smsf association national conference 2017...provident, benefit, superannuation, retirement or...

SMSF Association National Conference 2017 Melbourne 15 – 17 February

How safe are assets in an SMSF from creditors? Bankruptcy Act in context

Chris Ketsakidis

Partner Mills Oakley

Superannuation, Bankruptcy and Insolvency | Chris Ketsakidis

1 Introduction

Many Australians will rely on their superannuation savings to provide them with financial security in retirement1. This is especially true of SME business owners, for whom asset protection is a key consideration in any business or investment structure. Whilst often asset protection is considered in the context of trusts and particularly discretionary trusts, superannuation also forms an important and integral part of providing financial security during retirement particularly given the CGT concessions which encourage substantial contributions to be made into superannuation and the fact that many business real properties are held by self managed superannuation funds.

But when the time comes to retire, how safe are those superannuation benefits? Are they as secure as one might think?

This session will explore the impact of the Bankruptcy Act 1966 (Bankruptcy Act) on the superannuation interests of a bankrupt member including:

to what extent, and in what circumstances, contributions can be clawed back;

what existing superannuation entitlements are protected; and

what types of benefit payments are protected.

We will also explore the impact of an employer’s insolvency on any unpaid superannuation entitlements of its employees including:

where those entitlements rank in relation to other employee entitlements;

the extent to which the directors of any corporate employer are personally liable for the superannuation debts of their business in light of recent amendments to the Corporations Act 2001 (Corporations Act);

the superannuation reporting requirements under the Fair Work Act 2009 (FW Act).

All references to provisions in this paper are to the provisions of the Bankruptcy Act unless otherwise stated.

1 Or, controversially, financial security for their dependants in the event of their death.


2 Superannuation & Bankruptcy

2.1 Background to legislative framework

Bond Case

The current provisions of the Bankruptcy Act, insofar as they relate to superannuation interests, were shaped by the Full Federal Court decision in Caboche v Ramsay (Caboche) which involved the late Alan Bond’s superannuation fund.2

In 1990 (when the relevant facts took place), superannuation was not protected under the Bankruptcy Act. For this reason, the governing rules of many superannuation funds contained forfeiture provisions which purported to cancel a member’s entitlement to any benefits if certain events occurred, e.g. the member’s bankruptcy, or an event that could result in the member’s entitlement vesting in another person.3

Briefly, in February 1990, Mr Bond transferred benefits worth approximately $2.3m from the Bond Corporation Group Superannuation Fund to a superannuation fund of which he was the sole member. In August 1990, Mr Bond ceased employment with Bond Corporation Holdings Limited (BCH); the following month, in September 1990, he also resigned as a director of BCH. Importantly, he did not retire completely from the workforce.

He subsequently committed an act of bankruptcy (in October 1990) which resulted in his bankruptcy trustee seeking to access Mr Bond’s superannuation benefits for his creditors. The bankruptcy trustee claimed that, once Mr Bond’s employment with BCH had terminated, he became entitled to his superannuation benefits (because they had vested absolutely) and, consequently, his bankruptcy trustee could claim them on his behalf as property of the bankrupt.

The fund trustees argued that Mr Bond’s interest in the fund was contingent unless and until Mr Bond called for the benefits by applying to the fund trustee for them. Alternatively, they argued that, even if Mr Bond was entitled to the benefits, the effect of the deed’s forfeiture provision was to disentitle him immediately on his bankruptcy thereby removing any interest that the bankruptcy trustee could access.4

2 (1993) 119 ALR 215 3 Of course, the purpose of these forfeiture clauses was to ensure that benefits remained in the superannuation fund to provide retirement benefits for the member, or benefits to their dependants including in the event of the member’s death, when the ‘danger’ had passed. 4 The superannuation fund’s trust deed provided that a benefit which a member is entitled to, but at the date of bankruptcy is unpaid, would be forfeited by the member.


The Full Court rejected both of the fund trustees’ arguments. First, it quickly dismissed the argument that Mr Bond merely had a contingent interest in the fund finding that his interest in his superannuation entitlements was vested.5 In support of its conclusion, the Court noted the actions of transferring his benefits between superannuation funds, together with the reference to a member’s interest as “entitled to a benefit”.

Secondly, the Full Court concluded that Mr Bond gained a fully vested entitlement when his employment terminated with BCH. Regarding the argument that Mr Bond’s benefits were forfeited by virtue of his bankruptcy, the Court held that this could only apply to an interest in the fund that had not yet vested and, for present purposes, the $2.3m was taken to have vested.

The Full Court’s decision, therefore, confirmed that superannuation entitlements were vested (at least in interest) in a fund member and that, if the member become entitled to them, those entitlements were available to creditors of the member.

Following Caboche, section 302A of the Bankruptcy Act was introduced as an anti-avoidance measure with effect from 1 July 1994 to counteract forfeiture provisions even though, in the circumstances, the Full Court did not have to rule whether that particular forfeiture clause was effective.

Section 302A voids forfeiture provisions in the governing rules of a superannuation scheme.

302A Certain provisions in governing rules of superannuation funds and approved deposit funds to be void

(1) This section applies to a provision in the governing rules of a provident, benefit, superannuation, retirement or approved deposit fund to the extent to which the provision has the effect that:

(a) any part of the beneficial interest of a member or depositor is cancelled, forfeited, reduced or qualified; or

(b) the trustee or another person is empowered to exercise a discretion relating to such a beneficial interest to the detriment of a member or depositor;

if the member or depositor:

(c) becomes a bankrupt; or

(d) commits an act of bankruptcy; or

(e) executes a personal insolvency agreement under this Act.

(2) The provision is void.

(2A) This section does not apply to a provision that facilitates compliance with:

(a) section 128B; or

5 In my view, vested-in-interest but not vested-in-possession.


(b) section 128C; or

(c) a notice under section 128E; or

(d) an order under paragraph 128K(1)(b); or

(e) a notice under section 139ZQ; or

(f) an order under subsection 139ZT(2); or

(g) an order under section 139ZU.

(3) This section extends to governing rules made before the commencement of this section.

(4) In this section:

governing rules, in relation to a fund, means any trust instrument, other document or legislation, or combination of them, governing the establishment or operation of the fund.

Notwithstanding the existence of section 302A, many trust deeds for superannuation funds continue to contain forfeiture provisions.

2.2 Property divisible amongst creditors

A bankruptcy trustee’s role is to administer the estate of a bankrupt including by ascertaining and gathering in any property owned and/or controlled by the bankrupt. Then, subject to any exceptions set out in the Bankruptcy Act, the trustee is required to realize those assets and distribute the proceeds to creditors. Relevantly, section 58(1) provides:

58 Vesting of property upon bankruptcy - general rule

(1) Subject to this Act, where a debtor becomes a bankrupt:

(a) the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and

(b) after-acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee.

‘Property of the bankrupt’ is defined in section 5(1) to mean property divisible amongst the bankrupt’s creditors and any rights and powers relating to that property that would have been exercisable by the person if he or she had not become a bankrupt.


‘Property’, in turn, is defined in section 5(1) to mean:

… real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property.

The effect of section 58(1) is to vest all property of the bankrupt (regardless of its nature) in the bankruptcy trustee, immediately on a person becoming a bankrupt. At first, instance, this includes any rights and entitlements the bankrupt might have in relation to superannuation. The purpose of the provision is to help identify the bankrupt’s property and prevent any dissipation or other dealing that might defeat creditors’ interests.

