The impact of this case on ATO policy is discussed in Decision Impact Statement: ConnectEast Management Ltd (as Trustee for the ConnectEast Investment Trust 2) v Commissioner of Taxation (VID 347 of 2008).
CONNECTEAST MANAGEMENT LTD v FC of TJudges:
Full Federal Court, Melbourne
MEDIA NEUTRAL CITATION:
 FCAFC 22
Sundberg, Jessup and Middleton JJ
1. The appellant is the trustee of the ConnectEast Investment Trust (No 2) (the Subsidiary Trust). Units in the Subsidiary Trust are held by two other trusts of which the appellant is also trustee: ConnectEast Holding Trust (the Holding Trust) which has one unit and ConnectEast Investment Trust (the Investment Trust) which has 477,963,546. These three trusts, together with other trusts and companies, form the ConnectEast Group which is responsible for the construction and operation of the Eastlink tollway in Melbourne.
2. For the purposes of Schedule 2F of the Income Tax Assessment Act 1936 (Cth) the Subsidiary Trust is an "unlisted widely held trust": s 272-110. As such it is one of four "levels" of widely held trust. Trusts of each level are subject to different tax treatments in relation to carry forward losses. In order of increasing levels of favourable tax treatment they are:
- • unlisted widely held trust
- • unlisted very widely held trust
ATC 9465• wholesale widely held trust, and
- • listed widely held trust.
See ss 272-110, 272-120, 272-125 and 272-115 respectively.
3. The dispute between the parties concerns the application to the appellant of the rules relating to carry forward losses by trusts. Schedule 2F contains those rules. The Schedule was introduced by the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 (Cth). A trust cannot carry forward losses incurred in an earlier year unless it can show a specific degree of continuity of beneficial ownership. Different continuity rules apply to each type of widely held trust. The rules become more relaxed as one moves down the list in .
4. The rules applicable to unlisted widely held trusts differ in one important respect from those applicable to listed widely held trusts. Unlisted widely held trusts have to test their ownership when there is abnormal trading in their units, or an income year ends, during the test period: s 266-90. Listed widely held trusts can fail the continuity test applicable to them but may still be able to carry forward and deduct losses if they pass the "same business test": ss 266-125 and 269-100. The rules are in fact more complex than the foregoing suggests, but it is an adequate description for present purposes.
5. Under s 272-127 a trust which is owned by another trust of a higher level is treated as having the status of its owner. The section provides:
- "(1) If:
- (a) apart from this Subdivision, a trust is an unlisted widely held trust, an unlisted very widely held trust or a wholesale widely held trust; and
- (b) each of one or more trusts of a higher level (see subsection (3)) has, directly or indirectly, fixed entitlements to all of the income and capital of the trust;
the trust is instead a trust of the same kind (see subsection (2)) as the trust of the highest level.
- (2) For the purposes of this Subdivision, trusts are of the following kinds:
- (a) unlisted widely held trust;
- (b) unlisted very widely held trust;
- (c) wholesale widely held trust;
- (d) listed widely held trust.
- (3) The kinds of trust are allocated levels in the following order (from lowest to highest): unlisted widely held trust, unlisted very widely held trust, wholesale widely held trust and listed widely held trust."
6. Section 272-20 provides:
"A person holds a fixed entitlement to a share of the income or capital of a company, partnership or trust indirectly if the person holds the entitlement indirectly through fixed entitlements to shares of the income or capital, respectively, of interposed companies, partnerships or trusts."
7. The Holding Trust and the Investment Trust are both listed widely held trusts. In a private ruling the Commissioner ruled that the Subsidiary Trust did not, by virtue of s 272-127, acquire the status of listed widely held trust. An objection to that ruling was disallowed. An appeal to this Court was dismissed:
ConnectEast Management Ltd v Commissioner of Taxation 2008 ATC ¶20-024;  FCA 557. This appeal is from that dismissal.
8. The construction of s 272-127 propounded by the appellant and rejected by the primary judge is that where a trust (the status seeking trust) is owned in whole by more than one trust, the words "each of one or more trusts of a higher level" in subs (1)(b) should be read as referring to:
- • trusts of a particular (ie the same) higher level
ATC 9466• which collectively own fixed entitlements to all of the income and capital of the status-seeking trust.
9. On the appellant's construction of s 272-127, the Holding Trust and the Investment Trust are trusts of a particular (ie the same) higher level, namely listed widely held trusts, and they collectively own fixed entitlements to all of the income and capital of the Subsidiary Trust. The Subsidiary Trust is thus to be treated as a listed widely held trust.
