BH Pascoe SM
Administrative Appeals Tribunal
BH Pascoe (Senior Member)
These applications are for review of decisions of the respondent to disallow objections to assessments and amended assessments of income tax for years ended 30 June 1986 to 30 June 1991 inclusive. The applications were lodged by the trustee of two discretionary trusts and several beneficiaries of those trusts. The issues raised in this matter are complex and arise from the questions of whether distributions were made validly to non-resident beneficiaries and whether allowable deductions were incurred as interest on amounts of such distributions credited but not paid to the non- resident beneficiaries.
2. At the hearing the applicants were represented by Mr J de Wijn of counsel and the respondent by Mr T Murphy of counsel. The sole witness was Mr A, one of the applicants. He had formerly practised as a solicitor, had drawn the trust deeds and could be said to have been the principal decision maker in relation to the trusts in the relevant years.
3. By deed of settlement dated 29 June 1976, the A Family Trust (``First Trust'') was established and by deed of settlement dated 14 December 1981 the Second A Family Trust (``Second Trust'') was established. Under the terms of the deed for the First Trust the trustee was given a power to accumulate income but, failing the exercise of that power, was required to distribute income to the General Beneficiaries in such shares and proportions as the trustee decided. Any income not distributed in any year was to be held in trust for the persons who would be entitled to the trust fund at the vesting day. General Beneficiaries were defined as the Primary Beneficiaries and such additional persons named in the Schedule to the deed. Primary Beneficiaries were defined as:
``... any person or persons other than the Settlor as the Trustee may from time to time appoint being any child of Mrs A and Mr A (who shall thereafter be deemed to be a Primary Beneficiary) or being a child or spouse of any Primary Beneficiary herein set
ATC 299out and their respective descendants and the spouses of their respective descendants.''
The additional persons named as General Beneficiaries in the Schedule were Mr and Mrs A, a brother of Mr A and a partner of Mr A.
4. The Second Trust contained provisions similar to the First Trust with two major differences. Included in the definition of General Beneficiaries was any trust in which any General Beneficiary has an interest or any corporation or other legal entity in which at least one share or other interest is owned or held by any General Beneficiary. Secondly, the Primary Beneficiaries were stated as Mr A, Mrs A and any child or spouse of Mr or Mrs A as the Trustee may from time to time appoint. The General Beneficiaries named in the Schedule to the deed were Mr A, Mrs A and:
``any person or persons other than the Settlor as the Trustee may from time to time appoint being a brother sister parent grandparent uncle aunt nephew niece or cousin of the said Mr A or Mrs A.''
5. In the year ended 30 June 1987 the First Trust derived a net income of $146,146 from several unit trusts and from bank interest. In a minute dated 20 June 1987 the trustee resolved:
``THAT the following proportion of Interest Income of $97,019.93 less operating expenses of $295.84 of the Trust for the year ended 30th June, 1987, be appropriated, set aside and apportioned for the benefit of the following beneficiaries, equally to:-
- B Brother of Mr A's grandfather
- C Wife of B
- D Cousin of Mr A
- E Cousin of Mr A
- F Aunt of Mr A
and the remaining balance to the Second A Family Trust.
FURTHER RESOLVED that the taxable distribution to be distributed in the same manner as above.''
The named individual beneficiaries were all residents of Israel. The income tax return lodged for the trust in respect of that year showed a distribution of the net income as $96,724 to the five non-residents and $49,422 to the Second Trust. In the year ended 30 June 1988 the trust derived income from similar sources and disclosed a net income of $60,511 after claiming a deduction for $8,705 as interest paid on ``loans'' from the five beneficiaries of the previous year. This amount represented 10% of the net balances standing to the credit of those beneficiaries' accounts being a total distribution of $96,724 less 10% withholding tax paid. On 20 June 1988 the trustee minuted a resolution identical to that of the previous year save that the interest income was stated as $48,788 and operating expenses as $9,714. The income tax return for that year showed a distribution of $39,074 to the five non-residents and $21,437 to the Second Trust.
6. The respondent assessed the net income of the First Trust in both years on the basis that the purported distributions made to the non- residents were not considered to be valid. The amounts shown as distributed to the non- residents were assessed under section 98 of the Income Tax Assessment Act 1936 (``the Act'') as being income to which the two minor children of Mr A were presently entitled. These assessments were based on the respondent's interpretation of the default clause of the deed of settlement as the persons who were entitled where the trustee had not exercised the discretion to distribute to any other beneficiary. For the year ended 30 June 1988 the respondent disallowed the claim for $8,705 interest and increased the amount to which the Second Trust was entitled by that amount.
