R&D refund not circulating asset

Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as Liquidators of Spitfire Corp Ltd (In Liq) [2023] NSWCA 118

In Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as Liquidators of Spitfire Corp Ltd (In Liq) [2023] NSWCA 118, the New South Wales Court of Appeal delivered a decision which provides further clarify on the construction of s340 of the Personal Property Securities Act (Cth) 2009 and, in particular, when personal property is a circulating asset.

The appeal concerned a priority dispute between a secured creditor and the Commonwealth (as a subrogated employee creditor) in respect of tax refunds received by the liquidators of Spitfire Corporation Limited (in liquidation) after the commencement of the winding up on 7 August 2020.

The priority dispute arose in the context that s561 of the Corporations Act 2001 (Cth) (“Act”)  confers priority on certain employee entitlements and for advances to a company to make such payments to employees over the claims of a secured creditor in relation to property which is subject to a “circulating security interest”.

Facts

Spitfire was the parent company of the Spitfire group, which provided wealth management and share analysis technology platforms, including proprietary software.

Spitfire lodged R&D Tax Incentive applications with the Department of Industry, Innovation and Science for the 2019 tax year, and the liquidators on behalf of Spitfire lodged a similar application for the 2020 tax year. Both applications described the R&D project as “[t]he design and development of an automated B2B2C asset and investment management platform for wealth manager, family office and institutions”.

In April and August 2021, the liquidators received tax offset refunds in relation to expenditure on research and development (R&D Refunds) totalling some $2 million for the 2019 and 2020 income years.

A secured creditor, Resilient Investment Group Pty Ltd, and the Commonwealth of Australia as a subrogated employee creditor under s 560 of the Act, each claimed priority to the R&D Refunds. The liquidators applied to the Supreme Court for directions concerning the distribution of the R&D Refunds.  Resilient and the Commonwealth of Australia were given leave to be heard on that application.

It was common ground that if the R&D Refunds received by Spitfire post liquidation were circulating assets at the appointment date, 7 August 2020, then those amounts were required to be applied by the liquidators to satisfy the employee entitlements of Spitfire’s employees under s 556(1) of the Act in priority to Resilient’s claim as secured creditor.

At First Instance

In his principal judgment, Justice Black concluded that the R&D Refunds were circulating assets of Spitfire at the appointment date as the R&D Refunds were an “account” for the purposes of s 340)(5)(a) of the Personal Property Securities Act 2009 (Cth) (PPSA) and that the Commonwealth was entitled to the R&D Refunds as the subrogated employee creditor of Spitfire, subject to any equitable lien of the liquidators.

Resilient sought leave to appeal.

Appeal

The main issues on appeal were:

1. whether the R&D Refunds were an “account” (ie, a monetary obligation) for the purposes of s 340(5)(a) of the PPSA at the appointment date so as to fall within the meaning of “personal property” in s 340(1)(a).
2. if the R&D Refunds were an account at the appointment date, whether the entitlement to the R&D Refunds “arises from” Spitfire providing services “in the ordinary course of a business of providing services of that kind” within s 340(5)(a) of the PPSA.

The Court of Appeal, comprised of Justices Gleeson, White and Brereton upheld the appeal.  There were other issues considered on appeal which are not the subject of this case report.

Gleeson JA delivered the primary judgement (White and Brereton JAs agreeing).

Were the R&D Refunds ‘Circulating Assets’.

Whether the claims of employee creditors of Spitfire had priority over Resilient’s claim as the secured creditor depended on whether Resilient’s security interest was a “circulating security interest”: s561 of the Act. That depends on whether, at the appointment date, the R&D Refunds were a “circulating asset” of Spitfire for the purpose of s 340 of the PPSA.

Gleeson JA said that “As a general proposition there is some artificiality in treating the concept of “personal property” for the purpose of s 340 as conceptually distinct from the two groups of assets specified in s 340(1)(a) and (b).  The question of whether a right or claim to a tax refund is “personal property” for the purpose of s 340(1) is best addressed in context. Here, the relevant context is whether, at the appointment date, the R&D Refunds were personal property for the purpose of s 340(1)(a) because the R&D Refunds were an “account” within s 340(5)(a)”. (emphasis added)

This question has two aspects: first, whether the R&D Refunds were a “monetary obligation” at the appointment date; and second, if so, was the entitlement to the R&D Refunds an obligation that “arises from” the provision of services “in the ordinary course of a business of providing services of that kind”.

