, one entry to reduce the liability to the Tax Office because Fiona had paid the Tax Office, the Tax Office were no longer owed that money. I was then left with the dilemma of where does the corresponding entry in double bookkeeping go to. At that time - I got to put it somewhere - I put that account in there, more of an indication to me as to just where it - what the purpose of that loan was.

Q. Can you describe to the court what that particular cash receipt journal is saying in a layman term? A. It is saying that the Tax Office has been paid their $128,367.23 which was all PAYG withholding plus a little bit of interest and this is in double entry bookkeeping, this is the reason why I had to enter a credit entry, otherwise it wouldn't have balanced and to indicate to me that it was part of a - sorry - it was completely a loan made by Fiona I entered her name there for just the record.

Q. When you say a loan made by Fiona, what do you mean by that? A. Sorry, I am glad you asked me that because you probably picked up the wrong words. It is a loan that Fiona had obtained to pay the directors' liability that would be incurred due to that amount being wholly PAYG withholding.

Q. All right. Now just to correct me if I am wrong, as I understand your evidence you say that when it came to entering the $128,000 into the company books, you had to create with a double bookkeeping entry, you had to create a credit account; is that correct? A. That's correct." 21 Mr Knott was asked about his intentions in completing the Proof of Debt form on behalf of Mrs Cain and sending it to the liquidator: "A. Um, I didn't really give that much thought to that. Obviously she would be entered as a creditor but to my thoughts, it was really irrelevant because there was no money for the company to pay out.

Q. Well, sir that's not what you thought because if it was irrelevant, you wouldn't bother filling the forms out; would you? A. I started filling the forms out once and I thought this is totally irrelevant. The gentleman from the liquidator's company phoned and said, 'Would you send those forms in' and he sent me or faxed me a second lot of forms. At that stage I thought, well, they want these forms. They are useless. I will send them back to keep them happy." 22 Mr Knott was asked why he had written in Mrs Cain's Proof of Debt that the money had been provided to the company by her for "working capital": "Q. You have written there under 'consideration' your reference to working capital, do you see that? A. That's correct, yes, I saw that. I can see that.

Q. By that you meant money that the company can use to pay its suppliers and its debts? A. Would you repeat that question, because …

Q. First of all you meant money, didn't you? A. Yes.

Q. It is money that the company can use to pay its suppliers and its debts? A. I didn't consider that.

Q. That's what you mean by working capital, isn't it? A. It is. As I said before, I made a mistake in the wording of that." 23 Mrs Cain gave this evidence: "Q. Do I assume that when you signed that Proof of Debt form you didn't know how much money the company in liquidation still had left, that's right? A. Correct.

Q. But you thought, well if there is any left and I can get some on account of all this money, I would like to get some? A. I had no expectation that I was going to get any money back.

Q. If there was any, would you have wanted to have received it? A. Yes, but I had no expectation." Conclusions

24 I accept that Mrs Cain wished to arrange payment of the company's withholding tax liability because she feared prosecution for a derivative personal liability. I accept that both she and Mr Cain gave little, if any, thought as to how the payment was to be structured and whether, and how, the payment was to be recorded in the company's books. I accept that they left the whole transaction to be arranged, structured and recorded by Mr Knott as he thought appropriate, both as far as the company was concerned and as far as Mrs Cain's interests were concerned. 25 I do not accept Mr Knott's evidence that he did not intend to create a loan account in the company's books in favour of Mrs Cain in respect of the payment to the DCT. I am satisfied that Mr Knott was sufficiently knowledgeable in financial matters and in bookkeeping to understand that Mrs Cain's payment to the DCT could result in a reduction of the company's tax liability without necessarily raising a debt in the company's books in favour of Mrs Cain. 26 As at August 2007, Mr Cain was still hoping to sell the company's business for an amount sufficient to pay out all its creditors. In that circumstance, it would have no more than commonsense and prudence for Mr Knott to have treated Mrs Cain's payment to the DCT as a borrowing by the company with a direction by the company to the lender to pay a third party, in the hope that the company could repay Mrs Cain and she could then repay the loan from her aunt. 27 Mr Knott's participation in Mrs Cain's completion of her Proof of Debt in 2009 supports a conclusion that it was his actual intention in August 2007 that payment by Mrs Cain on the company's behalf be treated as creating a loan in her favour. In the Proof of Debt he described the loan as "funds advanced … to assist in working capital requirements". The discharge of the company's tax liability did, in fact, assist the company's working capital requirements. I do not accept Mr Knott's evidence that he gave no considered thought to the description of the debt claimed in Mrs Cain's Proof of Debt. 28 The fact that Mrs Cain wished to receive recoupment from the company in respect of her payment to the DCT, if there was any money left in the liquidation, confirms that she never had an actual intention that she would never be entitled to recoup the money from the company. I infer that Mr Cain and Mr Knott told Mrs Cain in August 2007 that there was still hope that the company's business could be sold for an amount which would pay out all its creditors. I conclude that at all times Mrs Cain agreed with her father's characterisation of the transaction as involving a loan by her to the company. Her fear of prosecution for a derivative tax liability of the company was no more than her motive in agreeing to enter into a transaction which her father, with her authority, structured as a loan by her to the company. 29 The legal consequences of the facts, as I have found them, are:

• Mr Cain, as sole director of the company, authorised Mr Knott in August 2007, expressly or by a course of conduct, to enter into an agreement as agent of the company with Mrs Cain for a borrowing of the amount required to pay the company's tax liability;

• Mrs Cain, expressly or by a course of conduct, authorised Mr Knott as her agent to enter into that loan agreement with the company;

• Mr Knott, in accordance with the authority conferred by both parties upon him, made a loan agreement between the company and Mrs Cain which he evidenced in the company's financial records. 30 The result is that the company was party to a "transaction" whereby money was borrowed from Mrs Cain and paid to the DCT, at the company's direction, in reduction of its tax liability. The "transaction" falls within paragraphs (a), (e) and (g) of the definition in s 9 of the Act. Orders

31 The parties are agreed that if the Court finds that the company party to a "transaction" in respect of the payment to the DCT:

• Mr Cain has no defence to the DCT's claim for indemnity. 32 I will stand the proceedings over for a short time to enable the parties to bring in Short Minutes of Order reflecting these reasons and for argument, if any, as to costs.
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