Can the Commissioner of Taxation receive the proceeds of sale of land in priority to a registered mortgagee?

The recent Full Federal Court decision in Commissioner of Taxation v Park [2012] FCAFC 122 related to an attempt (successful as it turned out) by the ATO to extract a tax payment from a taxpayer from the sale of property in priority to the registered second mortgagee. Although it seems that the decision may be confined to the peculiar circumstances of the case, alarm bells will surely be ringing throughout the lending community about the case.

The dispute was about the priority between the second mortgagee and the Commissioner, who had served the purchasers with a garnishee notice relating to tax debts owing by the vendor. 

The relevant facts of the case were as follows:

• Mrs Bassili, an individual, owned a property at Fig Tree Pocket in Queensland;
• On 19 January 2010 Mrs Bassili and two purchasers entered into a 30 day contract for the sale of the property for $1,675,000;
• The property was mortgaged to National Australia Bank by registered first mortgage, which, at the time of sale, secured approximately $1,289,000;
• Mrs Bassili had also granted a second mortgage to Instyle Developments P/L which, at the time of sale, secured approximately $430,200, meaning there would be a shortfall at settlement of the sale;
• Mrs Bassili was also indebted to the Commissioner for $75,508.64 for a tax debt. The Commissioner had commenced proceedings in the District Court in Queensland, and claimed the balance owing to him was this sum; 
• After the execution of the sale contract but before settlement, on 11 February 2010, the Commissioner issued a s260-5 notice to the purchasers referring to the price payable under the contract of sale, and demanding that the amount owing to the Commissioner ($75,508.64) be paid from funds owing by the purchasers to Mrs Bassili; and
• On 5 February 2010, prior to Mrs Bassili's Bankruptcy, a trustee (Mr Park) had been appointed to take control of Mrs Bassili's property pursuant to section 50 of the Bankruptcy Act 1966 (Cth).  She was eventually bankrupted on 23 April 2010. 

Therefore the dispute was about which claim to the balance of the purchase price took priority. On its face, a registered mortgagee, as a secured creditor, should have priority over the ATO, which is an unsecured creditor. 

However, the settlement of the sale of the property was delayed due to the dispute. To solve the impasse, the second registered mortgagee released its mortgage in exchange for an undertaking that the balance of proceeds of sale would be paid into its solicitors' trust account pending resolution of the dispute.

The Federal Magistrates' Court found in favour of the second registered mortgagee. 

The Commissioner appealed to the Full Court of the Federal Court.

Full Court decision 

The majority of the Full Federal Court (Jessup and Katzmann JJ) found that the Instyle mortgage granted security over the freehold interest in land and did not extend to the right to receive the sale proceeds of the property owing to the registered proprietor.  

Accordingly,  Instyle did not have a beneficial interest in the money owing under the contract of sale.  

As the Commissioner's s260-5 notice required the purchasers to pay their debt to Mrs Bassili by payment to the Commissioner, the Commissioner was able to jump the queue ahead of Instyle.  

The problem for the mortgagee was that the purchasers did not actually owe anything to Instyle as mortgagee.  Mrs Bassili owed money to the mortgagee and the purchasers owed money to Mrs Bassili.  

According to the majority, there was never a point in time when the amount payable by the purchasers became owing to the mortgagee.  

The court recognised that the position would have been different if Instyle had been enforcing its security against the property. 

Siopis J dissented agreeing with the original judgment of the Federal Magistrates Court.

Conclusion

Many mortgages in Victoria include a clause allowing the mortgagee to appoint a receiver to collect money on its behalf, and a clause charging the proceeds of sale in favour of the mortgagee. In those circumstances, the same situation should not arise here. 

If there is a priority dispute arising with the Commissioner of Taxation, the advice to the lender must be: Never release a registered mortgage without actually receiving payment of the amount secured by the mortgage; a payment into the lender's trust account pending the resolution of the dispute will not be enough. 

In an insolvency situation, if the borrower owes money to the Commissioner, and there will be a shortfall to the mortgagee on the settlement of the sale, the lender should not release the mortgage unless it receives the whole of the balance of the proceeds of sale. 

If an impasse results, the mortgagee could take over the sale (assuming the mortgage is in default and appropriate notices have been served), and complete the sale as mortgagee in possession. In those circumstances, no money will be payable by the purchasers to the vendor, and so compliance with the garnishee notice will not be required.

W G Stark

Hayden Starke Chambers