As noted, section 302A was introduced after Caboche to void any purported forfeiture of superannuation entitlements in the event of bankruptcy which might defeat the effect of section 58. Contemporaneously, section 116 was amended to exclude some but not all existing superannuation entitlements from being property divisible amongst the bankrupt’s creditors. Section 116 relevantly provides:

(2) Subsection (1) does not extend to the following property: …

(d) subject to sections 128B, 128C and 139ZU: …

(iii) the interest of the bankrupt in:

(A) a regulated superannuation fund (within the meaning of the Superannuation Industry (Supervision) Act 1993); or

(B) an approved deposit fund (within the meaning of that Act); or

(C) an exempt public sector superannuation scheme (within the meaning of that Act);

(iv) a payment to the bankrupt from such a fund received on or after the date of the bankruptcy, if the payment is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993;

(iva) a payment to the bankrupt under a payment split under Part VIIIB of the Family Law Act 1975 where:

(A) the eligible superannuation plan involved is a fund or scheme covered by subparagraph (iii); and

(B) the splittable payment involved is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993;

(n) property to which, by virtue of subsection (3), this paragraph applies; …

(3) Where, at any time, the whole, or substantially the whole, of the money paid for the purchase, or used in the acquisition, of particular property is protected money, paragraph (2)(n) applies to the property.

(4) Where, as at the time when the trustee realises particular property to which paragraph (2)(n) does not apply, the outlay in relation to the property is in part protected money and in part other money, the trustee shall pay to the bankrupt so


much of the proceeds of realising the property as can fairly be attributed to that protected money.6

Accordingly, interests in regulated superannuation funds, lump sum benefits, and assets acquired with those protected superannuation entitlements are exempted from the general rule (in section 58 of the Bankruptcy Act) which operates to vest all of a bankrupt’s assets in his or her trustee in bankruptcy. On the other hand, some superannuation contributions and superannuation benefits taken in the form of a pension are not necessarily protected.

Let’s consider each of these in turn.

2.3 Bankruptcy cases involving contributions

In relation to superannuation contributions, the anti-avoidance measures set out in sections 120 (concerning undervalued transactions) and 121 (transfers to defeat creditors) and the operation of Part IV Division 3 Subdivision B can operate to defeat transactions and contributions by a bankrupt. Sections 120 and 121, in particular, have been considered by the Federal Court and the High Court in the context of contributions and payments made to superannuation funds around the time of a member’s bankruptcy.

(a) Small’s case

In Official Trustee in Bankruptcy v Trevor Newton Small Superannuation Fund Pty Ltd,7 (Small’s case), the Federal Court considered whether certain superannuation contributions made by Mr Small to his self-managed superannuation fund (SMSF) were excluded by section 116(2)(d) from being divisible property; i.e. property available to be distributed amongst his creditors.

In September 1995, 3 tax assessments together with provisional tax notices were issued by the ATO to Mr Small. And as a result of these notices, approximately $310,000 in tax became owing in October 1995. In April 1996, Mr Small was personally served with a statement of claim issued in the NSW Supreme Court claiming almost $400,000. No defence was filed to the statement of claim.

With the proverbial walls closing in, Mr Small embarked on a questionable strategy. He established an SMSF in June 1996 with himself, his accountant and a third person as directors of the corporate trustee and made three payments totalling $263,674 to his SMSF:

on 26 June 1996 - $85,387;

6 There are equivalent provisions in relation to Retirement Savings Accounts.

7 (2001) 114 FCR 160


on 15 January 1997 - $85,387; and

on 23 July 1997 - $92,900.

A fortnight after the first contribution, the ATO obtained judgment against Mr Small for approximately $390,000. Six months later (in January 1997) he made the second contribution. Then in late February 1997, Mr Small was served with a bankruptcy notice issued on the application of the ATO.

The bankruptcy notice required Mr Small to pay or secure the payment of the required sum to the satisfaction of the Court or the ATO by 14 March 1997. When Mr Small failed to so comply, he committed an act of bankruptcy on that date.

In spite of this Mr Small made his third and final contribution in July 1997. The Federal Court held that this last payment belonged to the bankruptcy trustee under the relation back period set out in the section 120 and, consequently, Mr Small had no authority to pay it to the SMSF trustee.8 The Federal Court held that the SMSF trustee must be taken to have been aware of that lack of authority and, therefore, could not derive any title to the monies paid. Accordingly, by virtue of section 129(4), the payment to the SMSF trustee was recoverable by the bankruptcy trustee.

In contrast, as the first two contributions were made before the commencement of Mr Small’s relation back period, the bankruptcy trustee was required to argue that those contributions could be clawed-back under section 121 on the basis that either:

the main purpose behind Mr Small making the contributions was to prevent the money becoming divisible among his creditors: section 121(1)(b)(i); or

a reasonable inference could be drawn, at the time of the transfer, that Mr Small was or was about to become insolvent: section 121(2).

Mr Small and the SMSF trustee argued that the SMSF trustee had provided valuable consideration for the contributions by agreeing to deal with the payments in accordance with the SMSF governing rules and, therefore, the contributions were not void due to the operation of section 121(4). Considering the elements of the provision, including that:

the consideration for the transfer equalled the market value of the property; and

8 Due to the operation of s 115(1), Mr Small’s bankruptcy was deemed to have commenced on 14 March 1997. Accordingly, the amount represented by the third payment was deemed by section 58(1)(a) to have vested in the bankruptcy trustee.


the transferee (i.e. the SMSF trustee) did not know, and could not reasonably have inferred, that Mr Small’s main purpose was to prevent money becoming divisible amongst his creditors; and

the SMSF trustee could not reasonably have inferred that at the time of the transfer, Mr Small was (or was about to become) insolvent

the Court said that it could easily be found that the bankrupt had no reasonable defence to section 121 rendering the payments accessible to the bankruptcy trustee. The Court held that Mr Small had made the first two contributions to his SMSF at a time where it could readily to be inferred from all the circumstances that he was or was about to become insolvent. The Court noted that the legislative protection required a distinction between an interest in superannuation and payments (i.e. contributions) that were made to create that interest observing that “last minute” contributions did not constitute or create the type of superannuation interest which would be protected by section 116(2), observing:

There is a need to draw a distinction between an interest and a payment into a fund. I have little doubt that the protection provided for by s 116(2)(d)(iii)(A), operates in favour of any lawful interest in a regulated superannuation fund. However, the exemption of a wide range of superannuation interests from divisibility, along with a bankrupt's other property, amongst the creditors (subject to s 116(5)) applies to the interest. This does not exclude the potential for a payment to a superannuation fund to be caught by the relation back or avoidance provisions of the Act, even though that payment gives rise to the interest in the fund, which is protected. Such a payment is a transfer of property. The structure of Part VI of the Act is clear. Sections 120 and 121 deal with transfers. Section 116(2)(d)(iii) only protects superannuation interests which have arisen out of transfers of property prior to a person becoming a bankrupt that are not caught by s 121 as transactions to defeat creditors. If the Official Trustee can show that payment to a superannuation fund was, pursuant to the Act, void then the creditors are entitled to the benefit that flows from that.9

The Court also noted that the operation of section 121(4) resulted in a differentiation between voluntary and compulsory payments (such as employer and SG contributions) to superannuation funds. Compulsory payments cannot be voided where the transferee (eg an arm’s length employer) has acted in good faith, or was unaware of the contributor’s circumstances and provided consideration for the payments that were at least as valuable as the market value of the property transferred.10

9 (2001) 114 FCR 160 at paragraph 24 10 Section 121(4). See also Worrell v Kerr-Jones (2002) 190 ALR 146, where a payment made by a fund trustee to a bankrupt’s ex-wife in consequence of a divorce was not available to the husband’s bankruptcy trustee.


