Decision Impact Statement
Commissioner of Taxation v. Bamford & Ors; Bamford & Anor v. Commissioner of Taxation
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 HCA 10
2010 ATC 20-170
75 ATR 1
Venue: High Court
Venue Reference No: S310 and S311/2009
Judge Name: French CJ, Gummow, Heydon, Hayne and Crennan JJ
Judgment date: 30 March 2010
Appeals on foot: No.
Administrative Treatment (Implication on current Public Rulings and Determinations)Relevant Rulings/Determinations:
- Taxation Ruling TR 95/29: Income tax: Division 16 - applicability of averaging provisions to beneficiaries of trust estates carrying on a business of primary production
- Taxation Ruling No. IT 331: Income tax: trustees and beneficiaries: adjustments to estate income as returned to arrive at net income of estate for the purposes of section 95
- Taxation Ruling TR 92/13: Income tax: distribution by trustees of dividend income under the imputation system
Income of the trust estate
Assessable income of a beneficiary
A share of the income of the trust estate
Net income of a trust estate
Disparity between net income and distributable income
Outlines the ATO view of the Bamford decision which concerned the meaning of the phrase 'income of the trust estate' and the words 'that share' in subsection 97(1) of the Income Tax Assessment Act 1936 (ITAA 1936). All references are to the ITAA 1936 unless otherwise indicated.
Brief Summary of Facts
This decision is important because it concerns key elements of Division 6 of Part III by which the liability of trustees and beneficiaries to tax is determined under that Division.
Under Division 6, a notional taxable income for a trust estate is calculated in accordance with section 95. This is the first key element. That notional taxable income is referred to as the 'net income' of the trust estate, but to avoid confusion in this Decision Impact Statement it is referred to as the '[tax] net income'.
A resident beneficiary is liable to tax in respect of a part of that [tax] net income if the beneficiary is presently entitled to a share of the 'income of the trust estate' and not under a legal disability. If a beneficiary is so entitled, the beneficiary is liable to tax on 'that share' of the [tax] net income under section 97. These are the other key elements, but their meaning is not defined by the Act.
The case concerned the assessment of the [tax] net income of the Bamford Trust ('Trust') for the 2002 and 2000 years. The 2002 year (in respect of which the Commissioner was the appellant) raised the meaning of the phrase 'income of the trust estate'. The 2000 year (in respect of which the taxpayers were the appellants) raised the meaning of 'that share'.
The Trust recorded a net profit of $55,675 for accounting purposes for the year consisting wholly of a capital profit on the sale of certain real property. The capital gain for tax purposes on the disposal of the property was a different amount.
The trustee resolved, in exercise of its powers under the deed, to distribute the 'net income' of the trust as to 'the first $60,000, including capital gain' to Mr and Mrs Bamford equally (and the balance to the Church of Scientology). It was common ground that by virtue of this resolution the trustee had, pursuant to a power contained in clause 7(n) of the trust deed, treated the capital profit as income to which income beneficiaries could be entitled.
The income tax return lodged for the Trust recorded a nil [tax] net income (because of carry forward losses). However, following the disallowance of deductions by the Commissioner the Trust's [tax] net income was $16,100. It was common ground that these deductions were not allowable.
The Commissioner assessed the whole of the Trust's [tax] net income to the trustee pursuant to section 99A on the basis that there was no income to which any beneficiary was presently entitled. In particular, the Commissioner proceeded on the basis that the capital profit disclosed in the accounts was not 'income of the trust estate' within the meaning of subsection 97(1).
The Commissioner disallowed deductions claimed by the Trust in the amount of $191,701. It was common ground that these deductions were not allowable. The Trust's [tax] net income was therefore increased by the amount of the deductions disallowed.
Mr and Mrs Bamford were each presently entitled to an amount of $33,872 (or 18.062%) of the total income available for distribution for trust purposes ($187,530).
