At last we know a little of what the Commissioner thinks and doesn’t think, and a lot of what he does not know (yet) what to think in relation to the High Court’s decision in FCT v Bamford and also on the broader issue of taxing income received by trust beneficiaries. He has done this through his much anticipated Decision Impact Statement (”the DIS”) that was issued on 2 June 2010 and added a practice statement, PS LA 2010/1 (”New PS”). The New PS supersedes his interim Bamford practice statement of last year, PS LA 2009/7.
The DIS and New PS raise several practical points. We highlight some of these below. For clarity, in the DIS and New PS the Commissioner refers to net income calculated under s 95 of the ITAA 1936 as “[tax] net income” and we have adopted this phrase.
The most significant ongoing practical point is made with minimal discussion. The Commissioner concludes that the character of allocated income does not flow through the trust - subject to the effect of statutory provisions outside Division 6 of ITAA 1936. An amount of tax net income that is included in a beneficiary’s assessable income under s 97 comprises an “un-dissected or un-allocated proportionate share of the entirety of the [tax] net income” returned by the trust.
Many trustees would seek to stream franked dividends or capital gains to selected beneficiaries while directing other income to different beneficiaries. The Commissioner intends to consult with the tax profession on the manner in which statutory flow-through provisions, such as Subdivision 115-C ITAA 1997 (capital gains) and Subdivision 207-B ITAA 1997 (franking credits), interact with Division 6.
The second practical point is that trust clauses which re-characterise receipts as income or income equalisation clauses will not necessarily be effective in deeming notional tax income to exist for trust distribution purposes. For example, the Commissioner intends to consult on whether a capital gain arising through application of the market value rules or a franking credit can be deemed to give rise to an identical amount of distributable income under the trust deed. The issue is whether there must be an actual accretion to the trust in order for distributable income to exist.
The third practical point is whether income equalisation clauses can displace inconsistent accounting methodology required by the trust deed. For example, if the trustee is obliged under the trust instrument to account for investments at fair value, can an income equalisation clause override this by requiring gains to be recognised on a realisation basis? Such situations could give rise to variations between trust net income and tax net income every year. The Commissioner intends to consult on this third issue as well.
The fourth practical point is one that lies at the heart of the Bamford decision. As trust law governs the determination of “the income of a trust estate” (to the extent that general trust law is not overridden by trust terms), practitioners will need knowledge of relevant trust law principles. General trust law (in so far as it is not displaced by the trust provisions) will impact on the characterisation of receipts as income and on apportionment of outgoings and losses between income and capital. This apportionment is governed by presumptions that are highly rule based.
The Commissioner intends to consult in relation to “what constitutes a receipt or outgoing of a trust” for purposes of determining trust distributable income for a period. The consultation will extend to consideration of the relevance of accounting principles (eg application of cash v accrual basis) “in identifying and measuring apportionable receipts and outgoings of the trust”.
A fifth practical point is more pervasive and, for some practitioners, may require a cultural change that recognises that “one size does not fit all” when it comes to trusts (or even categories of trusts). Careful attention will have to be given to the specific terms of a trust. For example, trust clauses enabling the trustee “to re-characterise a receipt or outgoing cannot contradict other requirements of the trust instrument” (refer to the Commissioner’s DIS in relation to Forrest v FCT [2010] FCAFC 6).
The Commissioner has directed ATO staff that “[n]o case should be resolved without detailed consideration of the trust deed (including any amendments that have been made to it) and all relevant documents including (but not limited to) relevant trustee resolutions and financial statements”. In anticipation of intensive ATO scrutiny, practitioners will similarly need to be vigilant.
What does this mean for 2010 returns and beyond (and prior)?
If the foregoing discussion has been sufficient to engender mild panic as you read this and recall that the end of the tax year is not far off, the Commissioner has offered some degree of consolation.
He proposes a non-active approach to retrospective application of the decision - if “you don’t …, he won’t …”. In relation to the 2009-10 tax year, the New PS directs ATO staff not to “select cases for active compliance solely to” correct errors in tax returns or trust administration which the Bamford decision has brought to light. This leniency does not extend to circumstances of deliberate exploitation of Division 6 of the ITAA 1936. The New PS gives several examples where the exception applies.
While cases may not be selected “solely” on the basis of such errors, disputes on other grounds may lead to the review of the basis upon which trust distributions have been made. If there are disputes on other grounds ATO officers are directed to apply “the law as explained in Bamford“.
Practitioners will need to consider any practical implications of triggering disputes which might draw undesired ATO investigation. The New PS cites a dispute about the quantum of a trust’s net income as an example of a dispute that would lead to applying the post-Bamford legal position.