Before the primary judge
10. The primary judge saw the word "each" in the phrase "each of one or more trusts of a higher level" as an impediment to adopting the appellant's construction. His Honour said at :
"The applicant's construction immediately confronts the problem that the section does not mention collectivity or groups. On the contrary the word 'each', a quasi-pronoun (Oxford English Dictionary), usually denotes individuality. The Macquarie Dictionary gives the primary meaning 'every, of two or more considered individually or one by one'."
11. His Honour also rejected the appellant's contention that where there is more than one trust higher than the status-seeking trust, the higher trusts must be of the same level. He said at :
"The only requirement is that they be 'of a higher level' than the status-seeking trust. For example, suppose trust A is on level (a). Since the section contemplates that there could be relevant trusts on as many as three levels higher, there could be a situation where trust B is on level (b), trust C is on level (c) and trust D is on level (d). Of each of trusts B, C and D it can be said that it is on a 'higher' level than A's, that is to say on a level which has the quality or characteristic of being higher than (a)."
12. The primary judge explained away, by reference to the words "directly or indirectly", the apparent oddity that where there is more than one trust, each must have fixed entitlements to all of the income and capital of the status-seeking trust. He said at :
"A fixed entitlement may be held indirectly where there is entitlement via interposed companies, partnerships or trusts: s 272-20. Thus, to take the example above, if trust B owns 100 percent of trust A and in turn trust C owns 100 per cent of trust B, and trust D owns 100 per cent of trust C, each of B, C and D has a fixed entitlement to all of the income and capital of A. In the case of B, it has its entitlement directly; each of C and D has its entitlement indirectly."
13. The primary judge found support for his rejection of the appellant's "same level" contention in the concluding words of subs (1) - "the trust of the highest level". He said at :
"In using the superlative rather than the comparative, the text is telling the reader that the status-seeking trust will attain the status of only one of the higher trusts (where there are more than one), namely the one that is on the highest level."
14. His Honour said at  that the singularity of "trust" in the concluding words of subs (1) was:
"fatal to the applicant's construction, which must accommodate the possibility of multiple trusts together conferring their status on the status-seeking trust. The applicant's argument did not suggest a way in which the singular word "trust" could be made to fit into its construction."
15. The primary judge derived assistance from the Explanatory Memorandum which accompanied the introduction of Schedule 2F. It gives this example of the operation of s 272-127:
16. Of this example the Explanatory Memorandum says (at [13.92]):
"[T]he classification of the B Unit Trust remains as listed widely held since its parent (the A Unit Trust) is not of a higher level. The C Unit Trust and D Unit Trust are re-classified as unlisted very widely held trusts because they are each wholly owned by the A Unit Trust which is of a higher level. The classification of the D Unit Trust is unaffected by the classifications of the B Unit Trust and C Unit Trust since neither of them owns 100% of it."
17. At  his Honour said of this explanation:
"The concluding sentence is consistent with the Commissioner's construction and inconsistent with that of the applicant. The only response of the applicant was to point out that B and C in the diagram are not on the same level. But that is a bootstraps argument. It assumes the correctness of the applicant's argument that two or more trusts can confer their status on a collectively owned subsidiary as long as they are on the same level. For the reasons explained above, that is not so."
18. At  the primary judge concluded his reasons as follows:
"The ordinary and grammatical meaning of the section is as submitted by the Commissioner. The result could not be said to be arbitrary or capricious. To confer the benefit of the higher status only where the status-seeking subsidiary is wholly owned by the trust of that higher status is a rational legislative objective. That objective has been achieved in the language of the statute, which admits of only one meaning. The merits or otherwise of the objective are not a matter for the Court:
Cooper Brookes (Wollongong) Pty Ltd v Commissioner of Taxation (1981) 147 CLR 297 at 304-305."
19. The appellant attacked the primary judge's reliance on the word "each" in the phrase "each of one or more trusts of a higher level". It said that in the process of statutory construction a court should not be mesmerised by the dictionary meaning of words, but should have regard also to statutory purpose and context. Having resort to these latter aids, it contended that the phrase in question should be taken to refer to one or more trusts of a particular higher level which singly or collectively have the relevant fixed entitlements. The appellant argued that the use of particular is justified by the words "of a
ATC 9468higher level", the natural meaning of which is "one of the (particular) higher levels in subs (3)" as opposed to "any one or other of the higher levels".
Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 (Project Blue Sky) at , McHugh, Gummow, Kirby and Hayne JJ, after quoting the observation of Dixon CJ in
Commissioner for Railways (NSW) v Agalianos (1955) 92 CLR 390 at 397 that "the context, the general purpose and policy of a provision and its consistency and fairness are surer guides to its meaning than the logic with which it is constructed," went on to say that the process of construction must accordingly always begin by examining the context of the provision that is being construed. Later at  their Honours noted that sometimes the meaning the legislature is taken to have intended words to have does not correspond with their grammatical meaning. Where that happens:
"The context of the words, the consequences of a literal or grammatical construction, the purpose of the statute or the canons of construction may require the words of a legislative provision to be read in a way that does not correspond with the literal or grammatical meaning."
Their Honours then quoted a passage from Bennion, Statutory Interpretation (3rd ed, Butterworths, 1997), p 344 that "the desirability of applying the clear literal meaning may conflict with the fact that this does not remedy the mischief that Parliament intended to deal with". See also
Commissioner of Taxation v Cooling 90 ATC 4472; (1990) 22 FCR 42 at 68.
21. Paragraph 1.4 of the Explanatory Memorandum states:
"The purpose of the trust loss measures is to restrict the recoupment of prior year and current year losses and debt deductions of trusts in order to prevent the transfer of the tax benefit of those losses or deductions. The tax benefit of losses is transferred when a person who did not bear the economic loss at the time it was incurred by the trust obtains a benefit from the trust being able to deduct the loss. The measures are intended to prevent a significant leakage of revenue that has resulted from the transfer of the tax benefit of trust losses."
The Explanatory Memorandum goes on to say that this aim is achieved by examining whether there has been a change in the underlying ownership or control of a trust: see [1.5].
22. After describing the four types of widely held unit trust, the Memorandum at [13.91] outlines the effect of s 272-127:
"The characterisation of a trust may be affected by whether it is wholly owned, directly or indirectly, by another trust. An unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust whose fixed entitlements to income and capital are all held, directly or indirectly, by another trust of a higher level will instead be a trust of the same kind as that higher level trust. The parent trust must be of a higher level so that the subsidiary trust will not be worse off."
23. As noted at , listed widely held trusts are accorded a more favourable carry forward loss treatment than other widely held trusts. Specifically, a listed widely held trust can fail the continuity test but still be able to carry forward losses if it passes the "same business test": ss 266-125 and 269-100.
24. At a linguistic level the appellant's construction encounters a difficulty in the requirement in s 272-127(1)(b) that "each of one or more trusts of a higher level ... has ... fixed entitlements to all of the income and capital of the trust". The ordinary meaning of "each" is "every, of two or more considered individually or one by one": Macquarie Dictionary. The word "each" links up with the singular "has", and shows that the test is to be undertaken by reference to each one of the trusts, and not to a group of trusts collectively or as a whole. The words "each of" are an obstacle to reading the provision as allowing collective ownership by a group of trusts where no individual trust, directly or indirectly, owns the status-seeking trust.
25. The appellant offered no persuasive textual reason for its preferred construction. In its brief oral argument it said par (b) should be read as applying in three situations:
ATC 9469"Firstly, it applies where each of one or more trusts of a higher level has, directly, fixed entitlements to all of the income and capital of the trust. Secondly, where each of one or more trusts of a higher level has indirectly fixed entitlements to all of the income of the trust, and thirdly, where each of one or more trusts of a higher level have that entitlement, directly or indirectly."
The appellant submitted that when so read the section can accommodate the case where more than one trust of a higher level "holds the 100 per cent, provided the 100 per cent is held entirely at that particular level". It was said that this construction "does not do violence to the word 'each'". Rather, what it does is treat "each of one or more trusts" as qualifying the words "directly or indirectly".
26. The passage quoted at  appears to us merely to restate the content of s 272-127. To identify the three fact situations to which the section applies does not explain why it is that the section can accommodate the case where more than one trust of a higher level is entitled to all the income and capital of the lower level trust. The submission is no advance on the bald assertion that the section can accommodate that case. Accordingly we are unable to accept that the appellant's reading of s 272-127 does no violence to the word "each". It simply does not confront the word.