(b) Cook v Benson (Cook’s case)

In Cook v Benson,11 the valuable consideration argument was raised again before the High Court; albeit this time successfully. Briefly, the facts were:

Mr Benson had been employed by Industrial Sales and Service (Tas) Pty Ltd (ISAS) since 1972;

he was a trustee and member of his employer’s superannuation scheme;

ISAS ceased to carry on business on 20 April 1990 and went into liquidation in June 1990;

as a result Mr Benson’s employment was terminated and he consequently became entitled to a lump sum benefit of approximately $96,000 from the superannuation fund which was paid to him on 17 September 1990;

being in his forties at the time his employment was terminated and so many years for retirement age, he sought advice from a financial planner. He was advised that if he were to keep the lump sum, it would be taxed. However, if the benefits were 'rolled over' into another superannuation fund within the requisite period, the tax on any portion rolled over would be deferred;

in September 1990, Mr Benson chose to roll over $80,000 of his superannuation entitlements by directing that three payments, of $20,000, $40,000 and $20,000 respectively, be made to three public offer approved deposit funds (ADFs);

he was bankrupted on 21 July 1992, with a deemed commencement date of 18 September 1991.

Subject to certain exceptions, the then section 120 of the Bankruptcy Act allowed a trustee in bankruptcy to claw back any property disposed of by the bankrupt up to two years before the commencement of bankruptcy. One exception included where there was “a settlement … made in favour of a purchaser … in good faith and for valuable consideration'.12

The trustee of Mr Benson's bankrupt estate (Mr Cook) initially sought a declaration from the Federal Court that each of the three payments was void under the former section 120. Mr Cook also sued the corporate trustees of the three superannuation funds into which Mr Benson's superannuation entitlements had been rolled over, seeking orders that they

11 [2003] 114 CLR 370 12 The then section 120(1)(a)


repay the respective amounts they had received. And at first instance, Mr Cook was successful. The trial judge held that the exception in former section 120(1)(a) was not made out, and found in favour of the trustee in bankruptcy.

In a 2-1 decision, the Full Court of the Federal Court allowed an appeal by Mr Benson. Mr Cook appealed to the High Court. Ultimately, the High Court only had to consider two questions relating to former section 120(1)(a); whether the trustees of the superannuation funds:

were 'purchasers' of the contributions respectively paid to them at the direction of Mr Benson; and

had provided 'valuable consideration' to Mr Benson for his contributions.

If the rollovers failed either of these two elements, they were voidable transactions under section 120.

In a joint judgment, the majority (4-1) of the High Court found in favour of Mr Benson on both questions. On the question of whether the superannuation trustees were “purchasers”, the plurality found that the reference to “purchaser” in former section 120(1)(a) must be interpreted broadly and in a commercial sense that there is a quid pro quo rather than in the strict sense of a conveyance of property with a buyer and a seller.13

They also held that the superannuation trustees had also provided substantial and valuable consideration to Mr Benson for his contributions by undertaking to provide him with the rights and benefits to which he would, in due course, become entitled under the rules of each superannuation fund. 14

In a dissenting judgment, Justice Kirby held that the corporate respondents were not 'purchasers' of the money sum of $80,000 divided into three lots, and further held that no 'valuable consideration' was given for any purchase of those sums of money as such.

2.4 Bankruptcy rules affecting contributions

(a) What entitlements are protected

Cook v Benson was the catalyst for amendments to Subdivision B of Division 3 of Part VI of the Bankruptcy Act in 2006 to prevent high-income earners using bankruptcy as a way to avoid their tax and other debts and to

13 [2003] 114 CLR 370 at paragraphs [31] to [38] 14 [2003] 114 CLR 370 at paragraph [62]


prevent abuse of bankruptcy laws by manipulating superannuation payments.

Subdivision B enables a bankruptcy trustee to recover contributions made with the intent or deemed intent to defeat a bankrupt's creditors. The subdivision applies to contributions made by the member or by a third party such as a member’s employer where the employer is party to a scheme to make the contributions with the main purpose of defeating creditors.

Until 1 July 2007, the protection afforded to superannuation entitlements from the trustee was capped.15 The cap was equal to the person’s pension reasonable benefits limit (RBL) being $1,356,291 for the 2007 financial year.16 When former section 116(5) of the Act was repealed by the Superannuation Legislation Amendment (Simplification) Act 2007, it meant that the pension RBL threshold was removed and the bankrupt’s entire superannuation interest was excluded from being property divisible amongst his or her creditors. Superannuation became an even more attractive vehicle for asset protection and tax concessions.

To guard against the abuse of the generous carve out given to superannuation by section 116(2), a number of anti-avoidance measures were introduced. In particular, two types of superannuation contributions are recoverable:

those made to an eligible superannuation plan17 by the bankrupt; and

those made for the benefit of the bankrupt who is party to the scheme under which the contribution is made,18

where the main purpose of making the contribution was to prevent the transferred property becoming divisible among the transferor’s creditors or to hinder or delay the process of making property available for division among the transferor’s creditors.19

15 Former section 116(5)(b) 16 RBLs were the maximum amount of concessionally taxed superannuation benefits that a person could receive over his or her lifetime. Generally, there were two RBLs; a lump sum RBL and a pension RBL. The pension RBL was set at twice the lump sum RBL to encourage members to take their benefits in the form of an income stream. 17 Eligible superannuation plan is defined as an approved deposit fund, an RSA, a regulated superannuation fund and a public sector superannuation scheme, with the latter two funds having the same meaning as in the SIS Act. 18 A contribution paid by a third party in the event of the death of a person is disregarded under section 128C(2). 19 Sections 128B(1)(c) and 128C(1)(e)


A trustee-in-bankruptcy is able to commence recovery proceedings in respect of these two types of contributions at any time, provided that the transfer occurred on or after 28 July 2006.20

(b) Main purpose of making the contribution

When looking at the main purpose of the contributions two things may be taken into account; the member’s solvency at the time the contribution was made and any pattern of contributions. A court can infer that there was an intention to defeat creditors where the circumstances surrounding the contribution reasonably show that at the time it was made the person was (or was about to become) insolvent.

Courts may also consider the pattern of contributions to determine whether the contributions in question are out of character.

Moreover, scheme is broadly defined in the legislation to catch any type of arrangement that a person may enter into to convert property directly payable to them into a superannuation asset or benefit prior to their bankruptcy.21 That is, the nature of these contributions distinguishes them from superannuation contributions made under existing superannuation arrangements (e.g. employer contributions under an existing employment agreement or in discharge of Superannuation Guarantee obligations, as these contributions remain protected).

Few indications have been provided as to how a pattern of superannuation contributions might be established or when a contribution may be regarded as ‘out of character’.22 The Second Reading Speech to the Bankruptcy Legislation Amendment (Superannuation Contributions) Bill 2006 offers the example of a contribution by a bankrupt who has no history of making substantial superannuation contributions but made such a contribution shortly before becoming bankrupt.