7. The applications which arise from the operations of the Second Trust relate to the years ended 30 June 1986 to 1991 inclusive. Similar issues relating to the purported distributions to the same five non-resident beneficiaries and claims for interest on loans from beneficiaries as occurred with the First Trust were involved. The Second Trust derived its income in each year from distributions from the First Trust and in the years ended 30 June 1986 and 1987 derived income from two other family trusts. The net income and distributions according to the returns lodged and the manner in which the respondent assessed the income are conveniently set out in an attachment to a letter from the respondent to the tax agent dated 29 September 1992, as follows:
``1986 Previous Taxable Income of the trust $82,785 plus interest disallowed 13,006 Amended Taxable Income $95,791 Resolution Previous Adjusted Mrs A $19,500 $19,500 AA infant sons 416 416 BA of Mr and Mrs A 416 416 Balance to five non-resident beneficiaries 62,453 nil Balance ($75,459 default clause)* Default Clause Total Distribution Mrs A $18,865 $38,365 Mr A $18,865 $18,865 AA $18,865 $19,281 BA $18,864 $19,280 ------- $75,459 ------- 1987 Previous Taxable Income of the Trust $32,698 plus interest disallowed 20,421 ------- Amended Taxable Income $53,119 ------- Resolution Previous Adjusted AA 416 416 BA 416 416 Total to five non-resident beneficiaries $30,000 ($30,000 default clause)* Balance to Mrs A $1,866 $22,287 Default Clause Total Distribution Mrs A $7,500 $29,787 Mr A $7,500 $7,500 AA $7,500 $7,916 BA $7,500 $7,916 ------- $30,000 ------- 1988 Previous Taxable Income of the trust $70 plus interest disallowed 21,367 Adjustment to distribution from First Trust 8,705 ------- Amended Taxable Income $30,142 ------- Resolution Previous Adjusted Balance to Mrs A $70 $30,142 1989 Previous Taxable Income of the trust $269,766 plus interest disallowed 55,029 -------- Amended Taxable Income $324,795 -------- Resolution Previous Adjusted AA 416 416 BA 416 416 And balance equally to:- Mrs A $134,467 $161,981 Mr A $134,467 $161,982 1990 Previous Taxable Income of the trust $702 plus interest disallowed 59,098 Amended Taxable Income $59,800 Resolution Previous Adjusted AA $351 $416 BA 351 416 Balance to C Investments Pty Ltd $58,968 1991 Previous Taxable Income of the trust $829 plus interest disallowed 67,962 Amended Taxable Income $68,791 Resolution Previous Adjusted AA $415 $416 BA 414 416 Balance to C Investments Pty Ltd $67,959''
The interest claimed and disallowed included amounts relevant to distributions credited to a total of 27 non-residents in years prior to 1986 including the five non-residents credited with income from both trusts in the years in dispute.
8. The evidence of Mr A was that the Second Trust was established in 1981 for the benefit of all members of his family, but, primarily, for relatives residing overseas. He explained that he had been born in a refugee camp in Germany after the war and migrated with his family to Israel at the age of one. The family struggled financially and were assisted by relatives who had migrated to Israel also. After seven years he and his parents migrated to Australia. By 1981 he considered that he was in a comfortable financial position with good prospects for the future. He developed a desire to give something back to his relatives who had been good and kind when he was a child in Israel and a desire to help the State of Israel in a significant manner as a believer in its importance to Jewish people. Commencing in the year ended 30 June 1982, the trustee resolved to make distributions of income from the Second Trust to various beneficiaries living in Israel. Mr A's father, who died in 1993, was always consulted about the distributions and his advice taken as to which relatives should benefit. Mr A stated that the 1982 distributions were advised to the beneficiaries by his father who told him none of the beneficiaries was in any immediate need of money and each wished to have the funds retained in Australia. Although Mr A stated that he wrote to the beneficiaries and advised them of their entitlements, he also stated that he had received no written acknowledgments nor had he formally spoken or personally advised any of the beneficiaries of their entitlements under the trust. Any communication was by his father who undertook to advise the beneficiaries. This, it was said, was done generally by contact with the notional head of each family. Mr A said that no further distributions were minuted for the benefit of the non-resident beneficiaries after 1987 because of the collapse in financial markets and the need for the trustee to maintain liquidity. When no cash had been distributed to any of the beneficiaries to that time, or thereafter, it is difficult to understand this reasoning.
9. Early in 1995 and after these proceedings had commenced, Mr A travelled to Israel. He took with him a standard form of letter prepared
ATC 302by his solicitor in Melbourne with the view of having each of the non-resident beneficiaries sign such a letter. Sixteen of these were tendered at the hearing. Six of the letters were signed by a parent on behalf of a child beneficiary. Six signatures, three on behalf of a child beneficiary, were authenticated by a certificate by a Notary Public. The signed letters were identical save for the amount of money and stated:
``RE: THE FIRST AND SECOND A FAMILY TRUSTS
I understand that you need me to confirm a number of matters in writing concerning my interests in the above trust to complete your records. Accordingly, to assist you I have signed this letter (prepared by you) to confirm the following:
- 1. I acknowledge that the above trusts are discretionary trusts which means the distributions from the trusts of income or capital to the beneficiaries of the trusts, of which I am one, are made in the sole and absolute discretion of the trustee for the time being of the trust as and when it sees fit to do so.