Practitioners may also find some solace from the fact that the following rulings will be withdrawn only for the 2010-11 and later income years:
- TR 95/29 (Primary production averaging)
- IT 331 (Adjustments to [tax] net income)
- PS LA 2005/1 (GA) (Taxation of capital gains of a trust).
The DIS recognises that “trustees and beneficiaries may have relied on … [them] already in respect of the 2009-10 income year” and so should remain available for that and prior years. However, a taxpayer may choose to rely on the Bamford decision for the year ended 30 June 2010 or a prior year.
TR 92/13 (Trust dividends and franking) is conspicuously absent from the above list. The ruling will also be withdrawn, as it relates to former legislation. The Commissioner views the current imputation provisions (Subdivision 207-B of ITAA 1997) as more than a mere re-enactment of the former Division 7 of Part IIIAA and intends to consult on a replacement ruling.
However, he recognises “that for 2009-10 and earlier income years taxpayers may have relied on TR 92/13 as a guide to the application of Subdivision 207-B”. The DIS states that “Returns reasonably prepared on that basis will not be disturbed”. It might be prudent to be able to establish such reliance has occurred. Playing devil’s advocate (and, probably, not in the spirit of the assurance), does the DIS recognition of the disparity between Subdivision 207-B and Division 7 impact on the “reasonableness”?
In the absence of tax avoidance schemes, ATO staff are directed to “accept that trustees and beneficiaries who have prepared returns for 2009-10 or earlier income years on the basis of the Commissioner’s views of the operation of Division 6 (as argued in Bamford), or on the basis of an alternative view about the operation of Division 6 that is reasonably open having regard to other relevant authorities, have taken ‘reasonable care to comply with the taxation law’ and that their position is ‘reasonably arguable’ for the purposes of Division 284 of … [Sch 1 to TAA 1953]“.
Flowing from this, the Commissioner recognises:
- in these circumstances there is “no liability for administrative penalty in respect of a relevant ‘shortfall amount’…”, and
- the factors outlined above must be taken into account in determining whether to remit any shortfall interest charge or GIC imposed under the ITAA 1936 and/or the TAA.
Private Rulings, objection decisions or arguments in appeal will be based on the Commissioner’s view of “income of the trust estate” and “that share”. These courses of action will clearly then result in the Commissioner’s position being applied by him for FY10 and earlier years, so care will need to be taken in relation to these situations.
And the consultation continues…
At the outset, we noted that the Commissioner does not know (yet) what to think in relation to some matters. Some proposed consultations have been outlined above.
Other issues of uncertainty which the Commissioner has identified and in relation to which the ATO intends to consult include:
- whether a trustee must use the same accounting methodology to identify and measure the trusts distributable income and also to prepare periodic financial accounts for the information of the beneficiaries;
- “how a trust’s distributable income is to be determined where the trust instrument employs different notions of income for different purposes”;
- “the principles to be applied in identifying the section 97 income of the trust estate if a particular trust does not distinguish between income and capital for the purposes of ascertaining beneficiary entitlements to trust property”;
- “how paragraphs 97(1)(a), (b) and (c) are to be reconciled”; and
- “the manner in which Division 6 interacts with other provisions which rely on a beneficiary’s present entitlement to the income of a trust (for example, Division 11A of the ITAA 936)”.
The Commissioner is also considering the ability to re-characterise income as capital. He notes that Bamford was only concerned with the converse circumstance of re-characterising a capital gain as income.
All too hard?
The foregoing is not intended as a complete statement of the practical points emerging from the DIS and the New PS.
Although the Commissioner’s published position predating Bamford will remain in place to a degree for the 2009-10 year, careful consideration will need to be given to various matters in relation to that year, including drafting distribution resolutions. Furthermore, practitioners will need to review the terms of a trust, the manner in which trust structures are used in connection with a client’s tax affairs, and the distribution goals in relation to the 2010-11 tax year, in order to ensure timely implementation for efficacy in the new tax year.
If the implications of Bamford are beginning to sound “too hard”, you might like to consider speaking with one of our consulting team or arranging a visit from one of our consultants for a “one-on-one” session on the decision and its implications for your practice.
This edition of ‘The Assessment’ was prepared by Andrew Orange. If you would like assistance in relation to the BAMFORD - What the Commissioner Thinks, please feel free contact Andrew by phone on 03 8662 3200 or by email at andrewo@webbmartinconsulting.com.au
Disclaimer
‘The Assessment’ is intended to provide general information or comments on the particular topic. The content is not intended to exhaustively deal with all issues relating to that topic. As the content is general in nature, they are not to be used, relied or acted upon without seeking further professional advice. Webb Martin Consulting accepts no liability for any errors or omissions, or for any loss or damage suffered as a result of any person acting without such advice.