How this example might fit in with the large, one-off and irregular contributions permitted under the tax legislation is anyone’s guess, e.g. the CGT Exempt amount of up to $1 million, the non-concessional cap and bring-forward rule allowing up to $540,000 to be contributed in any one financial year in respect of a member who is under 65 years. Whether or not such a contribution will be seen as out of character and made available to the bankruptcy trustee ultimately depends on the court’s interpretation of the legislation.

20 Sections 128B(1)(d), 128C(1)(f) and 128D 21 See definition under s 128N and para 47 of the Explanatory Memorandum to the Superannuation Contributions Bill. 22 Statute Law Revision Bill (No.2) 2006, Second Reading, 6 December 2006.


It should be noted that ‘out of character’ contributions are not automatically assumed to have been made with the intention to defeat creditors. However, ‘out of character’ contributions may need to be explained to the court to prove that they were not made with the intention to defeat creditors.

The contribution caps, particularly the bring-forward rule, may assist in explaining why a large one-off contribution was made without having an intention to defeat creditors.

(c) When contributions are void

The whole of a contribution is void if it is found to be in breach of section 128B or 128C and, in addition to enabling courts to make orders for the repayment of void contributions by eligible superannuation plan trustees, the recovery powers exercisable by the Official Receiver include the power to issue notices directing fund trustees holding void contributions to forward them to the bankruptcy trustee.23

The Official Receiver is also authorised to issue a superannuation account ‘freezing’ order against an eligible superannuation plan in circumstances where there are reasonable grounds for believing that the contribution has been made with the intention of defeating creditors, either in whole or part.24 A freezing order may prevent the trustee from cashing, debiting, rolling over, transferring or forfeiting the superannuation benefit and will be revoked when, amongst other things, the void contribution is repaid or 180 days pass after the freezing order was issued.25

A trustee is entitled to recover the gross amount of the contribution paid into the eligible superannuation plan, less any fees and charges associated with the contribution or any taxes it has paid in relation to it.26 Where fees, charges and taxes have been debited, the bankruptcy trustee must refund the eligible superannuation plan any such amounts.27

23 See section 139ZQ. Additionally, section 139ZU is available against multiple trustees where a contribution has been rolled over or transferred to one or more funds. 24 Section 128E 25 Section 128F 26 Sections 128B(5A) and 128C(7A) 27 The Insolvency and Trustee Service of Australia has however indicated that a net amount will be accepted by the bankruptcy trustee or the Official Receiver (leaving aside fees and charges already deducted by the superannuation trustee) as an amount complying with a notice under section 139ZQ, see Department of Parliamentary Services, Bills Digest, 13 February 2007, no. 91, 2006-07: 10


(d) $1.6m transfer balance cap

From 1 July 2017, there will be a $1.6 million cap28 on the total value of a superannuation interests that can be used to support an individual’s retirement income stream29 (i.e. that can be transferred from a concessionally taxed accumulation account into a tax free retirement account from which the pension payments are drawn).

The cap is introduced by new Division 294 of the Income Tax Assessment Act 1997 which requires the creation of a transfer balance account and sets out a series of rules relating to credits and debits to that account.

From a bankruptcy perspective, it is important to consider the impact that void transactions30 may have on the transfer balance account. Where the value of the superannuation interest supporting the retirement income stream is reduced because of payments required to comply with a notice under section 139ZQ of the Bankruptcy Act, the individual is able to notify the Commissioner of Taxation (Commissioner) and receive a debit in their transfer balance account to the value of the reduction.31 There is no time limit within which the Commissioner needs to be notified.

The following case study is derived from the Explanatory Memorandum to the enacting legislation.32

Debits for void transactions

SMSF

During his 30 years as a partner in his accounting firm, Charlie had only made modest concessional contributions and no non-concessional contributions.

For the most part, Charlie’s practice had been successful but in the last few years, in particular, it had been struggling and Charlie was concerned about its ongoing viability and his ability to save enough for his retirement.

Given he was close to retirement, in the 2019 financial year, he makes the maximum amount of superannuation contributions allowed, being $25,000 of concessional contributions and $300,000 of non-concessional contributions to his SMSF.

He also finds an eager but naïve young accountant called Alana Bond, and sells his business to her for a princely sum; taking advantage of the CGT

28 Section 294-35(3) of the Income Tax Assessment Act 1997 29 Section 294-5 of the Income Tax Assessment Act 1997 30 That is, contributions voided under Subdivision B. 31 Item 3 in the Table in section 294-80(1) and 294-85(5) to (7) of the Income Tax Assessment Act 1997 32 See example 1.10 in the Explanatory Memorandum to the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016


retirement exemption to make further substantial contributions for his retirement.

As we know, Charlie and Cammie’s SMSF has assets in total of $1.5 million. Charlie’s account balance is $1.2 million and is mostly a tax-free component as it was funded by way of a CGT retirement contribution from the sale of his interest in his accounting business.

Cammie’s entire SMSF account balance represents the proceeds from the sale of her interest in a service company used by Charlie’s accounting firm. She did not make any other contributions to the SMSF due to her membership of a State government superannuation scheme.

Both Charlie and Cammie are individual trustees of their SMSF.

Charlie decides retires and commences a superannuation income stream of $1.2 million on 1 July 2019 with his entire superannuation interests, meaning his transfer balance account is also $1.2 million. Shortly after, Charlie files for bankruptcy to stave of his creditors and, notwithstanding his claim that the additional funds were for his retirement, it is determined that the $325,000 contributed in the 2019 financial year were out of character contributions made to defeat the creditors of his business.

The trustee of Charlie’s superannuation fund pays to the bankrupt estate $325,000 as required under the Bankruptcy Act. Charlie notifies the Commissioner that the superannuation interest that supports his superannuation income stream has been reduced by $325,000 because of the payment to comply with the Bankruptcy Act. His transfer balance account is then debited $325,000 reducing it to $875,000.

Importantly, these new rules have not reintroduced a de facto cap on the amount of superannuation entitlements that are protected by the operation of section 116(2).33 Accordingly, amounts attributable to both the pension and accumulation accounts will remain unavailable to a bankruptcy trustee.

2.5 Are ATO garnishee orders different?

So far, we’ve examined when existing superannuation entitlements are protected from the bankruptcy trustee and the circumstances in which payments giving rise to superannuation interests can be voided. Both of these require a consideration of the bankrupt’s circumstances at a particular point in time.

However, it is also possible to garnish a debtor’s future superannuation interest. On this point, the ATO has adopted a robust stance, asserting that it can serve such notices on superannuation funds requesting that payments be made to it in lump sums. Prima facie, this seems to conflict with the exemption to property which is divisible amongst creditors that applies to lump sum superannuation benefits.

33 See section 2.4(a) of this paper referring to the cap previously imposed by the pension RBL.


Subdivision 260-A Schedule 1 to the Taxation Administration Act 1953 (TAA) allows the Commissioner to collect debts, including amounts in respect of a tax-related liability of a taxpayer debtor, from third parties.

Under section 260-5(3) of TAA, a third party may be deemed to owe money to the debtor (i.e. taxpayer) if that third party:

is an entity by whom the money is due or accruing to the debtor; or

holds the money for or on account of the debtor; or

holds the money on account of some other entity for payment to the debtor; or

has authority from some other entity to pay the money to the debtor.