- 2. I acknowledge being informed by you previously of my entitlements under the trusts and for interest credited on my outstanding balance for the Australian financial years ended 30 June and for the respective amounts as indicated in the attached schedule to this letter marked as `Schedule A' and, in any event totalling the sum of Aud ...
- 3. I authorised you to invest those sums on my behalf, in Australia, as you sought fit and to pay the necessary taxation imposts as they became due.
- 4. I accept that due to the severity and length of the recent recession in Australia, that the trusts have been unable to pay any interest on my outstanding balance since 30 June 1991. However, I am delighted to know that you will now be in a position to pay me 50% of my entitlements. I further acknowledge that the balance outstanding to me will continue to be held by you interest free and that you will use your best endeavours to remit to me the sum outstanding to me within the next twelve months but reserving my rights under paragraph 7 of this letter in the event of a personal financial emergancy [sic] of mine.
- 5. As I have explained previously, I was pleasantly surprised to be informed of my previous entitlements and have treated them as a windfall benefit to be drawn upon as I required, as such I am pleased to give you the extra time to pay the balance to me.
- 6. Please continue to attend to completing all taxation matters on my behalf in Australia the costs of which I understand will be charged to my account with the trusts. Also, I authorise you to sign any taxation returns or other documents on my behalf in order to complete these matters.
- 7. Finally, I am happy to continue to leave the monies owing to me from the trust on an unsecured basis. However, if my circumstances or needs change in the future, I of course reserve all my rights to call up all the balance outstanding to me. If so, naturally, I will try and give you as much notice as possible before doing it.''
Only one of the five non-residents who were credited with income in the years in dispute had signed such a letter but without the signature being authenticated. Mr A stated that of the other four, one had died, one was very elderly and the remaining two were not in Israel when he was there. Each of the signed letters was accompanied by an acknowledgement of having received a sum equal to 50% of the amount outstanding. Mr A stated that, when he went to Israel, it was his intention to remit 50% of the amounts due to the beneficiaries. He obtained the acknowledgements but told the beneficiaries that he would hold them in escrow until he returned to Australia in three weeks time and could arrange to transfer the funds. He then stated that legal advice was that such transfer of funds would deplete the funds of the trust and as there were outstanding income tax assessments the trustee could be faced with criminal prosecution.
10. The issues which are required to be dealt with are:
- (a) whether any or all of the non-residents were presently entitled to a share of the net income of the First Trust in the years ended 30 June 1987 and 1988 and/or a share of the
ATC 303net income of the Second Trust in the years ended 30 June 1986 and 1987
- (b) whether deductions claimed for amounts credited to non-residents as interest by both trusts are allowable
- (c) if amounts claimed as interest are non- allowable, where does liability to income tax lie on the increase in net income of the trust
- (d) if the non-resident beneficiaries were not presently entitled to a share of the net income of the trusts, where does liability to income tax lie in respect to that share.
11. It is appropriate to deal with these issues as they relate to the First Trust before considering the position with the Second Trust. Both Mr A and Mr de Wijn, counsel for the applicants, accepted that the deed constituting the first trust did not include any of the non- residents within the class of beneficiaries of that trust. Mr A stated that the minute purporting to distribute income out of the First Trust in 1987 and 1988 must have been an error and could have resulted from confusion between the two trusts. It is clear that, under the original deed of settlement, beneficiaries were limited to any child of Mr and Mrs A who is appointed by the trustee, any child or spouse of an appointed child, their respective descendants and spouses, Mr A, Mrs A, the brother of Mr A and the partner of Mr A. No non-resident to whom a distribution was purported to be made could have satisfied any of these descriptions. Consequently it is easy to arrive at a finding that none of the non-residents was presently entitled to any share of the net income of the First Trust in the years ended 30 June 1987 or 1988.
12. For the year ended 30 June 1988 the trustee credited a total of $8,705 to the accounts of the non-residents described as interest and claimed as an allowable deduction against the assessable income of the trust. Even if the non- residents had been beneficiaries and a share of the net income of the prior year had been validly distributed to them, the further amount credited to them and described as interest could not be correctly described as interest nor an allowable deduction. Both at law and by the terms of the deed of settlement, any amount set aside for any beneficiary out of the net income of a year is thereafter held by the trustee as a separate trust fund. Pursuant to the terms of the deed the trustee was required to hold such amounts:
``as a separate trust fund upon trust to invest or apply or deal with such fund or any resulting income therefrom or any part thereof in any manner provided for and in accordance with any powers conferred by clause 6.''
Clause 6 gave the trustee power to distribute capital or lend money to beneficiaries, use funds to which an infant beneficiary may be entitled for maintenance, education and advancement of the infant and invest money to which a beneficiary under a legal disability may be entitled. Nothing was said about any broadening of the trustee's power of investment of these funds held under a separate trust. Given the facts of this case, the best that could be said was that the trustee allowed the funds purportedly held on behalf of the non-residents to be mixed with the funds held under the principal trust. As such, the beneficiaries of the separate trust may well have been entitled to a share of the income derived by the trustee from the investment of these mixed funds. No attempt was made to identify this share. Apart from the absence of any formal, oral or implied agreement it cannot be said that there was any loan of money by the non-residents. If properly documented, it may have been possible for the trustee in its capacity as trustee of the separate trust, to lend those funds held in trust to itself as trustee of the First Trust at an appropriate rate of interest. Nothing of this nature was done. In any event, having found that no non-resident had an entitlement to any share of the income of the trust, it follows that no funds were held by way of separate trust or loan for such non- resident. Consequently the amounts claimed as interest were not incurred and do not constitute allowable deductions.
