Wednesday, 18 February 2009

Family Court case: who pays the piper?

To misquote Somerset Maugham about economic independence, "he who pays the piper calls the tune" is the kind of quote that was dear to the Commissioner of Taxation in the recent Family Court case of Commissioner of Taxation & Worsnop & Worsnop.

Mr and Mrs Worsnop led a life that most of us would probably love- fast cars, tons of overseas travel, luxury living, a life of which Scheherazade would be proud- but there was only problem: Mr Worsnop had not paid his tax. Lots and lots of tax. In fact by the time of trial, with penalties and interest thrown in, over $12 million of unpaid tax.

Not wanting to risk the ire of the Commissioner, the husband on separating from his wife obtained legal advice and decided to 'fess up to the Commissioner about the unpaid tax. After some audits, the husband incurred (and paid) legal fees in excess of $1 million.

What was left? About $5 million left in the house and both the wife and the Commissioner wanted the lot.

The result? The trial judge, Justice Rose, gave them 50/50.

The trial judge found that the wife did not know nor did she ought to have known that the husband had not paid his tax.

The Commissioner, unhappy at not getting the lot, appealed.

The Commissioner's contentions

Counsel for the Commissioner contended:

... the following principles apply when dealing with debt legitimately owing to unsecured third parties (including but not limited to taxation debt), in the course of proceedings pursuant to section 79 of the Family Law Act [the section dealing with property settlement]:

  1. That except in exceptional circumstances the Family Court should make orders for property settlement out of the net property of the parties to the marriage.
  2. That in considering any adjustment pursuant to section 75(2) [future factors] the Court must consider the use to which the funds were put and the benefits received by each party from those funds.
  3. That a party who has had the benefit of the funds should share the burden of repayment of the debt.
  4. That a party to a marriage who has, whether knowingly or not, had the benefit of money or property available only as a consequence of their partner’s dishonesty, should share equally the burden of any debt thereby created.
  5. That in order to achieve justice and equity for all parties including the creditor, the Court must consider making an adjustment pursuant to section 75(2)(ha) to benefit the creditor.
  6. That the Court cannot ignore the contribution made to the acquisition of assets and the lifestyle of the parties by the creditor.
Contention 1

The Full Court responded:


There being an exception within the proposition itself, even if we thought the
proposition sound, the question in this appeal would arise as to whether the
circumstances before the trial Judge were exceptional or not.
We further
observe that the proposition is expressed in relation to cases in which there is
“net property”. The instant case immediately falls outside that category. In the
instant case, the critical tension arises precisely because such legitimate
claims as the wife has to a share of property cannot be met out of net assets.


The Full Court was then at pains to point out that there was no net property in this case, because the debt owing to the Commissioner was greater than the value of the property.

Contentions 2,3 and 6

The Full Court said:


Our reservations about these propositions are that they couch in mandatory
and absolute terms, factors which, though they may often carry great weight, are
ultimately ones, usually among numerous others, upon which a discretion might be
exercised.
Secondly, in the first of the three propositions under discussion
here, there is a reference to an obligation on the Court to consider the
benefits received by each party from [a creditor’s] funds, in considering any
adjustment pursuant to s 75(2).
Here, we are simply concerned to reject any implication that the only stage of
the approach to property settlement at which the question of a debt might be
considered is when considering s 75(2)
factors.
Those things said, we accept that it is highly unlikely that the
use to which funds were put and the benefits received by each party from those
funds would not be a significant consideration when addressing the position of
an unsecured creditor, whose prospects of recovery of debt are uncertain.

