The High Court (”HC”) has dismissed both the Commissioner’s and taxpayers’ appeals from the Full Federal Court (”FFC”) in a unanimous decision.
The FFC’s decision was analysed in the October 2009 edition of this newsletter <click here>.
Section 97(1) ITAA relevantly provides:
” … where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:
(a) the assessable income of the beneficiary shall include:
(i) so much of that share of the net income of the trust estate as is attributable to a period in which the beneficiary was a resident; and
(ii) …” (italics added)
The Commissioner’s Appeal
On appeal, the Commissioner maintained that a capital gain which the trustee had treated as income and distributed to Mr and Mrs Bamford was not included “in the income of the trust estate” (s 97(1)). He submitted that the capital gain was taxable in the hands of the trustee under s 99A.
More particularly, the Commissioner argued that “the capital gain was not, in the sense of the 1936 Act, ‘income according to ordinary concepts’”.
In rejecting the Commissioner’s contention, the HC took the view that “the income of the trust” imported the general law of trusts, in contrast to the legislatively defined expression “net income of the trust estate”.
The decision appears to preserve the efficacy of discretionary trust provisions which enable trustees to determine whether a receipt is income of the trust estate for s 97(1) purposes.
However, the Commissioner’s concession “that the appeal should be dismissed if ‘the income of the trust estate’ within the meaning of s 97(1) includes ‘statutory income’ such as capital gains which are brought in as ‘assessable income’” potentially impairs the authority of the case on this point. The author takes the view that the Court did not decide the case on this narrow ground.
The Taxpayers’ Appeal
The taxpayers’ appeal raised the issue of construction of ” ‘that share’ in s 97(1) in circumstances where the entitlement of beneficiaries is not to fixed proportions of the income of the trust estate but, as to some beneficiaries, to specific amounts and, to another beneficiary, to the residue”.
The Bamford trustee had determined that specific amounts of the trust’s net accounting income be distributed sequentially, with provision for distribution of a residue amount. Specified amounts were given in sequence to the Bamford’s children, to a company, to a Church, to Mr and Mrs Bamford in equal shares, and the residue was given to the same Church as the earlier distribution. The net accounting income ($187,530) was only sufficient to allow the distribution to Mr and Mrs Bamford to be partially met (each received $33,872) and the preceding distributions to be fully met. The accounting income was insufficient to allow for payment of any part of the provision for residue income.
The net income (s 95) of the trust exceeded the net accounting income. The Commissioner apportioned the excess ($191,701) amongst the beneficiaries entitled to specific amounts on the basis of the proportion which the amounts they received bore to the total amount distributed. For example, Mr Bamford’s assessable income was increased by $34,624.
Mr and Mrs Bamford contended “that their share of the net income of the trust estate and thus the amounts included in their assessable incomes should have been ascertained as if the terms of the [trust] Deed, including the effect of any exercise of power of appointment over income, applied to the calculation of that ‘net income’”.
In other words, they argued that where distributions were made to beneficiaries in specific amounts (rather than to a proportionate part), s 97 allocated only those specific amounts of net income to the beneficiaries because the term “share” in s 97(1) “reflects the particular method for determination of entitlement to trust income”.
The HC agreed with Emmett J’s decision (FFC) in rejecting this view. The Court endorsed the proportional approach of Sundberg J in Zeta Force Pty Ltd v Commissioner of Taxation - “the natural meaning to give to the word ‘share’ where it appears for the second time [in s 97(1)] is ‘proportion’ rather than ‘part’ or ‘portion’”.
The HC’s decision appears to deny a trustee has flexibility in determining whether a “proportional approach” or a “parts’ approach is to be applied in allocating net income (as calculated under s 95). Section 97 requires a proportional approach.
As a side comment, one should recognise the limited scope of the facts before the Court. For example, as the case did not concern dividends, the Court was not required to factor in the effect of s 207-35 (ITAA 1997) in relation to the treatment of franking credit amounts.
What next?
The HC recognised the shortcomings of s 97, noting that 20 years ago Hill J called for legislative change. The recognition of the need for legislative action and the terseness of the judgement are an invitation to the legislature to address the shortcomings. While the HC has ordered “steady as she goes”, the case shows s 97 is “foundering” in the rough seas of taxation application and the need for the construction of a new “vessel” for the taxation of trust distributions.
We are concerned that this could be the catalyst for a renewed call for entity taxation!
This edition of ‘The Assessment’ was prepared by Andrew Orange. If you would like assistance in relation to the FCT v Bamford - High Court orders “steady as she goes” please feel free contact Andrew by phone on 03 8662 3200 or by andrewo@webbmartinconsulting.com.au
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