13. There is one additional issue in relation to the First Trust. Since 1982 the Second Trust has been treated as a beneficiary of the First Trust and received distributions of part of the net income of the First Trust. As indicated earlier, the beneficiaries included in the original deed of settlement were natural persons. Under the terms of that deed, another trust could not be found within the class of beneficiaries. In his evidence, Mr A stated that the deed of the First Trust had been amended at, or about, the time that the Second Trust was settled in December 1981. He was unable to produce any amending deed. What was produced at the hearing was an unsigned deed of variation relating to a trust
ATC 304established for the benefit of his partner and family. Mr A gave evidence that he had been unable to locate a copy of the deed of amendment of the First Trust and said:
``I was the lawyer in a firm who dealt with trust documents. Now, the trust in front of me were trusts that I in fact settled or would have drawn up. The Second Trust was one, a precedent that I would have used continually after 1980 or since 1982; the amendments that we, sorry, the changes or the draft that we found reflecting changes to one of my partner's trusts was done by me and at the time I recall that I didn't just change it for my partner but I also changed it for myself, and my other partner and in fact other members of my family.''
``... and is it your recollection that the document that was drafted amending the terms of the First Trust was in substantially identical form?''
The applicant replied:
``[I]t would have been in identical form. When I look at this document I can see it was done in such a manner that allowed us to simply amend the document by inserting different schedules and names. I think they were the days before we had word processing.''
The amending deed added to the definition of General Beneficiary any trust in which any General Beneficiary has an interest or any corporation or other entity in which at least one share or other interest is owned or held by any General Beneficiary. The wording of the amended definition was identical with the wording contained in the deed of settlement of the Second Trust. It is worth noting that, while the applicants were unable to produce the actual amending deed for the First Trust, they were also unable to produce the original of the initial deed of settlement. The copy of the deed tendered at the hearing was a copy obtained from the respondent under the Freedom of Information Act (1982). It would appear that all of the documents establishing or amending the terms of the trust have been mislaid. In one sense it would be appropriate to arrive at a finding that, without production of the actual amending deed, and with only the recollection of Mr A that the amendment would have been executed, that the Second Trust was not a beneficiary of the First Trust. However, given the outline of the chronology of establishment of the Second Trust, the evidence of Mr A, the fact that the amending deed is not the only document mislaid and the fact that distributions have been minuted, accounted for and subjected to income tax in each year from 1982 onward, I am prepared to find that the deed establishing the First Trust was amended to extend the class of beneficiary as set out in the form of deed tendered at the hearing.
14. The remaining question in relation to the First Trust relates to the liability for income tax on the net income of the trust for the years ended 30 June 1987 and 1988. In the latter year the non-allowance as a deduction of purported interest to non- residents increases the net income of the trust from $60,511 as shown in the income tax return lodged to $69,216 as the net income for the purposes of section 95 of the Act. For many years there has been debate about the consequences of a difference between income for trust law purposes and income for taxation purposes. This debate was commented upon by Hill J in
Davis and Anor v FC of T 89 ATC 4377 where his Honour said (at pp. 4403 and 4404):
``In every case where the income for trust law purposes differs from the net income as calculated under sec. 95 a difficult question arises as to the application of sec. 97 of the Act. In a case, such as would be here the case if sec. 260 applied, the `net income' calculated under sec. 95 of the Act including the income otherwise purported to be assigned might be seen to be greatly in excess of the income for trust law purposes calculated without regard to the provisions of sec. 260. The tax consequences where the trust law income exceeds the tax law income have been the subject of much academic debate... As is pointed out by all commentators there has never been a court decision in which it was necessary to decide between the two competing views which have been put forward, although the matter has enjoyed the attention of Boards of Review: Case C36,
71 ATC 156; Case R32,
84 ATC 298.
The different views are best understood by considering the terms of sec. 97 as it stood prior to its amendment in 1979. It will be recalled that these amendments followed upon the Taxation Review Committee, Full
ATC 305Report, 1975 (Asprey Committee Report) and were largely concerned to overcome the problem exposed by the decision of the High Court in
Union Fidelity Trustee Co. of Australia Ltd. v. F.C. of T. 69 ATC 4084; (1969) 119 C.L.R. 177. Although these amendments do not affect the construction of sec. 97 for present purposes they obscure the simplicity of the section by what for the present analysis is unnecessary verbiage.
Section 97 read as follows:
`(1) Where any beneficiary is presently entitled to a share of the income of a trust estate and is not under any legal disability, his assessable income shall include that share of the net income of the trust estate.'