Contention 4

The Full Court held:

Again, we would disagree with the formulation of
the proposition as a principle to be mandatorily applied, rather than
recognition of the factors as ones highly likely to be powerfully relevant to an
exercise of discretion.
As the proposition is expressed, and as part of his
argument in support of it, Mr Lethbridge contended that “knowledge” of the
debtor spouse’s wrongdoing by the other spouse was irrelevant, in the other
circumstances posited. We note that the Commissioner pursued the question of
knowledge of the wife at trial, though he ultimately also submitted that the
question was irrelevant to the proper outcome. In any event, we do not suggest
that Mr Lethbridge is not free to argue as he now does.
We think that
in circumstances such as those in the instant case, this argument might carry
more weight in respect to a debt for prime tax, than in relation to interest and
penalties. An “innocent” spouse might receive benefit from funds which ought to
have been paid to tax but will receive no benefit from penalties and interest in
relation to unpaid tax. While we recognise an argument that when prime tax is
avoided, penalties and interest are consequential liabilities, and thus,
connected to the benefit of avoidance, logically the question of innocence or
ignorance on the part of the recipient might properly be relevant to the
question of whether penalties and interest ought be met entirely by the guilty
spouse.

That the matter of “knowledge” was relevant in like circumstances was
recognised, at least implicitly, in Johnson and Johnson [1999]
FamCA 369
(referred to earlier in a passage quoted from Rose J’s
reasons), when the Full Court said:
“20.5 In our view the fact that the wife
was or was not involved in the tax avoidance process which may lead to the
imposition of penalties was only one consideration that his Honour needed to
weigh up when determining liability for the penalties as between the parties.
The benefits indirectly gained by the wife in having the pool of assets
otherwise increased as a result of the availability of funds which would have
otherwise been paid out in tax also have to be considered. (emphasis
added)
In Johnson, (supra) there was no argument about the decision of the
trial Judge to order that the parties share the prime tax in accordance with the
percentage distribution of assets, so the Full Court was concerned only with the
trial Judge’s decision that penalties be borne solely by the husband.
Rose J said of what was said in Johnson (supra) as quoted above and of
what immediately followed:
The Full Court proceeded to also state that
“unless there were compelling circumstances to the contrary, a just outcome
demanded that the wife take the good with the bad”.(footnote omitted)
In my
view, those extracts from the Johnson [sic] was directed to the emphasis in the
“consideration” that must be given by the trial judge to the claim of the
unsecured third party creditor which in that instance was the ATO, as in the
present case. Otherwise, the decision was made on the particular facts in that
case but did not establish any further matter of principle. ...(original
emphasis)
We agree. Knowledge of the debtor spouse’s tax avoidance is a
factor relevant to the exercise of discretion, as the Full Court in Johnson
(supra), in respect of penalties, stated. In our view, though as we said a short
time ago, the question of innocence or ignorance in a spouse of the other
spouse’s tax avoidance may carry more weight in respect of penalties, we see no
reason why that question might not also be relevant to the issue of unpaid prime
tax, even if the “innocent spouse” has received benefit from the failure to pay
tax. It might be that “knowledge” would be almost irrelevant, where net assets,
sufficient to meet reasonable claims under s 79,
remained after payment of any debt for prime tax, but “knowledge” might come
into much sharper focus where liabilities exceeded assets.


Contention 5

The Full Court stated:


The wording of this proposition may imply that intervening unsecured
creditors gain some right or status from sub-paragraph (ha), additional to
that which they otherwise have at law.
Rose J addressed the terms of s 75(2)(ha),
when assessing s 75(2)
factors. He said:
The liability to the ATO cannot be considered merely in
terms of the husband’s personal liability.
Section
75(2)(ha)
refers to a matter which has prominence in these proceedings,
namely:
“The effect of any proposed order on the ability of a creditor of a
party to recover the creditor’s debt, so far as that effect is
relevant.”...

While it is well-established that under s 79
the Court may make orders within a s 79
order, for payment by a spouse, or by both spouses, of a debt to a third party,
whether that third party has intervened or not, in our view the s 79(2)
requirement that an order under the section not be made unless it is just and
equitable to do so, relates to the order made pursuant to s
79(1).
Altering the interests of the parties to the marriage in the property
does not mean that an intervening third party creditor acquires by intervention
some rights based on s 79(2)
for a just and equitable remedy, that are additional to the creditor’s other
rights at law.


