GST is a key element of any insolvency or some mortgagee sales. Inland Revenue is a preferred creditor and at times has an effective ‘super priority’ in terms of its entitlement to GST (along with other taxes such as PAYE). At times, this can have unexpected consequences from the perspective of mortgagees, secured creditors and for others involved in receiverships or liquidations.
The Global Financial Crisis resulted in a sharp uptake in businesses being placed into receivership or liquidation, along with an increase in mortgagee sales. Today, sectors like tourism and construction remain under pressure in the post-covid environment. With interest rates (and potentially inflation) likely to remain elevated for some time, there is a risk that New Zealand will again see a similar pattern of distressed debtors who become insolvent or who are forced to default on their mortgages. If this eventuates, then it will be increasingly important to understand the potential impact of GST on distressed transactions.
Mortgagee Sales
Mortgagees are liable for any GST that becomes payable on a mortgagee sale. As such, a mortgagee needs to determine whether GST is in fact payable, which requires an assessment of the borrower’s position in terms of whether it is GST registered in relation to that property. This analysis can be challenging given the usual breakdown of communication with the borrower, and due to privacy requirements which result in Inland Revenue being unable to share the GST status of the borrower. Further, the default position is that GST is payable unless the mortgagee has a letter from the mortgagor confirming the contrary, or otherwise has ‘reasonable information’ that no GST is payable.
Critically, the liability for the mortgagee to pay GST to Inland Revenue, creates an effective ‘super priority’ over and above the entitlement of the mortgagee to apply funds to repay the debt.
In some cases these rules might motivate a lender to prompt the borrower to sell in advance of a mortgagee sale, effectively bypassing these rules. Inland Revenue has previously expressed some concern regarding such so called ‘de facto’ mortgagee sales, however did not go as far as implementing any counteracting legislation. Such transactions may still attract scrutiny by Inland Revenue and it may take a dim view of any arrangement structured with the purpose of limiting the payment of GST to Inland Revenue.
Receiverships and Liquidations
The GST legislation provides a regime for receiverships, liquidations and other forms of incapacity (for example, in some cases bankruptcy). The effect is that the ‘specified agent’ appointed in respect of an incapacitated person is treated as carrying on the taxable activity of that person and is therefore personally liable for any GST liabilities during the period of appointment.
These rules do not apply to any historical GST liabilities before the point of appointment, making it important to consider the GST time of supply rules to determine which transactions predate the appointment for GST purposes.
A receiver or liquidator must also have regard to Schedule 7 of the Companies Act 1993. Schedule 7 of the Act outlines which parties are entitled to priority of payment where there are insufficient proceeds to repay all creditors – and gives preference to Inland Revenue in relation to certain taxes such as GST and PAYE. Secured creditors should be aware that there are special rules that may give Inland Revenue a super priority over certain ‘accounts receivable’ or ‘inventory’, therefore it may be critical to determine which assets fall within those categories. This may be especially important because the concept of accounts receivable has been given a broad interpretation by the courts.
Ramifications of Insolvency for Directors
The GST impact of a company becoming insolvent can create very difficult decisions for directors who may be exposed to personal liability if they breach their director duties.
This was an issue considered in 2020 by the Supreme Court in Madsen-Ries v Cooper[1]. That case involved a struggling property development company that had become technically insolvent. Alongside loans owed to creditors, the director was aware of a substantial GST liability that the company would not be able to meet if the project pushed forward to completion.
The director made the decision that the project could still be completed to provide a better financial outcome for the company’s creditors, but at the expense of Inland Revenue’s entitlement to receive GST. The Supreme Court held that the consequence of continuing to trade was a breach of directors’ duties, and he was therefore personally liable for GST. It was not an excuse that some creditors would be better off or even that the overall deficit to creditors would be reduced.
This presents directors of near-insolvent companies with a very difficult decision as to the potential GST implications, even before a receiver or liquidator is appointed. In such a case it may become necessary to commence an insolvency or restructuring process or to approach Inland Revenue and seek some form of instalment arrangement.
Other rules can also apply in these situations, for example, the tax legislation can impose personal liability on a director who ‘asset strips’ a company, leaving it without the ability to pay tax – for example, by way of related-party transactions that were designed to limit the company’s ability to pay its taxes.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed or your usual Bell Gully advisor.
[1] Madsen-Ries v Cooper [2020] NZSC 100