POPE v FC of T

Members:
P Hack DP

Tribunal:
Administrative Appeals Tribunal, Brisbane

MEDIA NEUTRAL CITATION: [2014] AATA 532

Decision date: 4 August 2014

PE Hack SC, Deputy President

4 August 2014

1. Mr Michael Pope is a beneficiary of a family discretionary trust. From time to time over the years the trustee of the trust has determined to distribute some of the income of the trust to him. Some of the distributions were actually paid to Mr Pope but the bulk of the money was credited to an account in Mr Pope's name in the books of account of the trust. In 2012 Mr Pope decided that the trust was not going to be able to pay him the amount of $227,258 then standing to his credit in the accounts of the trust.

2. When he lodged his income tax return for the year ended 30 June 2012 Mr Pope claimed to deduct the sum of $227,258 from his assessable income on the basis that it was a bad debt, and thus deductible under s 25-35 of the Income Tax Assessment Act 1997 (the ITAA 1997). On 8 March 2013 the Commissioner assessed Mr Pope's 2012 taxable income and the income tax payable thereon, on the basis that the deduction was not allowable. Mr Pope objected but his objection was disallowed by a decision made on 4 December 2013.

3. Mr Pope seeks a review in this Tribunal of the Commissioner's objection. For the reasons that follow I have come to the conclusion that the decision was correct. It will be affirmed.

BACKGROUND

4. The facts are not in issue. The Pope Family Trust (the Trust) was settled by deed dated 10 July 2003.[1] Exhibit 1, pages 450-472. Mr Pope and his spouse were beneficiaries of the Trust. They were, as well, the original trustee although they were replaced in that role in June 2006 by Matcour Pty Ltd, a company in which they were the only members.[2] Exhibit 1, pages 473-475.

5. Given one of the arguments of Mr Pope it is necessary to have regard to some of the provisions of the deed establishing the Trust. By virtue of clause 4.1 the trustee was obliged to hold the income available for distribution upon trust,

… to pay, apply or set aside the income, or any part of the income, to or for the benefit of the beneficiaries…


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The trustee had the power to resolve to accumulate the whole or part of the income of a financial year. Where, as happened here, the trustee resolved to distribute, clause 4.4, so far as is presently relevant, provided:[3] Exhibit 1, pages 454-455.

The payment, application on setting aside of income of a financial year may be effectively made as follows:

  • (a) for a beneficiary who is not under a legal disability:
    • (i) by paying the income to the beneficiary or to such person on behalf of the beneficiary as the beneficiary may authorise or direct; or
    • (ii) by setting the income aside to a separate account in the books of the Trust in the name of the beneficiary whereupon such monies will constitute a loan at call and will not bear interest unless the Trustee and the beneficiary otherwise agree;

6. Finally, reference is necessary to clause 4.6(a) of the deed. It provided:

The payment application or setting aside of income to or for the benefit of a beneficiary may be by a determination or resolution of the Trustee and upon such determination or resolution being made the beneficiary will have an immediate vested indefeasible interest in and to that part of the income so paid, applied or set aside for the financial year to which the determination or resolution relates.

7. On 29 June 2005 Mr and Mrs Pope, in their capacity as trustees, resolved that the "Net Taxable Income" of the Trust be distributed equally between them. The executed minute drew a distinction between "Income" and "Net Capital Gain".

8. The accounts of the Trust for the 2005 income year are not in the material but those for the 2006 year are.[4] Exhibit 1, pages 435-442. They show that the Trust made a profit from ordinary activities of $655,843 in the year ended 30 June 2005 and that all but $1 of that sum was distributed to beneficiaries. They also show that $327,921 was distributed to Mr Pope. The balance sheet shows that the Trust recorded a current liability to Mr Pope of $321,355. The Trust's 2005 income tax return[5] Exhibit 1, pages 27-39. showed a total net income of $330,751 and brought to account a capital gain of $325,092 after applying the 50% discount to a total capital gain of $650,184. A distribution of $162,546 to Mr Pope was disclosed. Mr Pope's individual income tax return for the 2005 income year included a net capital gain of $162,546 in his assessable income for that year.[6] Exhibit 1, page 53. .

9. In the 2007 year the trustee of the Trust[7] By that time Matcour Pty Ltd had become trustee of the Trust. resolved "to pay, apply or set aside" the income of the Trust to various beneficiaries including a distribution of $56,356 to Mr Pope.[8] Exhibit 2, page 5. The accounts of the Trust[9] Exhibit 1, page 427-434. for that year show net income of $168,524.44 with that entire sum distributed to beneficiaries including the amount of $56,356.15 to Mr Pope. That amount was credited to an account in Mr Pope's name under the heading "Beneficiaries Funds" in the financial accounts. The amount of $56,356 was included in Mr Pope's 2007 tax return as assessable income.[10] Exhibit 1, page 133.

