This is a bit more of a commercial bent, because it is mostly of relevance to lenders.
Those of you striking a little trouble with your business loans will also find it relevant, because the conclusions in the case may have a direct bearing on how much you will end up owing on your guarantees after the company you guaranteed goes into receivership.
To explain for readers not in the know, Banks that lend to companies that develop or otherwise trade in property like to have the borrower themselves sell the property when they default on the loan. The Bank DOES NOT WANT to mortgagee sell it. Often, as an aside, this is the only time a guarantor has leverage to make a deal with the bank that they won’t bankrupt him or her if they play ball.
The reason is simple. On a sale by the borrower, the bank as mortgagee can and will demand the entirety of the sale price (after selling costs). This INCLUDES the GST payable by the borrower.
The borrower, as a limited liability company, will sit there selling off its property as fast as it can before the IRD liquidates it for unpaid GST and/or other taxes. The directors and shareholders are most likely personally liable to the bank…..but Inland Revenue are just another unsecured creditor of the company, not of them personally.
If, however, the Bank mortgagee sells the land, the BANK is liable to account for GST on the sale price. Fifteen percent is a lot of money, which is then still owed personally to the bank under the director/shareholder personal guarantees.
Obviously, the strong incentive, where directors have guaranteed the loans, is for the directors to do everything possible to use what is notionally the IRD’s money to discharge their residual liability as guarantors to the bank.
Creditors will sometimes appoint receivers to manage a debtor company. The receivers will instigate a sale of property and, as per the example above, pay all the sale proceeds through to the creditor.
The IRD does not like any of this, and who can blame them? But what happens when the mortgagee itself is in trouble and receivership? Can the proceeds from a mortgagee sale be shovelled still further upwards? Simpson and Downes as Receivers of Capital and Merchant v Commissioner of Inland Revenue – CA 361-2011 – 30 March 2012 – Arnold, Ellen France and White JJ, has answered that question in the IRD’s favour for a change.
Here, the financier concerned (Capital + Merchant) had been forced into carrying out mortgagee sales….five of them, in fact. So normally they would be obliged to account for GST to the IRD. However Capital +Merchant were themselves in receivership. Their secured creditor Fortress had itself lodged caveats on the properties (or maybe the mortgages), and wished, quite fervently, to take all the sale proceeds in turn, including the GST payable, leaving the IRD once again as unsecured and unlikely-to-be-paid creditor of Capital + Merchant.
Inland Revenue got ahead of the ball here and lodged proceedings. It was agreed that, in order to get the caveats released and the mortgagee sales settled, the GST would be held by the IRD and disbursed as the Court directed.
Initially, the IRD was sucessful in arguing that the receivers were personally liable to pay the GST on the five mortgagee sales to the IRD. The High Court accepted that argument, holding that section 5(2) of the GST Act applies in all cases in which a sale is effected by the exercise of powers vested in someone other than the owner. Accordingly, the receivers were the relevant persons exercising the power of sale referred to in section 5(2) and were therefore liable under section 17 to return the GST.
In the Court of Appeal, that judgment was reversed – well, sort of/not really (take your pick). The court still held that the GST should be paid to the IRD and simply did not form any part of the sale proceeds capable of being paid out to the secured creditor.
The receivers escaped “personal” liability (which would have been quite a shock at the time of the High Court judgment), but were directed nonetheless as receivers of Capital + Merchant to pay the GST to the IRD, which rather negates the victory in practical terms for their client secured creditor.
The Court held that the application of s.5(2) and s.17 of the GST Act and s.185 of the Property Law Act 2007 was not altered by appointment of receivers, and that these provisions made it clear that the payment of GST to CIR on mortgagee sales took priority over any payment in respect of secured debts.
In other words, GST payment must be made as a cost of the mortgagee sales and simply did not reach the general funds of the mortgagee to then be swiped by the secured creditor. It is included within “costs of sale”, which have to be paid out in priority in accordance with s.185 of the Property Law Act before secured creditors take their cake.
To the Court, it was immaterial that the secured creditor’s caveats over the properties (a little unsure about this, as an aside; I don’t quite see why the creditor of the mortgagee would have had a basis for caveating the mortgage properties – it is possible we are here talking about caveats over the mortgages themselves so that they could not be released without the secured creditor’s consent) were only released on the basis that all moneys including GST were to be paid through to the secured creditor.
The categorisation of GST as a cost of sale has been plain law since the 2004 Privy Council decision in Commissioner of Inland Revenue v Edgewater Motel Ltd  1 NZLR 425 (CA), and the appointment of receivers to the mortgagee by a secured party does not change that.
Unfortunately, the reasoning doesn’t apply to the “rort” of companies selling on what is really the mortgagee’s behalf so the mortgage doesn’t have to conduct a mortgagee sale. A “normal” sale by a distressed company isn’t subject to section 185 of the Property Law Act, so there is no list of first-paid “costs of sale” for the GST to be shoehorned into. One wonders how long it will be before legislation is introduced to rectify this.