The Commissioner therefore assessed part of the increased [tax] net income to Mr and Mrs Bamford in proportion to their respective shares of the income of the Trust available for distribution. And, on that basis, their respective shares of the [tax] net income of the Trust increased by $34,624 each (being 18.062% of $191,701).
Issues for the Court
In relation to the 2002 year, the issue was whether the expression 'income of the trust estate' in the opening words of subsection 97(1) means:
- income according to ordinary concepts (the Commissioner's position as appellant); or
- income for trust law purposes (the taxpayers' position as respondent).
In relation to the 2000 year, the issue was whether 'that share' in subparagraph 97(1)(a)(i) means:
- the beneficiary's proportionate or fractional entitlement to so much of the income of the trust estate as has been distributed or is available for distribution - that is, the proportionate approach (the Commissioner's position as respondent); or
- the prescription of entitlement used for trust purposes to measure a beneficiary's entitlement to distributable trust income - whether it be a fixed amount, a proportion or a balance (the taxpayers' position as appellant).
Note: The Commissioner drew the Court's attention to an additional argument, namely that 'income' may mean that which is treated as income for taxation purposes (i.e., including statutory income) and 'that share' may mean so much of the income to which a beneficiary is entitled as corresponds to an amount of [tax] net income. However, this alternative construction, which would have effected a closer alignment of the liability for tax with the enjoyment of the income, was not contended by the taxpayer.
The Court's decision
The Court dismissed both appeals.
As regards the 2002 year, the Court decided that the capital profit made by the trust during the year was 'income of the trust estate' for that year as a result of the valid exercise by the trustee of a power under the deed to so treat the profit arising on the disposal of the property.
As regards the 2000 year, the Court adopted the proportionate approach in determining the share of the trust's [tax] net income to be included in the assessable income of Mr and Mrs Bamford.
However, the Court recognised that 'both sides in argument on the present appeals accepted that whichever of the competing constructions of Div 6 were accepted examples could readily be given of apparent unfairness in the resulting administration of the legislation'. In this context the Court noted that it was more than 20 years since Hill J observed that 'the scheme of Div 6 calls out for legislative clarification, especially since the insertion into [the ITAA 1936] of provisions taxing capital gains as assessable income'. See paragraph .
Meaning of income
The Court observed that the contrast between the undefined expression 'income of the trust estate' in the opening words of subsection 97(1) and the defined notion of 'net income of the trust estate' in section 95 suggests that the former expression takes its meaning from the general law of trusts.
In support of this conclusion the Court remarked that 'the language of present entitlement [in subsection 97(1)] is that of the general law of trusts, but adapted to the operation of the 1936 Act upon distinct years of income' and that '[t]he identification in subsection 97(1) of 'a trust estate' of which there is 'a beneficiary' also bespeaks the general law of trusts'. See paragraphs [36-38].
As to the meaning 'income' takes under the general law of trusts, the Court said:
... the distinction between income and capital in trust law was a product of the administration of successive equitable estates with the balancing in particular of the concern of those with life interests in the receipt of income and those with remainder interests in the conservation and augmentation of capital ... [and] the 'rules' which were developed in Chancery regarding apportionment between capital and income of receipts and outgoings and losses largely took the form of presumptions which would yield to provision made in the trust instrument. See paragraph .
As to the processes of administration by which is identified the 'share' of income of the trust estate to which a beneficiary is 'presently entitled', the High Court endorsed the statement of the Full Federal Court in Federal Commissioner of Taxation v. Totledge Pty Ltd ('Totledge') that:
A beneficiary under a trust who is entitled to income will ordinarily only be entitled to receive actual payment of the appropriate share of surplus or distributable income: the trustee will be entitled and obliged to meet revenue outgoings from income before distributing to a life tenant or other beneficiary entitled to income... [h]e is entitled to receive an account of it from the trustee and to be paid his share of what remains of it after payment of, or provision for, the trustee's proper costs, expenses and outgoings. See paragraph .