27. The appellant disputed the primary judge's observation that the concluding words of [13.92] of the Explanatory Memorandum (set out at  above) are inconsistent with its construction. Referring to the diagram at  the Memorandum says:
- • the status of trust B is unchanged since its parent (trust A) is not of a higher level
- • trusts C and D are re-classified because each is wholly owned by trust A which is of a higher level, and
- • the status of trust D is unaffected by the classification of trusts B and C since neither of them owns 100% of it.
28. If collective ownership had a place in the scheme, trust D would be uplifted to a listed widely held trust because trusts B and C together own trust D and one of them (trust B) is of a higher level. The commentary on the example is thus inconsistent with the appellant's submission that two or more trusts together can hold the required 100%. The commentary conforms with the text of [13.91]:
"An unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust whose fixed entitlements to income and capital are all held, directly or indirectly, by another trust of a higher level will instead be a trust of the same kind as that higher level trust."
29. The Commissioner relied on other parts of Schedule 2F which depart from the "each of" structure of s 272-127 and contemplate collective entitlement. Thus s 272-87(3) refers to a group of persons or entities who:
"have (between them), directly or indirectly ... fixed entitlements to a greater than 50% share of the income or ... capital of the company or partnership."
Section 272-90(5) refers to a combination of persons and entities that have fixed entitlements, directly or indirectly, to all the income and capital of a company, partnership or trust. The Commissioner relies on these examples from other "entitlement" contexts to show that where it is intended to include groups or combinations of entities, this is made express.
30. The appellant contended that on the primary judge's construction, s 272-127 can never apply to a wholesale widely held trust because such a trust must have more than one unit holder. Section 272-125(1) provides in part that:
ATC 9470"a unit trust is a wholesale widely held trust at a particular time (the test time) if:
- (a) it is an unlisted widely held trust at the test time; and
- (b) it is not an unlisted very widely held trust at the test time; and
- (c) at least 75% of its units are held at the test time by one or more qualifying holders (see subsection (2)); and
- (f) the amount subscribed for units in the trust by each person to whom units have been issued was at least $500,000 ...
The term "qualifying holder" is defined in subs (2) as each of a listed widely held trust, an unlisted very widely held trust, a life insurance company, an approved deposit fund, a complying superannuation fund and a pooled superannuation trust.
31. The appellant's argument was developed as follows. A wholesale widely held trust must be an unlisted widely held trust which is majority owned by qualifying holders: s 272-125(1)(a) and (c). Because the definition of wholesale widely held trust does not permit such a trust to be directly owned by a single trust, and because such a trust, owned directly by a mix of unrelated collective investment vehicles, would not be indirectly wholly owned by one higher level trust, it could never, on the primary judge's construction, be elevated to the status of a trust of a higher level. The appellant urged that its construction should instead be adopted because it is the only one which gives effect to the inclusion of wholesale widely held trusts in the section.
32. The Commissioner challenged the premise of the appellant's argument, namely that a wholesale widely held trust cannot be directly owned by only one qualifying unit holder. He relied on s 272-105 which defines a widely held unit trust as a fixed trust that is not "closely held". By subs (2) a trust is closely held if:
- "(a) an individual has, or up to 20 individuals have between them; or
- (b) no individual has, or no individuals have between them;
directly or indirectly and for their own benefit, fixed entitlements to a 75% or greater share of the income of the trust."
Subsection (2A) is to the same effect in relation to the capital of the trust.
33. The Commissioner's case was that the effect of the word "indirectly" in subss (2) and (2A) is that a trust can be widely held even if it has only one direct parent so long as there is sufficient breadth of indirect ownership through that parent (ie more than 20 unit holders). If there is sufficient breadth of ownership amongst the unit holders of a listed widely held trust, it is possible for that trust to be the sole qualifying holder of a wholesale widely held trust. Section 272-127 would then confer on that trust the status of a listed widely held trust. The Commissioner said that conformably with this, s 272-125(1)(c) (set out at ) describes one of the essential characteristics of a wholesale widely held trust to be that at least 75% of its units are held at the test time "by one or more qualifying holders ...". Section 272-125(2)(a) defines "qualifying holders" to include a listed widely held trust.
34. We accept the Commissioner's contention. Section 272-125(1)(c) contemplates that one qualifying holder may hold all the units. The appellant relied on par (f) of the definition of wholesale widely held trust, which requires that "the amount subscribed for units in the trust by each person to whom units have been issued was at least $500,000". It was said that "each person" contemplates direct ownership by more than one entity. Having regard to what we see as the clear indication in par (c) that one qualifying holder may hold all the units, we are of the view that "each" in par (f) is intended to cover two situations: where there is but one unit holder, it must have subscribed at least $500,000; and where there are two or more unit holders, each of them must have so subscribed. That is the sensible way of reading par (f) so as to accommodate par (c).
