Second mortgagee loses out to GST paid by first mortgagee on sale

An appeal by a second mortgagee, which argued a right to claim in the distribution of the mortgagor's assets ahead of payment of the GST on the sale of the assets by the first mortgagee, has been dismissed.

This New Zealand appeal(1) was heard by the Privy Council, which was required to consider, firstly, whether a mortgagee who exercises a power to sell property is liable for the GST payable on the sale and, secondly, whether it is entitled, as against subsequent security holders, to reimburse itself out of the proceeds of sale.

The facts of the case were that the first mortgagee sold the relevant property and paid GST on the sale to the IRD. It then reimbursed itself out of the proceeds of the sale and discharged its own debt, but the balance was insufficient also to discharge the second mortgagee's debt. The mortgagor was insolvent. The second mortgagee claimed a prior ranking to the IRD, and argued that it should have been paid ahead of the GST payment.

Their Lordships found that section 17 of the Goods and Services Tax Act 1985 clearly requires a mortgagee exercising a power of sale to pay the GST on any sale, and therefore effectively creates a debt between the mortgagee and the IRD. However, section 17 does not require the mortgagee to pay the GST out of the proceeds of sale or out of any particular fund, and the IRD has a claim only against the mortgagee and not by way of priority in the distribution of the mortgagor's assets.

The first mortgagee's claim to reimbursement was then found to be a valid claim to an "expense occasioned by the sale" for the purposes of section 104 of the Land Transfer Act 1952 (which regulates the application of the proceeds of a mortgagee sale).

The order of priorities set out in section 104 is:

"(a)	...the expenses occasioned by the sale;
(b)	...the money then due or owing to the mortgagee;
(c)	...subsequent registered mortgages or encumbrances (if any) in the order of their priority."

The second mortgagee therefore left the Privy Council empty-handed.

(1) Edgewater Motel Limited and Others v Commissioner of Inland Revenue (PC 44-2003, 26 July 2004)

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