The Court further observed that Sundberg J's approach in Zeta Force Pty Ltd v. Commissioner of Taxation (' Zeta Force') to the question of the meaning of income for the purposes of section 97 was 'to like effect':
The words 'income of the trust estate' in the opening part of subsection 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument ... The beneficiary's 'share' is his share of the distributable income. See paragraph .
Meaning of share
The Court recognised that the subsection 97(1) income and the [tax] net income were 'two subject matters which do not correspond' (see paragraph ).
Consistently with the decision of Sundberg J in Zeta Force , the Court held that the words 'that share' of the [tax] net income (being an 'artificial tax amount') relate back to the beneficiary's 'share' of the subsection 97(1) distributable income with the consequence that 'share' is to be construed as taking its natural meaning of 'proportion', rather that 'part' or 'portion'.
Thus 'once the share of the distributable income to which the beneficiary is presently entitled is worked out, the notion of present entitlement has served its purpose, and the beneficiary is to be taxed on that share (or proportion) of the taxable income of the trust estate'. See paragraph  quoting Sundberg J.
Tax Office view of decision
A number of general propositions emerge from the High Court's decision:
- the income of a trust estate for trust law purposes and its income for tax purposes are two different subject matters which do not necessarily correspond;
- in subsection 97(1) 'income of the trust estate' takes its meaning from the general law of trusts and not from taxation law;
- under the general law of trusts the concept of 'income' is governed by a set of rules designed to ensure that trustees fairly apportion the receipts and outgoings of a period between those entitled to income and those with an interest in capital;
- the rules of apportionment adopted by the general law of trusts take the form of presumptions about whether particular receipts or outgoings constitute income or capital. The trust law presumptions can be displaced by express provision in the trust instrument;
- the apportionment of receipts and outgoings forms part of the processes in trust administration, explained in Totledge , whereby the 'surplus or distributable income' to which income beneficiaries may become presently entitled in respect of 'distinct year[s] of income' is ascertained (the 'distributable income');
- once the amount of income to which a beneficiary is presently entitled has been ascertained it is converted into a percentage share of the distributable income (howsoever the entitlement was expressed for trust purposes); and
- that percentage is then applied to the [tax] net income of the trust to work out the amount which is included in the assessable income of the beneficiary under paragraph 97(1)(a). This is a simple mathematical calculation the product of which may not correspond with the beneficiary's actual entitlement.
For practical purposes this means that:
- a provision of a trust instrument, or a trustee acting in accordance with a trust instrument, may treat the whole or part of a receipt as income of a period and it will thereby constitute 'income of the trust estate' for the purposes of section 97;
- if a trust instrument does not specify when a receipt is to be treated as income of a period, and the trustee does not have any special power to characterise receipts, then the question of whether the whole or part of a receipt constitutes 'income of the trust estate' for the purposes of section 97 will fall to be determined in accordance with the general presumptions of trust law;
- similarly, the provisions of a trust instrument, or a trustee acting in accordance with a trust instrument, may determine whether an outgoing is properly chargeable against the income of a period (absent which the question will fall to be determined in accordance with the general presumptions of trust law); and
- subject to the possible operation of provisions outside Division 6, the amount included in a beneficiary's assessable income under section 97 consists of an un-dissected or un-allocated proportionate share of the entirety of the [tax] net income.
It has been suggested by some commentators that the High Court's observations about the manner in which the taxation law deals with trusts as distinct from companies (see paragraphs  and ) and the way in which it illustrated the differences between the parties' contentions as to 'that share' (see paragraph ) support the view that:
- amounts distributed to beneficiaries by trustees always retain the same character in the hands of the beneficiaries for trust and tax law purposes as they had in the hands of the trustees for those purposes; and
- Division 6 is an exclusive code for the taxation of beneficiaries.
The Commissioner does not accept that the abovementioned passages can be read in that way and, in any event, he notes that those issues were not before the Court. This is a matter that the Commissioner is testing before the Courts in Commissioner of Taxation v. Greenhatch.