35. The appellant also contended that the primary judge's construction of s 272-127 has the effect that an unlisted very widely held trust cannot assume the status of a wholesale widely held trust or a listed widely held trust. In order to be an unlisted very widely held trust a unit trust must have at least 1000 unit holders: s
ATC 9471272-120(1)(b). The appellant said that because of this requirement it is impossible for fixed entitlements to all the income and capital of an unlisted very widely held trust to be directly held by an individual higher level trust. Nor is it practically conceivable for a single trust to have fixed entitlements indirectly to all that income and capital. In order for that to occur, a single listed widely held trust would, for example, have to wholly own, directly or indirectly, each of the separate 1000 unit holders of the unlisted very widely held trust.
36. The Commissioner accepted that because s 272-120(1)(b) does not recognise that units can be held indirectly, an unlisted very widely held trust must have at least 1000 direct unit holders. He conceded that, aside from the very unlikely situation where each of the 1000 unit holders is in turn owned by a single entity, so that the entity indirectly holds all the fixed entitlements of the unlisted very widely held trust, s 272-127 is unlikely to have practical application to unlisted very widely held trusts. However he points out that on the appellant's construction (see ), the section could only apply to an unlisted very widely held trust in the very unlikely circumstance that every one of the 1000 or more unit holders in that trust was a trust of the same level. For example, for an unlisted very widely held trust to be elevated to the status of a wholesale widely held trust, all 1000 or more unit holders would have to be wholesale widely held trusts. Accordingly we do not consider that the fact that s 272-127 is unlikely to operate in relation to unlisted very widely held trusts on the construction propounded by the Commissioner advances the appellant's own construction of the section.
37. The result of the foregoing survey of the parties' submissions is that the primary judge's construction is supported by:
- (a) a dictionary/linguistic analysis of s 272-127;
- (b) [13.91] and the final sentence of [13.92] of the Explanatory Memorandum; and
- (c) the comparison between s 272-127 and the provisions noted at  above.
38. On the other hand the primary judge's construction means that it is highly unlikely that an unlisted very widely held trust will be elevated to the status of a wholesale widely held trust or a listed widely held trust.
39. In our view the primary judge's construction is to be preferred because of the considerations noted at . As we have said at , the fact that on that construction an unlisted very widely held trust is unlikely ever to be elevated to the status of a wholesale widely held trust does not support the appellant's own construction of 272-127(1).
40. The appellant submitted that the primary judge's construction was not supported by any discernible purpose or policy and leads to anomalous outcomes. The anomalous outcome in the present case was said to be that the Subsidiary Trust would have satisfied s 272-127 but for the fact that one unit out of 477,963,547 is held by the Holding Trust. We were urged not to endorse what was said to be the odd result that a trust that is wholly owned by a single listed widely held trust is treated differently from one that is owned by two or more listed widely held trusts.
41. Resort to the odd or anomalous consequences of a particular construction of legislation is to be approached with caution. In
Esso Australian Resources Ltd v Federal Commissioner of Taxation (1998) 83 FCR 511 at 518-519, speaking of ss 118 and 119 of the Evidence Act 1995 (Cth), Black CJ and Sundberg J said:
"In our opinion the plain language of the sections is confirmed by the only directly relevant extrinsic material, which shows that Parliament intended the consequence that is said by the appellant to be anomalous. Especially when different views can be held about whether the consequence is anomalous on the one hand or acceptable or understandable on the other, the Court should be particularly careful that arguments based on anomaly or incongruity are not allowed to obscure the real intention, and choice, of the Parliament."
Ganter v Whalland  NSWSC 1101 at , in connection with the caution just referred to, Campbell J highlighted the risk of the court "taking over the function of making policy choices which properly belongs to the legislature". See also Pearce and Geddes, Statutory Interpretation in Australia (6th ed, Butterworths, 2006) at [2.36].
42. We have recorded at  and  the primary judge's rejection of the appellant's "same level" contention. We agree with his Honour's view that the only requirement of s 272-127(1)(b) is that the "one or more trusts" be of a higher level than the status-seeking trust, and that this construction is confirmed by the later use of the superlative "highest" in the concluding words of the sub-section: "the trust is instead a trust of the same kind ... as the trust of the highest level".
43. For the reasons we have given, the appeal should be dismissed.