Under the `proportionate view' the opening words of sec. 97(1) require a calculation of the share or proportion of the trust law income to which each beneficiary of a trust estate is presently entitled. Once that share or proportion is calculated then the second half of the subsection operates to include in assessable income that same share or proportion of the `net income'. Under this view, provided that there is a beneficiary or there are beneficiaries who are alone or together presently entitled to the whole of the trust law income of a trust estate the net income for tax purposes will be distributed among those same beneficiaries proportionately and there will be no amount upon which the trustee will be liable to pay tax under the provisions of sec. 99 or 99A of the Act.
The alternative view, while accepting as it must that present entitlement can relate only to trust law income and not to tax law income for the simple reason that the composition of `net income' is merely a matter of computation and may include amounts which have no correlation with assets at all (e.g. an amount that might be included in the net income under sec. 36 of the Act) would construe sec. 97 as directing specific attention to a taxpayer's share of trust law income and requiring the inclusion in assessable income only of that part of the net income of the trust estate as is represented by the proportionate part of trust law income. Thus if one assumes that trust law income is to be divided equally between two beneficiaries A and B and the trust law income is $100, where the net income is $200 of which only $100 is represented by the trust law income only that $100 is distributed equally between A and B under sec. 97 leaving there to be a balance undistributed in respect of which the trustee is to be assessed and liable to pay tax under sec. 99 or 99A.
It is quite clear that neither interpretation of sec. 97 produces a desirable result as a matter of tax policy and the scheme of Div. 6 calls out for legislative clarification, especially since the insertion into the Act of provisions taxing capital gains as assessable income. On the proportionate view a taxpayer may be assessed on amounts he neither did nor could receive; on the alternative view a taxpayer could be taxed on less than he received if the share of trust law income exceeded that part of the net income as is represented by trust law income, and the maximum rate of the tax under sec. 99A would be applicable to the balance. However, the proportionate view does seem to me, as a matter of language, to be the better construction of the section and in the absence of any authority compelling me to adopt the alternative method, I propose to accept it. It was not argued by either side that the proportionate method was incorrect.''
In considering these comments of Hill J it should be borne in mind that with the exception of one year, Mrs Davis was presently entitled to 100% of the trust income. In that one year the income was divided in specific amounts between Mrs Davis and a company. The resolution of trustees effecting this division was not in evidence. In this matter, I was urged by Mr de Wijn to adopt that ``proportionate view'' adopted by Hill J. However, here there is a resolution of the trustee in evidence which resolves to set aside a specific amount of net interest income for specific persons and the balance to the Second Trust. The wording is somewhat clumsy in that the resolution states that ``the following proportion of interest income'' be ``appropriated, set aside and apportioned for the benefit of'' the following named persons ``and the remaining balance'' to the Second Trust. It could be read as relating solely to the interest income of the trust with no resolution dealing with the remaining income of
ATC 306the trust. However, as the amounts specified as interest income and set aside for the named persons was the total interest derived by the trust in the relevant year, I am prepared to accept that the trustee's intention was to deal with the remaining income of the trust for the benefit of the Second Trust. A further provision of the resolution was ``that the taxable distribution to be distributed in the same manner as above''. I accept that as a decision of the trustee that, if the taxable income differs from the accounting or trust law income, the same fixed amounts are to be attributable to the named persons and the balance of the taxable income attributable to the remainderman, the Second Trust. As such I have no hesitation in finding that the purported interest paid is to be included in the share of the net income to which the Second Trust is entitled.
15. Do I also accept the submission by Mr de Wijn that the purported distribution to the five named non-residents who were not eligible beneficiaries be added also to the share of net income to which the Second Trust is entitled? I think not. The resolutions of both years clearly set aside income to the Second Trust of such amounts as was in excess of $96,724 in 1987 and $39,074 in 1988. As those specific amounts were not validly paid, applied or set aside by a decision of the trustee under Clause 3(i) of the deed, Clause 3(ii) applied. These two clauses state:
``3. In each accounting period until the vesting day:
- (i) the Trustees shall pay apply or set aside the whole or such part (if any) as they shall think fit of the net income of the Trust Fund of that accounting period or for or towards the benefit of all or such one or more (exclusively of the others or other) of the General Beneficiaries in such shares and proportions and in such manner as the Trustees in their absolute discretion and without being bound to assign any reason therefor shall from time to time think fit and decide; and any amounts set aside for any General Beneficiary as aforesaid shall not form part of the Trust Fund as defined in clause 1(e) hereof but shall from and after such setting aside be held by the Trustees as a separate Trust Fund upon trust (pending payment thereof to such General Beneficiary) to invest or apply or deal with such fund or any resulting income there from or any part thereof in any manner provided for in and in accordance with any powers conferred by clause 6 hereof;
- (ii) the Trustees shall hold so much of the net income of that accounting period as the Trustees shall not pay apply or set aside pursuant to the powers contained in paragraph (i) of this clause in trust for the persons who would for the time being be entitled thereto whether absolutely or contingently under the trust and provisions of clause 4 hereof as if the last day of that accounting period were the vesting day;...''
