The Supreme Court’s recent unanimous decision in Jennings Roadfreight Ltd (in liquidation) v The Commissioner of Inland Revenue [2014] NZSC 160 was welcomed by insolvency practitioners up and down the country.

The Commissioner probably had the opposite reaction.

The point in issue was whether or not monies held in the bank account of the company at the date of liquidation were subject to the Commissioner’s trust under s 167(1) of the Tax Administration Act 1994, (in relation to PAYE deductions) or were subject to the preferential creditors priorities set out in the 7th Schedule of the Companies Act 1993.

The Court of Appeal (with Justice Ellen France dissenting) had determined that if there was a credit balance in the account, (as at the date of liquidation) then the money in the account was subject to a PAYE trust. Therefore the monies (to the value of any unpaid PAYE deductions) were trust monies, held on behalf of the Commissioner.

Different view

The Supreme Court took a different view. Unless the deemed deducted sum was treated in the manner contemplated by the Tax Administration Act and/or was paid to the Commissioner within the timeframes set out in the PAYE Rules, then upon liquidation, the trust was extinguished. In those circumstances, the Commissioner’s PAYE claim ranked as a preferential unsecured creditor.

Practically, what the Supreme Court decision reaffirmed was that certain claims in the liquidation took preference over the Commissioner’s claim for unpaid PAYE. Those claims included the liquidators’ own costs and unpaid employees’ wages.

So why did the Supreme Court take a different view to the Court of Appeal? In essence, the Court saw the scheme of the statutory provisions as being against what the Commissioner was arguing. The clear purpose of the statutory provisions was for “unpaid PAYE to be subject to the priorities set out in schedule 7 of the Companies Act”.

Section 167(1) of the Tax Administration Act sets out: “Every amount of tax or combined tax and earner related payment withheld or deducted under the PAYE rules … shall be held in trust for the Crown, and any amount so held in trust shall not be property of the employer liable to execution, and, in the event of … liquidation of the employer, shall remain apart, and form no part of the estate in … liquidation.”

Section 167(2) of the Tax Administration Act sets out: “Where an amount of … earner related payment has been withheld or deducted under the PAYE rules … and the employer has failed to deal with the amount of the tax or payment withheld or deducted … in the manner required by subsection (1) or the PAYE rules, the amount of the tax or payment for the time being unpaid to the Commissioner shall, in the application of the assets of the employer, rank as follows … where the employer is a company, upon the liquidation of the company, the amount of the tax or payment shall have the ranking provided for in Schedule 7 of the Companies Act.”

Conflict overcome

As the Supreme Court indicated, the relationship between s 167(1) and (2) of the Tax Administration Act is not straight forward. There is potential for conflict between the two subsections as both purport to apply in the event of bankruptcy, liquidation or assignment for the benefit of creditors.

The Supreme Court overcame the conflict by determining that s 167(2) was to be read as a specific qualification of s 167(1). The result was that in the circumstances where s 167(2) applied, the consequences set out in that section prevailed over the trust provisions in s 167(1).

Much of the argument in the Supreme Court centred on the nature of the trust created by s 167(1).

A traditional trust must have certainty of intention, subject matter and object. After the deemed deduction of PAYE, Jennings Roadfreight Limited’s bank account was in overdraft. It would be difficult to argue that the trust had certainty of subject matter. Applying orthodox reasoning, the trust would therefore usually fail at that point. This is effectively what has been decided in Canada (which previously had legislation similar to that in New Zealand).

To get around this line of orthodox reasoning, the Commissioner submitted that the statutory trust was a special trust that did not need to comply with traditional trust principles. Effectively, until liquidation (whether or not the account was in overdraft or monies came and went from the account) the trust remained. What this would mean is that any money in the account (no matter where it came from), would upon liquidation always be first available to meet outstanding PAYE.

Having it both ways

The Supreme Court accepted the s 167(1) trust was of a special nature (a notional trust) but considered the Commissioner’s interpretation did not give proper effect to s 167(2).

As Justice Arnold indicated to the Commissioner’s Counsel during the hearing: “But aren’t you … running with the hares and hunting with the hounds ... What you’re saying is that under s 167(1) there’s this very odd sort of trust. You don’t need a corpus and you just – so it’s a statutory trust which has to operate in ways that don’t fit neatly with our traditional concept of trust. To me, that has a lot of force, but I think the flip side of that is that when it comes to the operation of s 167(2), you can’t really go back to the fundamental notions of trust and try and assert a sort of traditional view of trust in that context. The point is that this is a statutory construct in terms of subsection (1) and another statutory construct in terms of subsection (2).”

In reaching its decision, the Court also put considerable weight on Parliamentary commentary made over successive decades as to the intended outcome from the legislation. As the Honourable Robert Muldoon indicated in 1968: “It was always intended when PAYE was introduced that unpaid tax deductions in these circumstances were to rank in preference after certain debts referred to in s 308 of the Companies Act.”

Although the judgment gave a clear indication as to the Court’s thinking in respect to the interface between the PAYE trust and the preferential creditor regime, it did leave a number of related legal issues that will need to be determined at a later date.

In particular, it left open the situation where PAYE monies have in fact been held separate and apart from the company’s other monies (a more traditional trust situation) and were still in existence at the date of liquidation.

In those circumstances, the Court did not rule out the possibility that the trust would not be terminated by the liquidation.

The Court also left open the possibility that the claw back provisions under s 192 of the Companies Act might in some circumstances apply to monies paid to the Commissioner by the company in meeting its PAYE tax obligations.

Tony Johnson is a partner at Martelli McKegg. He is a civil, trust and commercial law litigator with expertise in insolvency. He has contributed to the New Zealand Law Journal and is a past committee member of INSOL New Zealand.