The trustee is taken to owe the money to the taxpayer-debtor even if:

the money is not due, or is not so held, or payable under the authority, unless a condition is fulfilled; and

the condition has not been fulfilled.

Accordingly, for a garnishee notice to be effective, the ATO must show that the fund trustee on whom the notice is served holds an amount that is owing or may later be owing to the taxpayer. A failure to pay the relevant amount to the Commissioner in accordance with a valid garnishee notice is a criminal offence and a recalcitrant fund trustee may be held liable for the full amount claimed under the notice.34

(a) Denlay’s case – a false dawn

In Denlay v Commissioner of Taxation (Denlay),35 the Commissioner tried to access Mr Denlay’s superannuation entitlements to satisfy his personal tax liabilities, even though Mr Denlay’s bankruptcy was imminent.

Mr and Mrs Denlay came to the attention of the ATO as part of Project Wickenby. An ATO audit in 2007 uncovered that they had significant undeclared assets in Liechtenstein that the ATO believed had been generated from the sale of assets and business activities carried on in Australia. The Commissioner issued amended assessments for the 2002 to 2007 income years, including significant administrative penalties.

Mr and Mrs Denlay challenged their amended assessments in the Federal Court. Before the Federal Court appeal was finalised, the Commissioner

34 Sections 260-15 and 260-20 Schedule 1 of the TAA 35 [2013] FCA 307


also issued proceedings in the Queensland Supreme Court seeking and obtaining judgment against the taxpayers for their personal tax debts.

The Supreme Court stayed the enforcement of the judgment until the outcome of the Federal Court income tax appeals (in light of evidence that, amongst other things, the taxpayers were highly likely to be bankrupted, had limited funds for their daily living expenses or to pursue the Federal Court appeals and that this might defeat an otherwise meritorious appeal.) The Commissioner challenged the stay, and was unsuccessful.

Frustrated by the stay order, and having become aware of the Denlays’ interests in their SMSF, the Commissioner issued a garnishee notice on the custodian of the SMSF assets on the basis that:

the Denlays’ net assets in Australia had been recently and significantly diminished;

the reduction of these funds presented a ‘substantial' risk to the revenue; and

the Commissioner had formed the view that the taxpayers probably still had access to money outside Australia.

The Denlays applied for judicial review of the decision to issue the garnishee notice claiming it was an improper exercise of the Commissioner’s power. The Federal Court agreed, overturning the notice, noting that:

The decision to issue the notice was so unreasonable that no decision-maker, acting reasonably, could have so decided.

In the circumstances, the egregious nature of the ATO’s tactics was not only counterproductive but caused one observer to opine that the Commissioner might be prosecuted for contempt of court because following his unsuccessful challenge to stay the enforcement of the judgment debt, such orders were ultimately agreed to by consent.36

Clearly, the Commissioner has discretion to issue a garnishee notice in respect of a debtor’s superannuation interest, but before making such a decision, he must take into account relevant matters and not take into account irrelevant matters. The Court held the Commissioner did not consider the impact of the notice on the ability of the Denlays to continue their appeal against the amended assessments.

Although the Federal Court quashed the garnishee notice in this case, this was largely due to the specific facts; it did not resolve the fundamental

36 http://www.afr.com/news/policy/tax/ato-prevents-couple-making-their-case-20120205-i3ojr

http://www.afr.com/news/policy/tax/ato-prevents-couple-making-their-case-20120205-i3ojr


issue of whether a garnishee notice can attach to a debtor’s superannuation interests or whether those interests are protected by section 116(2). In fact, the Court noted that this was not an issue it was required to determine:

I note, in passing only, because it was not submitted to be a relevant consideration or a feature of why the decision was said to be unreasonable, that the decision-maker has not at all considered whether any of the funds garnered by the s 260-5 notices from BT Funds Management Ltd would, having regard to s 116(2)(d)(iii) of the Bankruptcy Act 1966 (Cth), have formed part of the property of the bankrupt estates of Mr and Mrs Denlay in the event that the Commissioner were successful in any future sequestration application.37

(b) ATO policy

Does this mean the Commissioner will back off from garnishing superannuation interests? Unlikely. In Practice Statement Law Administration PSLA 2011/18, the Commissioner states:

A garnishee notice in respect of any tax-related liabilities may be served on a superannuation fund but it will not be effective until the debtor's (member's) benefits are payable under the rules of the fund (for example, the debtor retires or dies). A notice served on the fund will generally request payment as a lump sum unless the anticipated retirement income stream can guarantee repayment within a satisfactory period of time.38

Moreover, in his Decision Impact Statement for Denlay,39 the Commissioner states he will continue to apply PSLA 2011/18 in pursuing tax debts although where “a tax debtor is appealing to a tribunal or court against the assessments that raised the debt, the Commissioner will consider whether a garnishee would significantly prejudice the tax debtor's rights in pursuing those appeals.”40

The Decision Impact Statement also states that ATO officers will also take into account the daily living expenses of taxpayers in determining whether to garnishee.

(c) Nature of a member’s interest

If a garnishee notice is effective, it would appear that the Commissioner is prepared to wait until the debtor’s superannuation entitlements become payable; possibly decades if he wishes to wait for the debtor to retire or die! Accordingly, to determine the efficacy of a garnishee notice, one must first

37 [2013] FCA 307 para [58] 38 Paragraph 118 of PSLA 2011/18 39 http://law.ato.gov.au/atolaw/view.htm?docid=LIT/ICD/QUD114of2012%3BQUD115of2012/00001 40 PS LA 2011/18 at paragraph 112

http://law.ato.gov.au/atolaw/view.htm?docid=LIT/ICD/QUD114of2012%3BQUD115of2012/00001


establish when a superannuation entitlement is due and payable. That requires a consideration of the nature of a member’s interest in the fund and the basis on which that interest is held and payable.

As a starting point, I would refer you to the excellent paper by Hill J41 which contains the following introductory remarks:

Superannuation schemes may take many forms and the form may dictate the nature of the members’ interests. Statutory schemes apart, a superannuation fund will generally be a trust and the interest of a member a beneficial interest in that trust estate. Depending on the scheme a member's interest may be vested, contingent or merely a right to be considered for benefits by the trustee. While there may be a contract between the member and employer to provide the benefits it is not normal for there to be an enforceable contract between the member and the trustee and in any case the contract right may merge in the trust interest. The general law position is to be effected in the area of family law and is affected now in bankruptcy cases. There have been cases in the United Kingdom and Australia which put emphasis on contractual rights but there is a difficulty in the analysis, particularly in the question what consideration there is between the member and the trustee. The better view will usually be that the beneficiary's interest lies in trust even where some contractual relationship might be made out. In Canada it was suggested that a superannuation deed is really a purchase trust. That suggestion has now been disowned by the Canadian courts in favour of the view that there is normally at least, a trust for beneficiaries.

The contrary view – that the interest of the member is a mere expectancy is demonstrated by the Federal Court’s decision in Re Coram: ex parte Official Trustee in Bankruptcy v Inglis,42 where Gzell J noted:

… the present right of a member of a superannuation fund is no more than an expectancy. His entitlements are all in the future and are all dependent upon the happening of a prescribed event, of which the most common was the attainment of an agreed retirement age.