Clause 4 sets out the provisions relating to entitlement on or after the vesting day and provides that, failing the exercise of a power of appointment, the trustee is to stand possessed of the trust fund and income thereof for, in order:
- (a) named primary beneficiaries
- (b) brothers and sisters of deceased primary beneficiaries
- (c) next of kin of the Guardian (Mr A)
- (d) specified charity.
In the schedule to the deed no primary beneficiaries were named and Mr A gave evidence that no child had been appointed as a primary beneficiary. The question of whether a child had been appointed is a difficult one. On one hand it could be said that for a child to be appointed a beneficiary, some specific resolution or deed of appointment is required so as to appoint the relevant person who thereafter will enjoy the right to be considered in the distribution of income, the right to capital and the right to enforce due administration of the trust. On the other hand, the deed simply states ``as the trustee may from time to time appoint'' and does not specify any mode by which that appointment shall be made. If, as occurred in this trust, the trustee had resolved to and set aside a part of the net income for each of the two infant children of Mr A in the years ended 30 June 1979 to 1985 inclusive, and the only way such a distribution of income would be valid would be if the children had been appointed beneficiaries, then was such a resolution, in itself, an appointment? Fortunately, it is not necessary to decide whether, in default of a valid distribution of income, the children would be entitled to such
ATC 307income as primary beneficiaries. Firstly Clause 4(1)(a) provides that, at vesting day, the trustee is to stand possessed of the trust fund and the income thereof ``where two or more Primary Beneficiaries are so named in trust for such of the Primary Beneficiaries as attain the age of twenty-one years''. As at 30 June 1988 the two children were aged 9 years and 8 years respectively. Consequently, they could not have taken under the clause even if appointed. Nevertheless, they were the next of kin of Mr A and would take as a result under Clause 4(1)(c) of the deed. I therefore find that AA and BA were presently entitled pursuant to the deed of settlement in equal shares to the share of the net income of the First Trust not otherwise validly distributed in the years ended 30 June 1987 and 1988 amounting to $96,724 and $39,074 respectively.
16. As the relevant assessments, to which the decisions under review relate, have assessed the net income of the First Trust in the manner which I have found in the foregoing reasons, it follows that the decisions in respect of that income are affirmed.
17. The issues as they relate to the Second Trust are similar but some different questions need to be considered. The initial matter for consideration is whether the five non-residents were presently entitled to a share of the net income of that trust in respect of the years ended 30 June 1986 and 1987. The non- residents were said to be included in the class of General Beneficiaries specified in the schedule to the deed. Subject to the same question as to whether they were ``appointed'', three of the non-residents clearly satisfy the definition being cousins or an aunt of Mr A. The respondent submitted that two of the non-residents did not satisfy the definition as they were a great uncle and a great aunt of Mr A, whereas the definition included only the words ``uncle'' and ``aunt''.
18. The primary submission for the respondent was that the purported creation of an entitlement of income to the non-residents was a sham, in that it was not intended at the relevant times that such non-residents would receive a benefit. For the applicant it was submitted that the resolutions were genuine, they provided the non-residents with a valid entitlement and a right to demand payment, and the evidence of Mr A as to the reasons for the desire to benefit the non-residents and the non- payment of any monies should be accepted.
19. It is appropriate to consider the question of whether the purported creation of the entitlements was a sham. If the finding is that it was a sham, then the questions of whether all of the non-residents were within the class of eligible beneficiaries of the trust and whether they were appointed is irrelevant. The applicable law in cases where sham is argued was set out by Tamberlin J in the decision of the Federal Court in
Richard Walter Pty Ltd v FC of T 95 ATC 4440. His Honour said (pp. 4449-4450):
``There is no dispute between the parties as to the applicable law which is conveniently summarised and set out in
Sharrment Pty Ltd & Ors v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454 where Lockhart J said:
`A ``sham'' is therefore, for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive.'
His Honour went on (at 454-455) to set out a number of guidelines, the substance of which is as follows:
- 1. The fact that the transaction involved a `round robin' of cheques does not necessarily establish that the transaction is a sham, even when no party has funds to meet the cheques.
- 2. The artificiality of the transaction does not give rise to its characterisation as a sham or to the characterisation of the constituent documents as a sham so long as each document `had the effect that it purported to have', and so long as none of the documents purported `to do something different from what the parties had agreed to do'.
- 3. The complexity of the transaction does not in itself establish its character as a sham.
- 4. A purported disposal of property or purported creation of a debt may be a sham where donor and donee or lender and debtor do not intend to give effect to
ATC 308the transaction, it being agreed between them that there will be no change in the legal and beneficial ownership of the property.
- 5. The fact that a transaction may have been intended to present a shield against creditors does not, absent the transaction being set aside under the Bankruptcy Act 1966 (Cth), for example, characterise it as a sham. Transactions may in themselves be legally effective although intended to achieve an unacceptable purpose. The essential question seems to be whether what has been done has been genuinely done.
- 6. Circumstances giving rise to suspicion do not establish a transaction as a sham unless it can be shown that the outward and visible form does not coincide with the inward and substantial truth.