Amendments to Subdivisions 115-C and 207-B of the ITAA 1997 ensure the tax effective streaming of capital gains tax and franked distributions for the 2010-11 and later income years.
2009-10 and earlier income years
Law Administration Practice Statement PS LA 2009/7 set out the Commissioner's approach to Division 6 pending resolution of the Bamford litigation.
Following the finalisation of the Bamford litigation PS LA 2009/7 was withdrawn. It was replaced by PS LA 2010/1 which, among other things, sets out the compliance approaches that staff should adopt in respect of the 2009-10 and earlier income years.
PS LA 2010/1 explains,that the Commissioner will not generally seek to disturb returns for the 2009-10 or earlier income years if taxpayers have relied on a view of Division 6 that was reasonably open prior to the Bamford litigation. The only exception to this will be if there has been a deliberate attempt to exploit Division 6 or there is a dispute for some other reason.
Implications for current Public Rulings & Determinations
The decision in Bamford meant that the following rulings and practice statements had to be withdrawn:
- Taxation Ruling TR 95/29: Income tax: Division 16 - Applicability of averaging provisions to beneficiaries of trust estates carrying on a business of primary production ( withdrawn 30 June 2010 )
- Taxation Ruling No. IT 331: Adjustments to estate income as returned to arrive at net income of estate for the purposes of section 95 ( withdrawn 30 June 2010 )
- Law Administration Practice Statement (General Administration) PS LA 2005/1 (GA): Taxation of capital gains of a trust ( withdrawn 13 October 2010 )
In recognition of the fact that trustees and beneficiaries may have already relied on these products in respect of the 2009-10 income year, they were withdrawn only with effect from the beginning of the 2010-11 income year. However, a taxpayer who wishes to rely on the law as decided in Bamford for the year ended 30 June 2010 (or an earlier year) may of course do so.
Taxation Ruling TR 92/13 (Trust dividends and franking) was withdrawn on 22 June 2011 on the basis that it concerned provisions of the taxation law which were no longer in force (the current imputation provisions in Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997) appear to be more than a mere re-enactment of the former Division 7 of Part IIIAA). Although the Commissioner considered replacing the ruling with a new interpretative product about the operation of Subdivision 207-B that did not proceed because amendments were made to Subdivision 207-B to enable streaming of franked distributions. Those amendments operate generally with effect for the 2010-11 and later income years.
The Commissioner understands that for the 2009-10 and earlier income years taxpayers may have relied on TR 92/13 as a guide to how the Commissioner would seek to apply Subdivision 207-B. Returns reasonably prepared on that basis will not be disturbed.
Implications for future Public Rulings & Determinations
Whilst the High Court's decision provides guidance for cases which are on all fours with Bamford a number of issues concerning the application of Division 6 in other circumstances remain unresolved.
For example, issues which remain uncertain include:
- what constitutes a receipt or an outgoing of a trust for the purposes of ascertaining the trust's distributable income of a period;
- the extent to which accounting principles are relevant in identifying and measuring the apportionable receipts and outgoings of a trust and therefore the trust's distributable income of a period (for example, cash versus accruals bases);
- whether a trustee can identify and measure the trust's distributable income using an accounting methodology that differs from the accounting methodology the trustee uses to account to beneficiaries as to the condition of the trust estate from period to period;
- the effect for trust law purposes of provisions in trust instruments (or trustee determinations) which purport to equate the trust's distributable income with its [tax] net income where the [tax] net income includes notional amounts (eg. franking credits or deemed capital gains) or where the time at which income is recognised for tax purposes differs from the time at which it is recognised for trust accounting purposes (eg. where trust assets are accounted for at fair value);
- 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;
- how the statutory flow through provisions such as Subdivision 115-C of the ITAA 1997 (capital gains and trusts) and Subdivision 207-B of the ITAA 1997 (franking credits and trusts) interact with Division 6 given that a beneficiary's liability to be assessed on the [tax] net income of the trust under Division 6 may not correspond with the beneficiary's actual entitlement; 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 1936).