With respect to Gzell J, the nature of a member’s superannuation interest is not a mere expectancy or a contingent interest and, given the number of contradictory curial decisions, I believe that view has now been discredited. Subject to a fund’s trust deed, a member will usually have a vested interest to the amount standing to his or her credit in the member’s account. Unless and until a condition of release is triggered, the member's interest is vested-in-interest but not in possession because the member has a future right to those benefits.

The superannuation interest is vested-in-interest rather than a contingent interest because the member has a present legal right to those benefits at

41 The True Nature of A Member's Interest In A Superannuation Fund – the Honourable Justice Graham Hill, a paper delivered at the Law Council Superannuation Conference, Adelaide 20-23 February 2002 42 (1992) 36 FCR 250 at paragraph 13


some point in the future when certain events will occur as distinct from the member having no right to those benefits unless a certain event occurs. If the latter were the case, it would not be possible for members to transfer their interests between funds, amongst other things.

Given the view expressed above, if the debtor’s superannuation entitlements are vested (albeit only vested in interest), could the Commissioner call for the superannuation entitlements to be paid to him before a condition of release is triggered? A fairly clever argument was considered (but dismissed) in In Re John Sloane Kirkland; Ex Parte: Official Trustee in Bankruptcy.43 The bankruptcy trustee for Mr Kirkland sought payment of his superannuation entitlements in his employer’s superannuation fund before Mr Kirkland had satisfied a condition of release; the argument’s basis being that his superannuation entitlements had unconditionally vested in Mr Kirkland and that, accordingly, he could call for their immediate payment under the rule in Saunders v Vautier.44

Ultimately, the Court held that the rule in Saunders v Vautier did not apply to superannuation funds before a condition of release had been triggered because the legislative regime governing superannuation funds in Australia restricts the access that members have to their entitlements in order to ensure, amongst other things, that those entitlements will be available on the member’s retirement. Put simply, a Court will not put a creditor in a better position than the bankrupt.

When a condition of release is met, giving the member a right to call for payment of their benefits which is exercised, the member's interest becomes vested-in-possession because now the member has an indefeasible right to present enjoyment of those benefits. The benefits cannot be vested defeasible interests because Regulation 13.16 of the SIS Regulations prohibits adversely altering a member’s benefits. Accordingly, in this case, a garnishee notice attaching to a member’s superannuation entitlements would have to be satisfied by the fund trustee.

Not all fund assets are affected by garnishee notices because they only attach to money held by third parties, such as cash held by a fund trustee. Where the debtor’s benefits are held in a public offer fund, subject to the trust deed, the trustee is likely to have sufficient cash reserves to satisfy a garnishee notice. In an SMSF context, the amount of cash held may result in the whole or only part of the garnishee order being satisfied.

The effect of the SIS Regulations conditions of release may well be overridden if the fund’s trust deed contains rules that delay the timing of the payment of a benefit.

43 [1997] FCA 684 44 (1841) Cr & Ph 240, 49 ER 282


(d) Are all benefits affected?

The preceding analysis begs the question whether a potential beneficiary of a member’s interest may have the sort of interest which could defeat creditors.

For example, we noted earlier that if a bankrupt pensioner is receiving a pension income stream from a superannuation fund, the pension is not protected under section 116(2). However, if the terms of the pension contained an automatic reversionary pension to another person, then it seems unlikely that a bankruptcy trustee would have any further interest after the bankrupt pensioner dies.

Moreover, the nature of death benefits payable after the debtor’s death raises some interesting questions. After death, are those death benefits property of the debtor and, therefore, subject to a garnishee order. If so, that would mean that the debtor’s dependants could miss out.

Where the member has not nominated dependants or has prepared a non-binding nomination leaving the fund trustee with the discretion to whom to distribute the member’s death benefits, it is arguable that a garnishee notice is able to attach to those benefits. However, to the extent that the fund assets do not consist of cash, the garnishee notice may not be completely effective. Of course, this is more relevant in the context of a SMSF.

What is the effect of a binding death benefit nomination? Does it create a vested interest for a beneficiary in the member’s entitlements such as to defeat a garnishee notice? In my view, that depends on whether the binding nomination is revocable. If the binding nomination is revocable, it is no different to an interest which is contingent or a mere expectancy.

However, if the binding nomination is irrevocable and was made prior to the garnishee notice attaching to the fund, it is arguable that it is a vested defeasible interest of that beneficiary because that interest cannot be revoked but can be brought to an end if, for example, the beneficiary predeceased the member debtor.


3 Ranking employee super in liquidation, voluntary administration, receivership

3.1 Background

As the administrator of the superannuation guarantee (SG) scheme, the ATO has outlined for taxation professionals how superannuation affects various insolvency administrations.45

Under the Superannuation Guarantee (Administration) Act 1992 (SG Act), employers are required to provide a prescribed minimum level of superannuation support for their employees in each quarter. Failure to do so in a timely manner results in the employer being liable to pay a tax known as the Charge.46 The Charge is equivalent to the total of the individual employee shortfalls plus the administration component plus the nominal interest component.47

Apart from the administration component, amounts recovered by the ATO must be paid to a superannuation fund for the benefit of the employee in the same way as if the employer had made the required contribution.

In respect of the Charge, an employee is not a creditor of the company. It is the Commonwealth that has a debt due and owing and the Commissioner must take steps to recover the debt. Therefore, in order to recover any outstanding SG contributions, the company’s failure to pay the Charge must be reported to the ATO.

That, at least, is the theory. In reality, the ATO has limited resources and the process can be tedious and time consuming given that it can require each affected employee to make an individual complaint. In that respect, the SG system has a number of limitations in the enforcement of employers’ superannuation obligations:

it has been estimated that, in the 11-year period to March 2010, the difference between the Charge raised and collected is almost $1 billion. Of this, approximately $600 million has not been recovered, with most of this debt having been written-off. These amounts represent known SG Act non-compliance; actual non-compliance is estimated to be much higher with the least empowered employees most at risk;48

45 https://www.ato.gov.au/tax-professionals/your-practice/insolvency-practitioners/superannuation-and-insolvency/ 46 Section 6 of the Superannuation Guarantee Charge Act 1992 47 Section 17 SG Act 48 Chapter 2 of the Review into the Australian Taxation Office’s administration of the Superannuation Guarantee Charge – A Report to the Assistant Treasurer by the Inspector-General of Taxation (March 2010)

https://www.ato.gov.au/tax-professionals/your-practice/insolvency-practitioners/superannuation-and-insolvency/https://www.ato.gov.au/tax-professionals/your-practice/insolvency-practitioners/superannuation-and-insolvency/


contributions made under an effective salary sacrifice arrangement49 are regarded as employer contributions and, therefore, are taken into account in determining whether an employer has complied with its obligations under the SG Act. This means that the employee’s salary sacrificed contributions (intended to be extra contributions) subsidize the employer’s SG Act obligations by reducing or eliminating the Charge Percentage. If the employer’s superannuation obligations exceed its SG Act obligations, the excess is not recoverable by the ATO as it does not represent a tax liability owed by the employer. This limitation was recognized as far back as March 2002 by the Superannuation Working Group which recommended that the Government specify a timeframe within which salary sacrificed contributions should be paid to a superannuation fund for the employee;50

the Charge is only enforceable by the ATO as a tax liability owed by the employer. Whilst an employee may complain to the ATO requesting that it investigate whether there is a shortfall, they must find another avenue of enforcement. There is a gap in the ATO rulings and administration system that does not permit the ATO to make public rulings on superannuation issues or superannuation guarantee issues.