The critical question is whether the right or claim to the R&D Refunds arose upon the making of an assessment (as Resilient contended), or whether it arose at the conclusion of the relevant income year for 2019 and 2020, which was prior to the appointment date of 7 August 2020 (as the Commonwealth contended and the primary judge found).

After conducting a very thorough analysis of tax law, her Honour concluded that whilst a taxpayer has an obligation to pay income tax in the future which comes into existence at the end of the income year, the Commissioner does not have an obligation or duty at the end of an income year to pay a tax offset refund to the taxpayer.  As a corollary, a taxpayer is not entitled to enforce payment of a tax offset refund against the Commonwealth at the end of the relevant income year.

Accordingly, Gleeson JA upheld the challenge to the primary judge’s conclusions as to the R&D Refunds constituting personal property and a monetary obligation.  At the end of the relevant income years, 2019 and 2020, Spitfire did not have a chose in action against the Commissioner for the tax offset refunds.

Services in the Ordinary Course of Business

Although unnecessary to do so, her Honour went on to address the related issue raised by the definition of an “account” in s 10 of the PPSA.  That is, assuming the R&D Refunds were a “monetary obligation” at the appointment date, whether the R&D Refunds “arise from” providing services “in the ordinary course of a business of providing services of that kind”.

Her Honour observed that both s 340(5)(a) and the definition of an account in s 10 require a causal connection between the account and the “provision of services” in the requisite sense of “the ordinary course of a business of providing services of that kind”.

Here, the matter from which the account must arise is services provided by Spitfire in the ordinary course of a business of providing services of that kind.

Her Honour said that the words “arise from” do not require the account to arise in the ordinary course of business; it is the services provided by Spitfire which must be provided in the ordinary course of a business of providing services of that kind, and the account must arise from the provision of services answering that description.

The nature of the services provided by Spitfire was described as “wealth management and share analysis technology platforms”.

Gleeson JA said the primary judge erred in construing the causal connection in s 340(5)(a) such that the incurring of R&D expenditure enables the provision of services, rather than whether the R&D Refund arises from the provision of services in the requisite sense.

The entitlement to a tax offset in respect of R&D expenditure arose from the Spitfire group incurring deductible expenses or becoming entitled to claim a deduction in respect of depreciating assets, rather than providing financial platform services to Spitfire’s customers. The entitlement to receive the R&D Refunds did not arise in the ordinary course of providing services of that kind (ie, financial platform services).  Even if it was accepted that the R&D activities were for the ultimate benefit of Spitfires’ customers who used its financial platform services, the entitlement to receive R&D Refunds does not arise in the ordinary course of a business of providing such services.

Accordingly, her Honour concluded that no monetary obligation in the form of R&D Refunds arose from the provision of services to Spitfire’s customers.

White JA disagreed with Gleeson JA’s conclusion as to whether the R&D Refunds were an account.  His Honour said he “was inclined to the view that prior to the date of its administration Spitfire had a contingent asset which should be characterised as property, and the Commonwealth was under a monetary obligation, albeit a contingent obligation, to pay a tax refund; the contingency being that Spitfire lodge its tax returns claiming the tax refunds”.

It was unnecessary for White JA to express a concluded view on that question, because, for the reasons Gleeson JA had given, White JA agreed that the monetary obligation did not arise from Spitfire’s providing services in the ordinary course of a business of providing services of that kind within the meaning of s 340(5) of the PPSA.

Take Aways

Given Brereton JA’s concurrence with the primary judgment, this case provides an authoritative pronouncement that R&D refunds received after the relevant appointment date are not circulating assets and, so, not available for priority employee claims.

The case also provides a useful framework for insolvent practitioners to establish the necessary causal connection between an account and the services from which the monetary obligation must arise in determining the character of the account as a circulating or non-circulating asset.