Mr Lethbridge also referred to the terms of s 90AE(3)(d)
of the Act, which is one of the conditions which must be met if an order is made
changing a third party’s rights under the preceding subsections.
Sub-paragraph (d) requires that the Court be satisfied that in all the
circumstances, it is just and equitable to make the order. However, this
requirement is in respect of the Court’s direct interference with a third
party’s rights, for example, in respect of a creditor, rights relating to the
person from whom recovery may be sought. In contrast, the aspect of a creditor’s
position to which the Court must have regard under s 75(2)(ha)
are not rights to recovery but the practical prospects of recovery from a debtor
spouse’s property.
For example, one might imagine a circumstance where one
spouse’s initial contributions and the shortness of the marriage might mean that
the great bulk of property existing at the time of a property settlement trial
had belonged to, and does belong to, that spouse and that position ought not be
altered under s 79.
In the meantime, a creditor might have lent, perhaps unwisely, to the other
spouse, who lost the borrowed money and could not repay from his or her own
assets. As we have said, we do not think that in such circumstances, either s 79(2)
or s 75(2)(ha)
has the result that the creditor has some opportunity, on the basis of justice
and equity, of improving the position that the creditor would have been in had
he pursued the debtor spouse alone. In other words, the creditor who becomes a
party does not step up in status to become entitled to greater “justice and
equity” than the non-party creditor.
This does not mean that the principles
of fairness, justice and equity to a creditor ought not be addressed, where
there is in prospect a reduction in the property of the debtor spouse, for the
purpose of satisfying the s 79
claim of the other spouse, which reduction might adversely effect the prospects
of recovery of the creditor, but this position does not arise because of the
application of s 79(2).


Did the trial judge, Justice Rose, err in his discretion?

Justice Rose split the value of the home 50/50. The Full Court stated that he did not err, and dismissed the Commissioner's appeal.

The Full Court stated:


In our view, Rose J clearly appreciated the critical features of the
exercise he was called upon to carry out; that is, the balancing of the claims
of the wife against those of the Commissioner.
As to the wife’s position,
during the decade when tax was avoided, she continued to make significant
contributions of the nature recognised under s 79,
in the context where she was denied the choices that would have been hers, had
the husband informed her of his avoidance of tax. On the findings that
Rose J made about the wife, her innocence of even any knowledge of the tax
evasion, let alone complicity in it, her suggestions to the husband from time to
time that they live a less extravagant lifestyle, her equality of contributions
to those of the husband and the s 75(2)
factors that favoured her significantly, her claims were weighty.
Against
this was the position of the Commissioner. In our view, the Commissioner of
Taxation is in a position distinguishable from that of a commercial creditor.
Commercial creditors have a choice about to whom they extend credit. On the
other hand, the position of the Commissioner as a creditor of taxpayers is of a
completely different origin. The onus is on taxpayers to make full and proper
disclosure to the Commissioner of Taxation. The Commissioner does not extend
credit at all, but becomes a creditor by virtue of the conduct of the affairs of
the taxpayer. As seen, Rose J gave “...much weight to the fact that the
outstanding tax indebtedness of the husband is a debt to the Crown and
implicitly there is a public interest issue”, though he also recognised that the
Commissioner had no priority over the wife’s claims....