Other relevant guidance is to be found in
Snook v London and West Riding Investments Ltd  2 QB 786 at 802;
Allsene Pty Limited v FC of T 89 ATC 5333;
Esanda Ltd v Burgess & Anor  2 NSWLR 139 at 144, 146 and 153.
Cranstoun v FC of T (1984) 75 FLR 220 at 228, Carter J said:
`If two persons sign a document which on its face purports to be a loan agreement evidencing a loan from one to the other for $180,000 but it is agreed either expressly or impliedly that the document is intended to give the appearance only of a loan transaction then it is, in my view, a sham; it is something devised to delude, it is a trick or a hoax, an imposture, it is something that is intended to be mistaken for something else, it is not really what it purports to be, it is a spurious imitation or a counterfeit... However one defines it, it is in law nothing, nor, in my view, can it be elevated to be something which the law will recognise and enforce merely because documents which are drawn in legal language appear, a series of book-keeping entries is made and extensive use made of the banking system involving debits and credits of the order of hundreds of thousands of dollars. No amount of professional ingenuity will make the agreement into what in fact it is not if the parties do not so intend.'
The central feature of a loan transaction is that the parties must intend that the whole of the moneys lent should be repaid. In the present proceedings, I do not consider there was ever intended to be, nor was there, any such obligation created. See
Ferguson v O'Neill  VLR 30 at 32.''
In that case His Honour was dealing with an alleged loan and a question of whether money received by the company was a loan or income. Here we are dealing with an alleged creation of a present entitlement to income of a trust estate. It was submitted by Mr de Wijn that it ``takes two to sham'' and it is necessary to find a ``shammer'' and a ``shammee'' to make a finding of sham. While this may be true when the transaction involves a specific action by each of two parties, such as the execution of a loan agreement, it is not true when the matter under consideration is the unilateral act of one party which seeks to attribute income to another. It may well be an adequate defence against a contention of sham if the other party consented or was aware of such attribution and received the income.
20. In this case there was no evidence that the persons named in the resolution of the trustee were made aware of their good fortune at the time of the resolution, or at any time thereafter, or at least until the visit of Mr A some eight to nine years after the date of the resolution. In his evidence Mr A stated that his father had advised either the particular beneficiary or the head of the relevant family. Unfortunately the father has died since. No copies of written advice or confirmation could be produced. No money was ever paid to the alleged beneficiaries. Mr A stated that the non-residents preferred to leave their money in Australia. No evidence of this was provided. Even the carefully drafted letters taken to Israel for signature by the various non- residents included the statement ``I was pleasantly surprised to be informed of my previous entitlements''. This appears to be at odds with the description of the father maintaining communication contemporaneously with the decision of the trustee in 1986 and 1987. Mr A stated that he wanted to help his relatives who had been kind to him and his immediate family in his early years and assist the economy of Israel. Initially he said that the criteria for deciding on which family members
ATC 309should benefit included need. Later he agreed that the persons named were those whom his father preferred. Whatever the reason for choice, the fact that no money was ever paid out by the trust to the persons chosen makes it difficult to accept that there was any intention of providing a financial benefit to those persons. The only evidence of the knowledge of the non-residents of their alleged entitlements was the letter of acknowledgement produced after the applications were made for review of the respondent's decision to disallow the objections. Only one letter was signed in the name of a non-resident listed in the 1986 and 1987 resolutions. Other letters were signed in the names of beneficiaries of prior years. In each of the years 1982 to 1985 inclusive the trustee resolved to distribute income to various non-residents. In 1982 the resolution included 21 non-residents for $1,700 each. In 1983 there were 27 non-residents for $585 each. 1984 and 1985 limited the number to four and five respectively with distributions of between $6,500 and $7,500 each and these persons were not the same persons to whom the trustee resolved to distribute in 1986 and 1987. While accepting the difficulties in arranging for any of the non-residents to give evidence before the hearing, no attempt appeared to have been made. The sole evidence of the validity of the alleged entitlements was that of Mr A with support sought from untested acknowledgements, dated 1995, from some of the non-residents named in prior years' resolutions and from one of the non-residents named in the resolutions of 1986 and 1987.
21. After full consideration of the evidence, I find that there was no intention by the trustee in the relevant years to benefit the named non- residents by giving them a present entitlement to income of the Second Trust. I do not accept the evidence of Mr A that there was any genuine desire to benefit those non-residents. There was no contemporaneous evidence that the alleged beneficiaries were aware of their alleged entitlements, no attempt was ever made to remit any money to the purported beneficiaries and Mr A was vague and contradictory on the reasons for purporting to benefit those non-residents named in the resolutions. There was undoubted carelessness in the trustee giving effect to the trust provisions when resolutions were recorded purporting to give the same non-residents an entitlement to income in the First Trust when it was clear that they could not be included in any class of beneficiary of that trust. Mr A was of the view that this was a simple error. However, I am left with the conclusion that it arose as a result of the lack of concern about legal entitlements because there was no intention of creating genuine entitlements to interests in the trust for the benefit of the non-residents. I am satisfied that the attempt to create a present entitlement to income of the Second Trust was a sham and not intended to have the legal effect which it purported to have. The resolutions were designed, in my view, to retain the maximum funds within the trust for the ultimate benefit of Mr A and his immediate family with the minimum reduction from the expense of income tax.
