Supreme Court found that PAYE trust ceases upon liquidation
2014 case note - Supreme Court held that any s 167(1) trust ceases upon liquidation of a company if the employer has failed to deal with PAYE deductions.
Tax Administration Act 1994, Companies Act 1993
The Supreme Court held that any s 167(1) trust ceases upon liquidation of a company if the employer has failed to deal with PAYE deducted in the manner required by s 167(1) of the Tax Administration Act 1994 ("TAA") or in accordance with the PAYE rules.
Jennings Roadfreight Ltd ("Jennings") was placed into liquidation on 24 March 2011. At the time, it owed approximately $50,000 in PAYE for the month ended 28 February 2011.
The Commissioner of Inland Revenue ("the Commissioner") issued a notice pursuant to s 157 of the TAA requiring the Bank of New Zealand to deduct funds from Jennings' bank account. Jennings was placed into liquidation and the appeal concerns $14,076.38 held in the Jennings' bank account when Jennings was placed into liquidation but placed into a suspense account.
The High Court held that the $14,076.38 was refundable by the Commissioner to the liquidator. The Court of Appeal, by majority decision, held that the $14,076.38 was held in trust for the Commissioner, did not form part of Jennings' estate in liquidation and did not need to be refunded.
The liquidators were granted leave to appeal to the Supreme Court.
The Court first considered the relationship between ss 167(1) and 167(2) of the TAA.
Jennings submitted that any s 167(1) trust is extinguished if the PAYE rules have not been complied with and, in any event, upon liquidation by virtue of s 167(2) of TAA. The Commissioner submitted that s 167(1) creates a statutory trust to protect the amount of any PAYE deduction (or deemed deduction) and if at liquidation, there is any credit balance in a company's bank accounts, then the Commissioner is entitled to it because of the statutory trust.
The Court considered the wording of ss 167(1) and (2) and found that s 167(2) must be read as a specific qualification on s 167(1) where s 167(2) applies. This means that where it applies, s 167(2) prevails over s 167(1).
Section 167(2) of the TAA applies on the liquidation of a company to unpaid PAYE in two situations:
- where an amount of PAYE has been deducted and the employer has failed to deal with the amount deducted in the manner required by s 167(1); or
- the employer has failed to deal with the amount deducted as required by the PAYE rules.
The Court saw no reason to depart from the long-established reading of s 167(1) of the TAA to construe it as requiring funds to be segregated. It is unlikely that many businesses would in practice segregate the funds. It may be that s 167(2) does not apply to PAYE that has been deducted where, despite there being no obligation to do so, it has been held separately from other funds. Although the Supreme Court left this question open as the funds in this case were not held in a separate account.
The Court saw the second situation in s 167(2) of the TAA as straightforward. The PAYE rules require amounts deducted to be paid to the Commissioner on a due date. In this case, payments were not made to the Commissioner on the due dates and the amounts remained outstanding as at the date of liquidation. Accordingly, the employer failed to deal with the amounts as required by the PAYE rules and the priorities in s 167(2) apply to Jennings' overdue but unpaid PAYE deductions.
The Court went on to consider the case law and the scheme of the statutory provisions, finding that both supported that s 167(2) of the TAA is a qualification on the general nature of s 167(1). The Court noted that if the Commissioner's interpretation was correct, then the Commissioner would have first access to the credit balance in bank accounts for PAYE deductions by virtue of it being trust property and this would reverse the order of priorities in schedule 7 of the Companies Act 1993 (which ranks items deducted from an employee such as child support obligations and student loan repayment obligations above PAYE).
The Court set out the legislative history of PAYE and, in drawing together the various threads, found that s 167(2) applies on liquidation where one of two conditions are met: the employer has failed to deal with the amount deducted as required by s 167(1); or failed to deal with the amount in accordance with the PAYE rules. This means that in the event of liquidation, s 167(2) and the priorities set out in that subsection apply to all amounts of PAYE deducted that fell due before liquidation but not paid before liquidation to the Commissioner. Section 167(1) does not apply to such amounts, unless (possibly) unpaid PAYE has been segregated by the employer in a separate account.
As the PAYE in this case had been deducted but not paid to the Commissioner on its due date, remained unpaid at the time of liquidation and was not held in a separate account, all of the PAYE unpaid at the date of liquidation (including the $14,076.38) was to be dealt with under s 167(2) of the TAA and thus distributed in accordance with the priorities set out in schedule 7 of the Companies Act 1993.
The Court went on to consider the nature of the trust under s 167(1) of the TAA. Jennings submitted the trust only applied to funds set aside in a separate account at the time of deduction. The Commissioner submitted it was a statutory notional trust in the nature of a floating charge.
The Court noted that as a matter of construction between ss 167(1) and (2), it had already rejected the Commissioner's interpretation of s 167(1) continuing to apply to any credit balance held in a company's accounts at liquidation. It was therefore not strictly necessary to come to a definitive view of the nature of the s 167(1) trust but the Court made five general observations:
- Jennings' submission that s 167(1) only applies to funds set aside in a separate account is consistent with the interpretation of similar provisions in Canada.
- In the context of deemed or notional deductions of PAYE, the notional statutory trust in s 167(1) is not limited to funds held in bank accounts.
- The Court did not accept that the Commissioner's interpretation in part protects employees from being pursued for unpaid PAYE in the event of liquidation. An employee is not liable for PAYE on liquidation unless the employee has received the gross amount of his/her salary or wages or has received from the employer a benefit in cash or equal kind to the PAYE that should have been deducted.
- The s 167(1) trust is not brought to an end where there is a failure to pay PAYE on the due date. On liquidation, any trust is bought to an end not by any action of the company but by virtue of the legislation under s 167(2).
- A notional trust protects the Commissioner from claw-back amounts actually paid (whether late or not) to the Commissioner before liquidation.
The Court upheld Jennings' appeal, the unpaid and overdue PAYE fell subject to schedule 7 of the Companies Act 1993 by virtue of s 167(2)(b) of the TAA and the Commissioner must repay the $14,076.38.