Rose J balanced these competing claims by depriving the wife of an
adjustment to which he saw her as otherwise entitled, on account of s 75(2)
factors, and of an adjustment for the notional asset represented by the
husband’s paid legal costs, and of one-half of the monies in the controlled
monies account and the B property.
As seen, Rose J regarded the s 75(2)
factors favouring an adjustment to the wife as significant. We agree. She had in
her primary care four children, at trial aged between 1¾ years and
13 years. Rose J found that though she had capacity for employment,
child care responsibilities prevented her from exercising it. If the wife had
been granted a 10 or 15 per cent adjustment on account of s 75(2)
factors, applied to the value of the former matrimonial home, she would have
received in the order of $500,000.00 more. Had Rose J notionally written
back in the husband’s legal fees, and divided the former matrimonial home
proceeds to provide one-half of that notional asset to the wife, together with
half of the account and B property, she would have received another $700,000.00
approximately. Thus, the wife has been deprived of large entitlements otherwise
made out, to reflect the debt to the Commissioner.
Nonetheless, in
endeavouring to persuade us that the Commissioner should have received the whole
of the former matrimonial home sale proceeds, Mr Lethbridge returned to
Johnson and Johnson (supra), in particular where the Full Court said:
20.4 We
are of the view that his Honour’s discretion miscarried when he failed to
provide for the wife to share in any penalties that may be imposed by the
taxation commissioner.
...
20.6 In the context of an examination of twenty
years of financial dealings by the parties, which dealings were almost entirely
within the province of the husband, in our view, unless there were compelling
circumstances to the contrary, a just outcome demanded that the wife take the
good with the bad...
20.7 ...Absent any suggestion that the husband was on a
frolic of his own and acting contrary to the wife’s express wishes, we see no
reason for his Honour to have left the husband to shoulder the burden of the tax
penalties.
As we earlier indicated, and we noted Rose J found, the
decision in Johnson (supra) was no more than the opinion of that Full Court as
to the proper exercise of discretion in that case. Moreover, in Johnson, as with
Biltoft and Kowaliw, there was no question of the propriety of an “innocent”
spouse receiving nothing, to be weighed against the claims of a creditor. The
assets of the parties in Johnson were some $30,000,000.00, the debt to the
Commissioner $8,000,000.00, of which penalties, the only part with which the
Full Court was concerned, were $1,000,000.00.
Mr Lethbridge also
submitted that the wife’s knowledge, as transferee of the husband’s
half-interest in the former matrimonial home, of the reasons for that transfer
had some relevance to the balancing of her claims against those of the
Commissioner. Rose J found:
201. ... The evidence is that the purpose of
the transfer was to protect the property from the potential claims of third
party commercial creditors. I have accepted that evidence.
At best,
Rose J’s finding can only relate to the wife’s receipt of the husband’s
half-interest, which by Rose J’s orders was to go in reduction of the tax
debt.
In any event, even if we took up the approach of the Full Court in
Johnson, and applied it to the entire tax debt here, Rose J effectively
found that the husband was on “a frolic of his own”. As to whether this was
contrary to the wife’s express wishes, that could hardly be a fair question
where the wife was, as Rose J found, kept uninformed. Thus, the wife’s
position would likely fall within the exception that the Court in Johnson,
acknowledged....


As earlier seen in Johnson, in relation to penalties owing to the
Commissioner, the Full Court said “unless there were compelling reasons to the
contrary, a just outcome demanded that the wife take the good with the bad”.
While we have already said that we do not take that statement as one of
principle to be applied in every case in which there is a debt to the
Commissioner, whether in respect of primary tax or penalties, we think that, in
many cases, where the debt is for primary tax, the statement is likely to
describe a proper balance between the interests of the debtor party’s spouse and
the Commissioner, even where that spouse is “innocent” and the liability to the
Commissioner exceeds the assets.
Had the focus before Rose J been more
along the lines of identifying (and calculating the monetary representation of)
“compelling reasons” for an award to the wife, then apart from the questions of
her “innocence” in relation to tax evasion, her contributions relevant under s 79
of the Act and other s 75(2)
factors, there may have been closer examination of the needs of the wife for
basic housing and sufficient other capital to set up a modest standard of living
for herself and the children. The future support of the wife and children might
have been seen as properly coming from her earning capacity (when she was able
to exercise it), the husband’s earning capacity and, if necessary, social
security. We think a decision that the wife receive no more than that might well
have been open, when a huge debt resulting from tax evasion, albeit by her
husband without her knowledge, would remain. After provision for the wife on the
basis stated, the balance of the former matrimonial home sale proceeds could
have gone to the Commissioner.

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