Treating income as capital
There also remains a particular issue as to the effect for taxation purposes of a recharacterisation clause that requires or permits the trustee to treat as capital what is otherwise received as income. Those were not the facts before the High Court in Bamford .
The manner in which the High Court in Bamford dealt with the decision in Federal Commissioner of Taxation v. Australia and New Zealand Savings Bank Ltd (ANZ) does not assist in the resolution of this issue. (Refer paragraph  of the judgment in Bamford .)
In ANZ a beneficiary with an entitlement to exempt income was found to have an individual interest in the exempt income which satisfied subsection 97(1) notwithstanding that the exempt income was treated as capital for trust purposes. The High Court did not explicitly overrule ANZ but it remains unclear how that decision can be reconciled with Bamford . The question will be whether ANZ was correctly decided and, if it was, the basis upon which it rested. Until such time as the decision in ANZ is reversed the Commissioner does not feel free to treat the decision as having been wrongly decided.
The Commissioner has consulted with interested practitioners on the prioritisation and resolution of all these issues. A draft ruling TR 2012/D1 about the meaning of the expression 'income of the trust estate' deals with many of the issues identified above.
As the government has announced a broad review and rewrite of the trust assessing provisions in Division 6 of Part III of the ITAA 1936, the Commissioner does not currently propose to issue any advice products about the remaining issues..
Existing ATO products which may be also relevant
Creation of a new trust - Statement of Principles
As noted above if, in a particular case, the deed contains no definition of 'income', the income of the trust will fall to be determined in accordance with the general law of trusts. It might be expected that some taxpayers may wish to amend their deeds to insert a definition of income where one does not exist and, in particular, insert an income recharacterisation or income equalisation clause.
Assuming any such amendment would be within power, its taxation effect would fall to be determined in accordance with the Commissioner's Statement of Principles regarding resettlements (see the document Creation of a new trust - Statement of Principles , August 2001).
Decision Impact Statement - Forrest
A clause that permits or requires the trustee to recharacterise a receipt or outgoing cannot contradict other requirements of the trust instrument. That is, such powers must be construed so as to give effect to the settlor's objective intention - ascertained from the trust deed read as a whole and from any other relevant matters evidencing the settlor's intention. Refer to the Commissioner's Decision Impact Statement in respect of the decision of the Full Federal Court in Forrest v. Commissioner of Taxation  FCAFC 6.
That is, it may be that what appears to be an unfettered discretion to determine whether receipts are capital or income is in fact no more than an administrative power to honestly classify receipts according to law.
We invite you to advise us if you feel this decision has consequences we have not identified, or if a precedential decision such as a Public Ruling or an ATO ID requires reconsideration or amendment. Please forward your comments to the contact officer by the due date.
|Date Issued:||2 June 2010|
|Due Date:||28 July 2010|
|Contact officer:||Paul Bray|
|Telephone:||(03) 9275 5124|
|Facsimile:||(02) 9275 4801|
|Address:||6 Gladstone St,
Moonee Ponds, VIC, 3039
|Alternative contact officer:||Gavin O'Shea|
|Alternative email address||TrustSubGroup@ato.gov.au|
|Alternative telephone:||(03) 9285 1955|
|Alternative Facsimile:||(03) 9285 1943|
Federal Commissioner of Taxation v. Australia and New Zealand Savings Bank Ltd
(1998) 194 CLR 328
39 ATR 419
98 ATC 4850
Federal Commissioner of Taxation v. Totledge Pty Ltd
(1982) 40 ALR 385
82 ATC 4168
12 ATR 830
Zeta Force Pty Ltd v. Commissioner of Taxation
(1998) 84 FCR 70
(1982) 12 ATR 830
(1982) 82 ATC 4168