22. Having reached that finding, that no valid entitlement to income was provided to the five non-residents in respect of the years ended 30 June 1986 and 1987 and, in fact, in respect of any of the prior years, it follows that no amounts were payable and on which interest could be due. Consequently, there is no basis for the allowance of a deduction for the amounts claimed as interest even if they could be said to represent interest as such. As indicated earlier, even if the alleged distributions had been valid, the un-remitted amounts would not be loans but amounts held under separate trust for each of the individual non-residents. It would be difficult to argue that such unpaid distributions in themselves have generated income where the income of the trust was wholly derived from distributions from another discretionary trust. No direct income could have been said to have been derived from the investment of those unpaid distributions of prior years' income.
23. As stated in my reasons relative to the First Trust, the increase in the net income of the Second Trust resulting from the non- deductibility of the claim for interest paid and the increase in entitlement to income of the First Trust, for the same reason, should be added to the entitlement of the beneficiary to whom the trustee resolved to distribute the balance of any income remaining after the specific distributions to other beneficiaries.
24. Again for reasons set out earlier in relation to the First Trust, the entitlement to income not validly distributed to the non- residents by the trustee of the Second Trust is
ATC 310established pursuant to the default clauses of the trust deed. The clause of this deed which applied to income not paid, applied or set aside pursuant to the trustee's discretionary powers was identical to the equivalent clause in the deed of the First Trust. The primary beneficiaries who became entitled to such non- applied income would be Mr and Mrs A and such child of theirs as the trustee may appoint. Whilst it could be argued that both children were so appointed because they each were entitled to income under resolutions of the trustee since 1979, they were not default beneficiaries in any year up to and including 30 June 1991 because they had not attained the age of 21 years prior to that date. Consequently the provisions of Clause 3(11) and Clause 4(1) result in Mr A and Mrs A being presently entitled in equal shares to the income not otherwise validly distributed in the years ended 30 June 1986 and 1987. The respondent incorrectly regarded the two children as having an equal entitlement with their parents in those years.
25. It follows from the foregoing reasons that the decisions under review are affirmed with the exception of four applications. The decisions in relation to the objections lodged against the assessments issued to the trustee of the Second Trust, pursuant to section 98 of the Act, on account of each of the two infant children for each of the years ended 30 June 1986 and 1987 are set aside. In relation to each of these four assessments the children were entitled to no more than $416 each in both years.
26. In his submission, Mr Murphy led the Tribunal through the complex provisions of Division 16F of Part III of the Act relating to thin capitalisation by non-residents and section 82KK relating to schemes designed to postpone tax liability. These provisions were said to be relevant if the amount claimed as interest were held to be interest. With no disrespect to counsel who sought to relate these provisions to the questions in issue here, I need not deal with his submissions on these points having found that the amounts claimed were not interest and not deductible.
27. The final issue in these matters was the question of additional tax or penalties imposed by the respondent in the amended assessments in dispute. It is difficult to identify the quantum of additional tax imposed from the documents provided to the Tribunal. Mr Murphy stated that he had been instructed that the additional tax had been assessed on the basis of a culpability component of 45% of the additional income tax due under the amended assessments plus the appropriate per annum rates for the period of time before the amended assessments were payable. Mr de Wijn submitted that penalties were not appropriate. It was said that returns were lodged in the full belief that resolutions made by the trustee were effective and there was no intention to deceive. It was argued also that substantial sums had been paid by way of withholding tax and income tax on income said to have been derived by the non-residents in the relevant years. Whilst I have some sympathy with the concern at the apparent lack of recognition of tax already paid by, and on behalf of, taxpayers where the respondent is now seeking payment of tax on the same amount from other taxpayers, it is difficult to find that an amount of tax paid by one person should be taken into consideration in ascertaining the liability of another. I can make findings in relation to those applicants who are before me. I would urge the respondent to ensure that an appropriate amount of tax and additional tax is recovered in relation to the actual net income of the two trusts in each year and give due recognition to the collection of tax from taxpayers where these findings demonstrate that no actual liability existed. However, I would assume that this can be accomplished within the per annum or time component of the additional tax over which, in any event, I have no jurisdiction. Given my findings of a deliberate attempt to move liability to tax away from the real beneficiaries of the trust to non-genuine alleged beneficiaries, I affirm the decision to impose a culpability penalty at the rate of 45% on the relevant income tax payable.
28. There were sixteen applications covered in this hearing. Twelve of the decisions under review are affirmed. The remaining four applications relate to the assessments issued to the trustee under section 98 in respect of income of the two children from the Second Trust in respect of the years ended 30 June 1986 and 1987. The decisions in relation to
ATC 311these applications are set aside and the objections allowed in full.