Evasive Action - Potential Tax Evasion Insufficient To Justify Termination Of A DOCA

In the case of Commissioner of State Revenue v McCabe (No 2) [2024] FCA 662, the Federal Court of Australia was asked to consider whether a deed of company arrangement (DOCA) entered into by the Comlek group of companies (Comlek Companies) should be terminated due to concerns regarding the tax affairs of the group.

In September 2022, the Commissioner of State Revenue in Queensland (Commissioner) issued default notices against the Comlek Companies for tax liabilities of over $10m as well as notices of investigation in respect of alleged tax evasion.  The companies were placed into voluntary administration in December 2022.  Creditors subsequently approved a DOCA which meant that the companies would avoid liquidation and therefore that there would be no liquidator investigation into the alleged tax evasion.

The Commissioner then commenced proceedings seeking that the DOCA be terminated on the basis that it would be detrimental to the public interest and to commercial morality for the DOCA to remain on foot.  Justice Derrington carefully considered the facts of the case before concluding that the Commissioner had not made out its case for termination of the DOCA.  

Background

The Comlek business was commenced in 2008 and provided engineering, electrical and labour hire services to various industries in Queensland.  In the period from 2010 to 2022, the business was variously conducted by over 30 different companies as well as a number of partnerships and trusts. 

Three of the companies involved in the conduct of the business and that had accrued and unpaid liabilities to pay payroll tax for the financial years FY11, FY12 and FY13 were deregistered in July 2013.  Then in August and September 2022, applications were lodged with ASIC to deregister another four companies which also had accrued and unpaid liabilities for payroll tax for the financial years FY14 to FY21.

On 26 and 27 September 2022, the Commissioner issued default assessment and reassessment notices to the group, with the total liability of the Comlek Companies as a result of the assessments being $10,073,318.28.

Between 28 September 2022 and 5 October 2022, the Commissioner also issued Notices of Investigation under the Taxation Administration Act 2001 (Qld) (TAA) which stated that the Comlek Companies constituted a “group” for the purposes of the Payroll Tax Act 1971 (Qld) and that the Commissioner believed that the group had engaged in deliberate activities to avoid detection and payment of payroll tax.

A payment arrangement was proposed to the Commissioner for what would have effectively been a 20 year payment plan to pay the $10m tax debt, but this was rejected by the Commissioner.

The Comlek Companies were placed into administration on 5 December 2022.

In the course of the administration, the administrators received two DOCA proposals – one from the directors of the Comlek Companies and one from a key competitor of the Comlek Companies.  The administrators ultimately recommended the directors’ DOCA proposal as they considered that it provided better prospects for the ongoing viability of the companies (or at least some of them) and the business as well as for the continued employment of the staff of the group.

The second meeting of creditors for the Comlek Companies was held on 19 January 2023.   The Commissioner was the only creditor that voted against the directors’ DOCA, resulting in a majority in number of creditors in favour of the DOCA but a majority in value against.  The administrator acting as chairperson then exercised his casting vote in favour of the DOCA enabling the resolution to pass.

Following the execution of the DOCA, the three key trading companies in the Comlek group continued to carry on the business, trading profitably and employing 88 employees across three geographic locations.

On 17 March 2023, the Commissioner commenced proceedings challenging the decision of the administrators to exercise their casting vote in favour of the DOCA, and seeking orders that the DOCA be terminated on the basis that it was contrary to the public interest and commercial morality and that it unfairly prejudiced the Commissioner as a creditor.

Casting Vote

The Commissioner argued that the casting vote had been improperly exercised in that the administrators should not have exercised the vote in favour of the directors’ DOCA where the DOCA was detrimental to the public interest.

However, the Court rejected this argument, noting that:

• administrators are entitled to exercise their casting vote as they see fit, provided it is in the creditors' best interests;
• the administrators' decision to vote in favour of the directors’ DOCA was justified;
• the administrators had acted reasonably, and had considered the broader benefits of allowing the key trading companies to continue to trade profitably and of preserving over 80 jobs; and
• the administrators genuinely and reasonably believed that the DOCA would offer a better overall return to creditors compared to an immediate liquidation.

Challenge to the DOCA

The key arguments and findings were as follows.

Public Interest and Commercial Morality

The Commissioner argued that the DOCA undermined the purpose and object of the tax laws and shielded the directors from scrutiny in relation to potential breaches of duty and tax evasion. 

The Court, however, found that:

• there was insufficient prima facie evidence of wrongdoing on the part of the directors to warrant termination.  Despite the Notices of Investigation stating that the Commissioner had already formed the view that there had been tax evasion, the case put at the hearing was that the facts of the matter gave rise to strong grounds to suspect that tax evasion or fraud had taken place, and the Commissioner did not actually establish that this had occurred;
• further, it was unclear that the DOCA would prevent these matters being investigated.  The Commissioner argued that if the companies were placed into liquidation, the liquidators could properly investigate whether the tax laws had been breached.  However, the Court noted that the Commissioner in fact has the power to investigate and prosecute breaches of the tax laws, and that it was unclear why the Commissioner could not in fact continue to do so even if the DOCA remained in place; and
• finally, it was not established that the DOCA subverted the purposes of Part 5.3A as there was no evidence to suggest that the DOCA had been deliberately designed so as to specifically target and defeat the tax liabilities or to avoid scrutiny of the alleged tax evasion.

Fairness and Prejudice to Creditors

The Commissioner also argued that the DOCA unfairly disadvantaged him as a creditor, resulting in the Commissioner receiving a lower return than the other creditors.  

However, the Court found that the DOCA was not unfairly discriminatory and noted that:

• while the DOCA did provide for a different return to the Commissioner than the other creditors, the Commissioner was still receiving 60% of the available pool of funds in circumstances where the Commissioner had already garnished company accounts (and therefore received 100c in the dollar for some of the debts), the companies had lodged objections to the assessments but the Commissioner’s claim had nonetheless been admitted in full, and the return to the Commissioner was estimated at 7.8c to 17.4c in the dollar compared to the estimated return to other creditors of 16.9c to 37.8c in the dollar;
• mere prejudice to a creditor is not enough, and it must be established that there is unfair discrimination or unfair prejudice;
• a critical issue is to consider what the purportedly prejudiced creditor would receive in a winding up; and
• in this case there was insufficient evidence to establish that the Commissioner, or indeed any creditor, would be worse off under the DOCA as compared to a liquidation.

Overall, the Court dismissed the application and found that there were no grounds to terminate the DOCA or to set aside the casting vote, and noted that the trading companies were trading profitably, the 88 employees continued to be gainfully employed, and the Commissioner had other means by which to continue to pursue the tax issues relating to the Comlek Companies.

Lavan Comment

This case is a good example of the pragmatic approach taken by the Courts in considering applications to challenge a DOCA that has otherwise been approved by the creditors of a company.

It also provides a useful analysis of the law in relation to the public interest and commercial morality ground, and how those factors will be considered and applied by the Courts.

If you have any questions in relation to this case, or in relation to when a DOCA can be terminated on the grounds that it is contrary to the public interest and commercial morality, the experienced Lavan team is here to help.

Thank you to Jackson Flematti, Solicitor, for his valuable research and assistance with this article.