Most people associate the term income with the income that is disclosed in their tax return, however if a person becomes bankrupt, what is included as income in the Bankruptcy Act 1966 (Act) is much broader.
In the September Quarterly Newsletter, Daniel Luckman of our Sunshine Coast office described how a bankrupt was not prevented from earning income during the period of their bankruptcy and how that income was treated for the purposes of the bankruptcy. The link to the article is located here.
Further articles have been prepared by SV Partners on other aspects of income, which are relevant and may be of interest including:
- What is Income? Written by Malcolm Field of our Perth office; and
- Post-Bankruptcy Income and After Acquired Property – Beware the Pitfalls! Written by Fabian Micheletto of our Melbourne office.
What is Income – in Bankruptcy?
Section 139L(1) of the Act, sets out what is considered income for the purposes of Division 4B of Part VI of the Act (income contribution division).
The definition includes income according to its “ordinary meaning” which is modified by a number of additions to what is considered income even if it does not fall within the ordinary meaning of income. These additions include (but are not limited to):
- Benefits that fall within that meaning in the Fringe Benefits Tax Assessment Act 1986 (FBT);
- Loans or other monies paid to the bankrupt (or for the benefit of the bankrupt) from associated entities, which may not necessarily be enforceable at law; and
- Funds received by another person/entity as a result of work done or services performed by the bankrupt.
What is not Income – in Bankruptcy?
The Act specifically excludes certain receipts as not being income including (but not limited to):
- Child Support received;
- Funds received under a legal-aid scheme;
- Superannuation contributions where those obligations are provided under a State, Territory or Commonwealth law; and
- Family tax benefits.
Examples of Income
There are many unique situations that arise in a bankruptcy context and the following are examples of benefits/other income that may not normally be included in an individual’s tax return but are included in the bankruptcy income contribution assessment.
Housing and Vehicles Provided by Relatives
It is not uncommon for a house or motor vehicle to be provided to a bankrupt rent-free, not in any employment capacity, which will be caught as income for the purposes of the Act.
Whilst the FBT applies only to employers, section 139L(1)(v) of the Act, modifies the operation of the FBT to assess the benefit received as if “the provider were the employer of the bankrupt as an employee and the provider had provided the benefit in respect of the employment of the bankrupt”.
The income may be an equivalent market rent in the case of free housing provided to the bankrupt or in the case of a motor vehicle, the benefit will be calculated by reference to a statutory formula as set out in the FBT (with necessary modifications for the purposes of bankruptcy).
Funds Provided by Family to Assist with Expenses
An example that may be caught by the Act’s income definitions is where a bankrupt’s children attend a private school and due to a reduction or loss in income, the bankrupt’s family pay the school fees.
Section 139(L)(1)(vi) of the Act captures as income the value of any loan provided by an associated entity of the bankrupt, even if:
- The loan is not paid to the bankrupt but is paid or applied at the bankrupt’s discretion; or
- The loan isn’t considered a loan at law or in equity.
Accordingly, the value (or a portion thereof) of the school fees may be assessed as income in the bankrupt’s income contribution assessment.
Revenue Received by Another Entity
Circumstances can arise, where a person who is about to become bankrupt may interpose between them and their source of income another legal entity. As an example let’s assume that the bankrupt’s spouse may be a Director of a company that is Trustee of a discretionary trust, but where the bankrupt provides all the services that generate the income.
Now assuming that the Personal Services Income provisions set out in the tax legislation do not apply, the company as Trustee of the trust would prepare its own tax returns and distribute the income to any beneficiary at its discretion. This may exclude the bankrupt or may include a small amount to the bankrupt but not enough to require any contributions to be paid to the bankrupt’s Trustee, with the balance being payable to the spouse or other related party beneficiary.
Using the above example, section 139L(1)(vii) of the Act may capture the income of the trust as being income of the bankrupt. The Trustee in Bankruptcy must take into account expenses necessarily incurred by the trust in earning the income, except expenses of a capital nature. These expenses may differ from deductions allowed for income tax purposes. For example, depreciation on depreciable assets does not reduce the bankrupt’s income for the purposes of the income contribution calculation.
Accordingly, the bankrupt’s income for the purposes of calculation of income contributions may be significantly increased even though they didn’t receive the income (or received a small distribution thereof).
But wait there’s more
Whilst the Act defines certain other receipts as income, the Act also provides a mechanism for the Trustee to assess income of a bankrupt as greater than the amount the bankrupt either receives or declares for income tax purposes.
Section 139Y of the Act allows the Trustee to determine that the bankrupt receives or received remuneration in excess of the amount they were actually paid. A PAYG employee working for an unrelated entity will not usually encounter this situation, however, where the bankrupt is employed by a related entity the Trustee will usually closely scrutinise the arrangement.
The section sets out the requirements for determining the reasonable remuneration which include:
- Assessment of the minimum rates or salary for the employment based on an industrial instrument; or
- The amounts that might reasonably be expected to be received for similar work or services if there was no connection between the bankrupt and the employer.
Lastly, even if a bankrupt does not receive the funds which may be reinvested, accumulated, capitalised or otherwise dealt with on behalf of the bankrupt, section 139M of the Act allows the Trustee to assess these monies as being income of the bankrupt.
Conclusion
Most people will associate income with the income they include in their tax return which holds true in most situations. However as shown above, if a person becomes bankrupt, their income may be significantly greater than the amount they declare to the tax office due to broader definitions of income as set out in the Act.
The Act provides wide powers for the Trustee to assess income of a bankrupt even in circumstances where that person never receives the funds.
Article written by Travis Olsen (Director) – Adelaide