More recently, the Inspector-General of Taxation undertook a Review into the ATO’s employer obligations compliance activities. The terms of reference and submission guidelines noted in relation to SG that:

(a) approximately, 97% of businesses identified as small businesses with turnovers of under $2million;

(b) in the 2015 financial year, more than $79.19 billion in contributions was paid to employees’ superannuation funds;51

(c) SG is an important element of the broader taxation and superannuation system where non-compliance adversely impacts retirement savings resulting in increased reliance on the aged pension as well as an uneven commercial playing field between competitors in the same industry;

(d) during consultations, a range of stakeholders raised particular concerns with the Inspector-General regarding the ATO’s approach to employer compliance with taxation and superannuation obligations, including: (i) the difficulty and uncertainty in determining employee or independent

contractor status;

(ii) SG non-compliance due to difficulties in ATO detection and enforcement as well as limited ability of employees to take direct action for unpaid

49 An effective salary sacrifice arrangement is a contractual agreement between an employer and an employee where the employee agrees to forego part of his or her future salary or wages in return for the employer providing benefits of a similar value. 50 See Recommendation 28 of the Report of the Superannuation Working Group on Options for Improving the Safety of Superannuation – 28 March 2002. 51 ATO, Taxation statistics 2012-13 (4 May 2015)


SG. There is also a lack of ATO feedback to employees who report potential employer non-compliance. In the last five financial years, the ATO has raised a total of $2.97 billion in unpaid SG liabilities and collected a total of $1.59 billion.9 Further liabilities may remain undetected as the ATO relies more on employee notifications than proactive risk-based audits;10

(iii) unnecessary compliance costs for employers arising from ATO conduct during compliance activities. These include onerous information requests to employers, Director Penalty Notices (DPN) being issued in inappropriate circumstances, unwillingness to discuss issues and practical solutions;

(iv) aspects of the penalty regimes, particularly with respect to the Charge, not adequately promoting voluntary compliance or self–reporting of non-compliance. However, it should be noted that the Government has recently concluded consultation on proposed legislation to simplify and reduce the harshness that may result from imposition of interest and penalties with respect to the Charge.11

(v) ‘phoenixing’, which involve companies being deliberately placed into administration or liquidation, leaving taxes and employee entitlements unpaid. The review will also examine the effectiveness of ATO actions to address these phoenix activities.

3.2 New employer notice requirements

There have been a number of important developments in relation to the SG Act including the manner in which employees are notified about proposed and actual employer superannuation contributions.

(a) Stronger Super – Cooper Review

The starting point is Recommendation 9.16 in the Cooper Review which provided that relevant legislation should be amended:

(vi) to require employers to remit salary sacrificed and SG Act contributions no less frequently than required to remit member’s after-tax contributions;

(vii) to adjust the timing of payment of SG Act contributions after SuperStream has been implemented so that SG payments align with employers’ payroll cycles;

(viii) to require employers to report on each payslip issued to employees the amount of superannuation to be paid to the employees’ funds and

http://igt.gov.au/publications/reports-of-reviews/atos-approach-to-employer-obligations-compliance-activities/#P32_5493http://igt.gov.au/publications/reports-of-reviews/atos-approach-to-employer-obligations-compliance-activities/#P33_5791http://igt.gov.au/publications/reports-of-reviews/atos-approach-to-employer-obligations-compliance-activities/#P36_6592


whether the contributions related to SG, salary sacrificed or after tax contributions;

(ix) to nominate the ATO as the sole regulator generally responsible for compliance with all aspects of superannuation contributions other than those relating to compliance with industry awards. APRA is to retain responsibility for overseeing solvency of defined benefit plans and any action needed to restore a defined benefit fund to a satisfactory financial position; and

(x) where an employee makes a complaint that an employer is not meeting an SG Act obligation, to allow the ATO to assess the employer’s compliance for all employees in the particular workplace and not only the complainant.

However, most of these recommendations and proposals have either not been implemented or have been implemented in a diluted manner.

In relation to SuperStream – the package of measures designed to enhance the back office of superannuation – there is no requirement to notify an employee whether and to what extent their employer has paid any superannuation contributions for them.

(b) Employer must give information about contributions

In the 2011/2012 Federal Budget, the then Federal Government announced that it would introduce measures to require employers to report certain information about superannuation contributions on their pay slips.

Until then, employers had only been required to report on pay slips what entitlements to superannuation had accrued during the pay period or actual contributions paid. There was no requirement to distinguish between the two. That meant employees were unable to determine from their pay slips whether the contributions had actually been paid or, if not, when they would be paid.

With the enactment of the Tax and Superannuation Laws Amendment (2012 Measures No. 1) Act 2012, a new Part 29B to the SIS Act was introduced from 1 July 2013 obligating employers who were required to issue pay slips under an industrial agreement to report on their employees’ pay slips any information prescribed in the SIS Regulations about superannuation contributions.

Regulations 3.37 and 3.46 of the Fair Work Regulations 2009, in turn, requires employers to keep records and report on the amount of superannuation contributions paid or the date on which the employers


expect to pay their contributions.52 This is intended to allow timelier checking of information by the employee with their superannuation fund.

Ultimately, the commencement of the initiatives outlined in Part 29B was delays and then repealed within a few years due to its limited coverage; there were a significant number of employees to whom those requirements do not apply, such as public sector employers in a number of states or partnerships, sole traders and other unincorporated entities who joined the national workplace relations systems through the States’ referral of powers. However, the reporting obligations under the Fair Work legislation remain.

Nevertheless, the reporting obligations under the Fair Work legislation remain. Responsibility for administering and enforcing the pay slip provisions is given to the Fair Work Ombudsman and Fair Work Inspectors who are empowered and authorised to disclose information to the Minister responsible.

Finally, although some thought was given to requiring APRA regulated funds either:

(i) to notify members that they have received or not received contributions during the quarter, and maintain a web-portal for members to consult; or

(ii) to issue six monthly notices to members with active accounts which show contributions made,

this proposal was never progressed.

3.3 Employer is a company

(a) Ranking of employee entitlements on liquidation

The Corporations Act 2001 (Corporations Act) sets out a list of priority debts and claims to be paid in priority to all other unsecured debts and claims in the winding up of a company.53

Unless an employee is an excluded employee,54 all wages, superannuation contributions and the Charge payable by the company in respect of services rendered to the company by the employees before the day on

52 The primary employer obligation in relation to employee records arises in section 535(1) of the Fair Work Act 2009. 53 Section 556(1) of the Corporations Act 54 Defined in section 556(2) of the Corporations Act as a director of the company (or the spouse or a relative of the director) within the previous twelve months. Where an employee is an excluded employee, the amount recoverable by the excluded employee is capped.


which the company is wound up will form part of the debts and claims payable in priority to all other unsecured debts.55

Employee entitlements are not first ranking – they rank behind secured creditors, expenses properly incurred by the liquidator, costs in respect of winding up applications in involuntary liquidation, expenses for which an administrator is entitled to be indemnified, expenses properly incurred by an official manager, the costs of various reports and audits required by the Corporations Act, the fees of the liquidator and any other relevant authority and expenses incurred by a committee of inspection.