10. No distributions were made to Mr Pope by the Trust in any other year. By April 2012 the balance of Mr Pope's account in the books of account of the Trust stood at $227,258. That sum was made up of the distributions of $327,921 (2005) and $56,356 (2007) less payments actually made to Mr Pope of $6,566 (2005), $54,476 (2006) and $94,977 (2007).[11] Exhibit 4, paragraph [21]. On 30 April 2012 Mr Pope, on the advice of his accountant, determined that the outstanding balance of $227,258 was irrecoverable and ought be written off. The Commissioner does not put in issue the fact or the correctness of that decision.

11. Mr Pope lodged his 2012 income tax return in September 2012. He claimed an amount of $227,258as a deduction from his assessable income. There was correspondence thereafter between Mr Pope's accountants and officers of the Commissioner. The Commissioner was not persuaded that the amount claimed was an allowable deduction. On 8 March 2013 the Commissioner made an assessment of Mr Pope's taxable income denying the claimed deduction of $227,258. Mr Pope objected to the assessment of 9 July 2013. The Commissioner disallowed the objection on


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4 December 2013, maintaining the view that the claimed bad debt was not deductible. These proceedings were commenced on 4 February 2014.

THE STATUTORY SETTING

12. It is only necessary to have regard, at this stage, to s 25-35(1) of the ITAA 1997. It reads:

You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

  • (a) it was included in your assessable income for the income year or for an earlier income year; or
  • (b) it is in respect of money that you lent in the ordinary course of your business of lending money.

There is no suggestion that paragraph (b) has any application; the case turns on paragraph (a) and, in particular, what "it" means.

THE ARGUMENTS

13. Mr Pope now contends that $142,545 of the amount of $227,258 written off is deductible pursuant to s 25-35 of the ITAA 1997. He accepts that part only of the amount written off can be deducted on his argument. He contends that the debt is to be characterised as unpaid trust entitlements and that the debt written off bears the same character as the Trust distributions included in his assessable income in the 2005 and 2007 income years.

14. The Commissioners now accepts[12] He took a contrary view when determining the objection. that the amount written off was a debt but contends that the amount written off was not Mr Pope's unpaid present entitlement; it was the outstanding balance in the loan account in Mr Pope's name in the books of account of the Trust. As such it was of an entirely different character to the monies included in Mr Pope's assessable income in 2005 and 2007 and accordingly not deductible under s 25-35 of the ITAA 1997.

CONSIDERATION

15. The starting point must be an analysis of the distribution transaction. That analysis is necessarily informed by the terms of the deed creating the Trust. Each distribution was in discharge of the trustee's obligation to hold the income of the Trust "to pay, apply or set aside the income" of the Trust.[13] See clause 4.1 set out in paragraph [5]. The trustee made a resolution in accordance with clause 4.6(a) of the trust deed and, upon that resolution, Mr Pope had "an immediate vested indefeasible interest in or to that part of the income" subject of the resolution. Having resolved to distribute to Mr Pope, a beneficiary not under a legal disability, the trustee could pay the income of the Trust to Mr Pope or could set it aside to a separate account in the books of the Trust in the name of Mr Pope. In the 2005 income year an amount of $6,566 was paid directly to Mr Pope from a total distribution to him of $327,921. The difference, $321,355, is the balance of the account in Mr Pope's name in the accounts of the Trust as at 30 June 2005. As the Commissioner submits, the only rational inference in these circumstances is that the balance of the distribution to Mr Pope was effected in the manner set out in clause 4.4(a)(ii) of the Trust deed and that the monies distributed in that way constituted a loan at call between Mr Pope and the Trust.

16. I do not accept Mr Pope's argument that this amount was an "unpaid entitlement". Mr Pope's entitlement was paid in the manner prescribed by the deed and, once paid, lost its character as unpaid entitlement.

17. The same is true of the 2007 distribution except that all of Mr Pope's entitlement in that year was credited to the account in his name in the books of account of the Trust and became a loan at call from him to the Trust. It follows that I do not accept Mr Pope's first argument.

