For individuals struggling with unmanageable debts to the Australian Taxation Office (ATO) personal bankruptcy is an option to enable the individual to obtain a release from those debts and make a fresh financial start in life.
Listed below are 9 issues that individuals with tax debts need to be aware of when considering bankruptcy:
- Tax debts don’t become statute barred over time. Many debts in Australia become statute barred after six years under state based limitations of action legislation. However, tax debts are governed by federal law and not subject to state based limitations Acts. Consequently, tax debts need to be addressed as the passing of time will not make the debt disappear.
Warning: The ATO may have marked a debt as “non-pursuit”, removed the debt from the tax payers account and stopped chasing the taxpayer for recovery of the debt. However, this doesn’t mean the debt is written off and the ATO can “reinstate” the debt and commence recovery action at any time.
- Tax debts can only be resolved in the following manner:
a) Payment, including payment over time via a payment plan. In some cases, the ATO will accept security, such as a second mortgage over property, as part of a payment plan. Particularly where the payment plan is proposed to last for more than 2 years.
On occasions, the ATO will waive certain penalties and interest on debts, but it is rare for them to release a taxpayer from the core debt (see paragraph (c) below).
b) Through a formal insolvency appointment. Namely declaring bankruptcy, or entering into a Personal Insolvency Agreement (aka part X) or Debt Agreement (aka part IX). The ATO won’t accept an offer from a taxpayer that involves a compromise of the ATO’s core debt unless it is via a formal insolvency appointment or the taxpayer makes a successful serious hardship application (see paragraph (c) below).
c) Successful application to the ATO for a release of certain tax debts where payment of the debt would cause serious hardship to the taxpayer. Not surprisingly, the eligibility criteria to obtain a release is a high bar and only a small percentage of releases are approved. Certain debts including GST, PAYG withholding, Director Penalty Notices (DPN), Superannuation Guarantee Charge (SGC) debts cannot be released.
d) The Minister for Finance has the power to waive ATO debts, but this is rare.
- Declaring bankruptcy does not avoid the obligation to lodge income tax returns, BAS or other lodgements. However, overdue tax returns do not have to be lodged before you declare bankruptcy. Any debts arising from those returns upon their eventual lodgement will still be caught and extinguished by the bankruptcy.
- A taxpayer who declares bankruptcy can lodge 2 income tax returns in the year of their bankruptcy. One covering up to the day before the date of bankruptcy and one covering the period from the date of bankruptcy onwards. This assists the ATO and the taxpayer calculate with some precision the amount they owe to the ATO that is caught and extinguished by the bankruptcy.
- Tax refunds received by a bankrupt that relate to the period up to the date of bankruptcy are an asset of the bankrupt estate and will be collected by the bankruptcy trustee. Tax refunds received by a bankrupt that relate to the period after the date of bankruptcy will be assessed as income for bankruptcy purposes.
- If a bankrupt is due a tax refund, but has a tax debt, the ATO are entitled to retain the refund and apply it towards their pre-bankruptcy debt. This applies to any returns that relate to the period prior to and during the term of the bankruptcy. Once a bankrupt is discharged from bankruptcy, any refunds form returns they lodge that relate to a period after discharge will be paid to the taxpayer.
- If the ATO issues a garnishee notice to a taxpayer’s employer garnisheeing a portion of their wage, then declaring bankruptcy won’t stop the garnishee. That is because the garnishee is a secured debt and bankruptcy doesn’t restrict the rights of secured creditors. If a bankrupt whose income is the subject of a garnishee notice resigns their employment, the garnishee notice won’t attach to their income from a subsequent employer. Furthermore, the ATO isn’t able to issue a garnishee notice after the date of bankruptcy in respect of a pre-bankruptcy debt.
Because of the risk of a garnishee notice, taxpayers who have tax debts should address their tax debts promptly (see paragraph 2 above) as failure to do so, might result in a garnishee notice being issued by the ATO. This in turn would mean restrictions on taxpayers income due to the garnishee unless and until they are willing and able to resign their employment and obtain employment with a different employer.
- Bankruptcy extinguishes tax debts that exist or were incurred prior to the date of bankruptcy, including debts owed under DPNs and SGC. This is the case even if the debts haven’t been assessed or a DPN hasn’t been issued.
- Declaring yourself bankrupt is a prompt and effective way to deal with insurmountable tax debts and there is usually no up front cost to declare bankruptcy. Declaring yourself bankrupt has the following advantages:
a) You control the timing as to when you declare bankruptcy. If the ATO commences bankruptcy proceedings via legal proceedings, you have no control over the date of your bankruptcy.
b) You choose who will be your trustee. If the ATO commences bankruptcy proceedings via legal proceedings, they choose the trustee.
c) It reduces the risk that the ATO will issue a garnishee notice to your bank or your employer prior to bankruptcy (the latter of these two becomes a secured debt – see paragraph 7 above).
d) It reduces the risk the ATO will stop you from travelling overseas via issuing a Departure Prohibition Order (DPO). The ATO has recently increased the use of DPOs for taxpayers where the ATO forms the view that preventing a taxpayer from travelling overseas will improve the prospects of receiving payment of their outstanding tax debt.
e) It enables you to clear your debts, reduce the stress and uncertainty that tax debts inevitably cause and make a fresh financial start.
If you have a tax debt that needs to be addressed, please contact the following partners for a no obligation discussion about your circumstances and alternatives:
Mark Pearce E: markp@pearceheers.com Ph: 07 3221 0055
Andrew Heers E: andrewh@pearceheers.com Ph: 07 3221 0055
Michael Dullaway E: michaeld@pearceheers.com Ph: 07 3221 0055
1 Each state and territory has their own act and whilst they are generally similar, there are differences. Not all debts and actions have a 6 year limitation period, some have less and some have more.