The total amount of a claim for the wages, superannuation contributions and Charge payable in respect of an excluded employee is also a priority to the extent of the first $2,000 claimed. Any amount exceeding $2,000 ranks with unsecured creditors. 56

Where there are sufficient moneys available to meet priority claims, employees are entitled to receive priority payment for all wages, superannuation contributions, leave entitlements and retrenchment payouts owing to them.57 In other words, there is no cap on priority amounts due to employees.

(b) Deeds of company arrangement

All deeds of company arrangement must contain a provision to the effect that any ‘eligible employee creditor’ will be entitled to a priority at least equal to what they would have been entitled had there been a winding up.58

An ‘eligible employee creditor’ is defined to include a creditor whose debt or claim would, in a winding up of the company, be payable in priority to other unsecured debts and claims in accordance with section 556(1)(e) of the Corporations Act which deals with the priority ranking for payment of wages, superannuation contributions and SG charge discussed above. The ATO’s claim for the SG charge, therefore, falls within this definition.

Generally, eligible employee creditors will be paid in priority to other unsecured creditors ahead of any priority that otherwise might be enjoyed by a charge holder. An exception to this is where affected employees pass a resolution at a meeting, convened in accordance with section 439A of the Corporations Act, agreeing to the non-inclusion of such a provision. This is provided that the notice informing the eligible employee creditors of such a meeting is accompanied by a copy of a statement setting out, amongst other things, the administrator's opinion whether the non-inclusion of such

55 Section 556(1)(e) of the Corporations Act 56 Section 556(1A) of the Corporations Act 57 Section 596AA of the Corporations Act 58 Section 444DA(1) of the Corporations Act


a provision would be likely to result in the same or a better outcome for eligible employee creditors as a whole than would result from an immediate winding up of the company.

(c) Receivership

By virtue of the Charge being a priority debt in section 556(1)(e) of the Corporations Act, the Charge will obtain a priority in a receivership. In effect this means that the receiver must pay the priority debt out of company property that comes in his or her possession or control.59

(d) Proof of debt

The administrator of a deed of company arrangement must prefer a proof of debt for the Charge to a proof of debt for unpaid superannuation contributions and all deeds of company arrangement must contain a provision to that effect.60 This is because the Charge includes an interest component that provides employees a greater benefit.

(e) Application of dividend payments

If there is more than one benefiting employee, separate shortfall components are worked out for each of the benefiting employees.

The Commissioner has a discretion to vary an employee’s proportion of an amount to take account of special circumstances, for example, in the case of an excluded employee under section 556(1A) of the Corporations Act or under section 109(1)(e) of the Bankruptcy Act in the case of an employee.

(f) Fair Entitlements Guarantee

Some employees may be eligible for financial assistance to cover certain unpaid employment entitlements to eligible employees who lose their job due to the liquidation or bankruptcy of their employer.

In 2012, the Government introduced the current form of the legislative scheme called the Fair Entitlements Guarantee (FEG) under the Fair Entitlements Guarantee Act 2012 (FEG Act). The FEG replaced a previous scheme called the Government Employee Entitlements and Redundancy Scheme (GEERS).

GEERS will continue to apply to outstanding employee entitlements relating to employer insolvencies prior to 5 December 2012. Employees may be eligible to receive payment for amounts deducted from wages (like

59 Section 433(3)(c) of the Corporations Act 60 Section 444DB of the Corporations Act


employee superannuation contributions that were not passed on to a superannuation fund), up to three months prior to insolvency.

FEG applies if their employer went bankrupt or entered liquidation on or after 5 December 2012. FEG is a legislative safety net scheme of last resort, with assistance available for:

wages – up to 13 weeks of unpaid wages61;

annual leave62;

long service leave63;

payment in lieu of notice—maximum of 5 weeks64;

redundancy pay—maximum of 4 weeks per full year of service65.

To be eligible for FEG assistance, former employees must meet all of the eligibility requirements outlined in the FEG Act.66

Relevantly, the FEG does not cover unpaid employer superannuation contributions required under the SG legislation.

3.4 Employer is individual (sole trader or partner)

(a) Bankruptcy

Before a bankruptcy trustee can apply the proceeds of the property of the bankrupt to any other payments, the trustee must apply those proceeds in payment of amounts due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages or commission or otherwise, for services rendered to the bankrupt before the date of the bankruptcy.67

However, the maximum amount payable is limited to an amount not exceeding $4,400 for the 2017 income year. 68

The Charge is included in the category of employee entitlements including salary, wages or commission.

(b) Part IX and X arrangements 61 Sections and 24 of the FEG Act 62 Section 20 of the FEG Act 63 Section 21 of the FEG Act 64 Section 22 of the FEG Act 65 Section 23 of the FEG Act 66 The basic eligibility requirements are set out in section 10 of the FEG Act 67 Section 109(1)(e) of the Bankruptcy Act and regulation 6.01 of the Bankruptcy Regulations 1996 68 Regulation 6.02 of the Bankruptcy Regulations 1996


The Charge is not afforded a priority in arrangements made pursuant to Parts IX and X of the Bankruptcy Act.

However, since the Commissioner can vote against a deed that does not provide priority for Charge (thereby causing bankruptcy), trustees often include a clause in the deed that gives the Charge a similar priority to that which it would have received in bankruptcy.69

(c) Directors personally liable

From 1 July 2012, directors may be personally liable for their company’s unpaid SG contributions. This new measure was part of the former government's broader Protecting Workers' Entitlements Package and was intended to deter company directors from engaging in phoenix activities or using amounts for company or other purposes that should be paid to the Commissioner of Taxation or superannuation funds.

Introduced with the Pay As You Go Withholding Non-compliance Tax Act 2012, the Tax Laws Amendment (2012 Measures No. 2) Act 2012 amends the Taxation Administration Act 1953, amongst other things:

to extend the director penalty regime so that directors are personally responsible for their company’s unpaid superannuation guarantee amounts;

to make directors and their associates liable to pay as you go (PAYG) withholding non-compliance tax in certain circumstances which will now include any unpaid superannuation guarantee charge (Charge); and

to ensure that directors cannot discharge their director penalties by placing their company into administration or liquidation when PAYG withholding or superannuation guarantee remains unpaid and unreported three months after the due date.

Amounts collected under the director penalty regime that represent the Charge will be dealt with in the same way as under the SG Act, i.e. remitted to the ATO which will then endeavour to locate the relevant taxpayer and his or her fund.

Unlike PAYG withholding, the Charge is not due and payable until the employer lodges a superannuation guarantee statement (Statement) or the Commissioner issues an assessment. Accordingly, directors could escape or delay liability for director penalties by failing to lodge their Statement as required, causing the Charge to not become due and payable.

69 http://www.ato.gov.au/taxprofessionals/content.asp?doc=/content/62555.htm&page=6&H6

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To address this issue, and make a director personally liable for unpaid superannuation in a timely manner, the legislation requires an amount estimated by the Commissioner to be the unpaid superannuation guarantee charge to be outstanding and payable as a liability to him that is separate and distinct from the liability constituted by the Charge itself and even if the Charge has not yet been assessed.70

For the purposes of the director penalty regime, the Charge will be treated as being payable on the day the employer is required to lodge their Statement for the quarter to the Commissioner.71

70 See Divisions 268 and 269 of Schedule 1 TAA 71 Section 33 of the SG Act

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