18. There is a degree of tension in the language of s 25-35 of the ITAA 1997. As the Commissioner's Statement of Facts, Issues and Contentions points out, strictly speaking, a "debt" is never included in assessable income. Thus the word "it" in paragraph (a) cannot be precisely equated with "debt" in the introductory words. Dr O'Sullivan, counsel for the Commissioner, submitted that "it" was to be read as "income comprised in your right to receive a future payment under that debt". Mr Bunkum, the accountant who represented Mr Pope, at the hearing, relied on the decision in
Federal Commissioner of Taxation v BHP Billiton Finance Ltd[14] [2010] FCAFC 25 ; (2010) 182 FCR 526 . as authority for the proposition that Parliament did not intend a change in the law when s 25-35 was introduced to replace s 63 of the Income Tax Assessment Act 1936 (Cth) (the ITAA 1936). The reasons


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of Edmunds J (with whom Sundberg and Stone JJ agreed) in fact draw attention[15] At [66]. to s 1-3 of the ITAA 1997 which expresses that concept. It provides:
  • (1) This Act contains provisions of the Income Tax Assessment Act 1936 in a rewritten form.
  • (2) If:
    • (a) that Act expressed an idea in a particular form of words; and
    • (b) this Act appears to have expressed the same idea in a different form of words in order to use a clearer or simpler style;
  • the ideas are not to be taken to be different just because different forms of words were used.

19. Section 63 of the ITAA 1936 used to provide:

  • (1) Debts which are bad debts and are written off as such during the year of income, and;
    • (a) have been brought to account by the taxpayer as assessable income of any year; or
    • (b) are in respect of money lent in the ordinary course of the business of the lending of money by taxpayer who carries on business;
  • shall be allowable deductions.

Both s 25-35 of the ITAA 1997 and s 63(1) of the ITAA 1936 operated comfortably in the common circumstance where a trader, accounting on an accruals basis, brought to account as taxable income the total value of sales, even those unpaid as at the end of the financial year. If it transpired that a debt, represented by an amount included in the value of sales, was written off, either version of the section allowed a deduction of the amount of the debt. That is so, as a matter of policy, because the expectation of the total value of, for example, goods sold, on which the first year's accounts and tax return were prepared was not met thus justifying the effective reversal of the product of that expectation. As it seems to me, the language and context of s 25-35 of the ITAA 1997 convey the notion of a continuing identity between the money brought to account by the taxpayer as assessable income and the debt subsequently written off. In the common example, the character of the payment has not changed; it retains its character as the price of goods sold. Once the character of the original receipt has changed that identity is changed and what is sought to be written off no longer represents the income brought to account.

20. That being so the matter is capable of being resolved quite simply[16] The Commissioner advanced more sophisticated arguments to deny deductibility. I do not find it necessary to consider them. on the footing that the debt that was written off was entirely different in character to the income included in Mr Pope's assessable income in the 2005 and 2007 income years. What, relevantly, was included in Mr Pope's assessable income in those years had as its source the share of the trust income to which he became presently entitled. What was written off was of an entirely different character; it was an investment Mr Pope chose to make in the business of the Trust.

21. There is nothing anomalous or unusual in the result. Mr Pope, who was the alter ego of the Trust in any event, chose to leave the bulk of the amounts distributed to him invested in the business of the Trust. Once he chose that course the "debt" thereby created was of an entirely different character to his entitlement to the distribution from the Trust. Let it be supposed that Mr Pope had chosen to be paid his entitlements and had invested the amount paid in a venture, ultimately disastrous, entirely unrelated to the Trust. Had all of the funds been lost there could be no suggestion that Mr Pope had written off a debt that had been included in his assessable income.

22. If follows that I consider that Mr Pope was not entitled to deduct any amount as a consequence of writing off the debt owed to him by the Trust. The Commissioner's objection decision was correct, in substance if not in reasoning, and should be affirmed.


Footnotes

[1] Exhibit 1, pages 450-472.
[2] Exhibit 1, pages 473-475.
[3] Exhibit 1, pages 454-455.
[4] Exhibit 1, pages 435-442.
[5] Exhibit 1, pages 27-39.
[6] Exhibit 1, page 53.
[7] By that time Matcour Pty Ltd had become trustee of the Trust.
[8] Exhibit 2, page 5.
[9] Exhibit 1, page 427-434.
[10] Exhibit 1, page 133.
[11] Exhibit 4, paragraph [21].
[12] He took a contrary view when determining the objection.
[13] See clause 4.1 set out in paragraph [5].
[14] [2010] FCAFC 25 ; (2010) 182 FCR 526 .
[15] At [66].
[16] The Commissioner advanced more sophisticated arguments to deny deductibility. I do not find it necessary to consider them.

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