Decision impact statement
Kafataris v Deputy Commissioner of Taxation
 FCA 1454
(2008) 172 FCR 242
2008 ATC 20-048
73 ATR 531
Venue: Federal Court of Australia
Venue Reference No: NSD 2510-9/2007
Judge Name: Lindgren J
Judgment date: 19 September 2008
Appeals on foot:
Impacted AdviceRelevant Rulings/Determinations:
meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the ITAA 1997
Capital Gains Tax
CGT event E1 and E2
Sole beneficiary of trust
Whether CGT event E1 happened when a taxpayer's interest in real property was placed on trust, which trust was in the nature of a superannuation fund of which the taxpayer was a member. In particular, whether the absolute entitlement exception in paragraph 104-55(5)(a) applied.
Brief summary of facts
In May 1987, Helen and Peter Kafataris (the taxpayers) purchased a commercial property for $612,000. The taxpayers were registered proprietors of the property as joint tenants.
On 28 June 2002, the taxpayers executed a trust deed establishing 'The Helen Kafataris Superannuation Fund'. On the same day they executed a trust deed establishing 'The Peter Kafataris Superannuation Fund'. Both taxpayers were the trustees of each fund.
The execution of these deeds by the taxpayers subjected their respective interests in the property to their respective funds (to be held on the terms of their respective funds) and severed the joint tenancy. That is, Helen's interest in the property was held by Helen's fund and Peter's interest by Peter's fund.
On 4 July 2002, the property was sold to Marriott Restaurants Pty Ltd for $4,000,000.
The issues were firstly, whether subjecting the taxpayers' respective interests in the property to the relevant trusts caused CGT event E1 or E2 to happen; and secondly whether the exception to those events in paragraph 104-55(5)(a) or 104-60(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) applied.
The 2002 and 2003 income tax returns of the taxpayers did not disclose any disposal of property by the taxpayers. The 2003 income tax returns for both of the funds showed that a CGT event had happened but disclosed a nil gain arising from the happening of the event.
Issues decided by the court
CGT Event E1 happens if a trust is created over a CGT asset by declaration or settlement. CGT Event E2 happens if an asset is instead transferred to an existing trust. Paragraph 104-55(5)(a) of the ITAA 1997 states that CGT Event E1 does not happen if you create a trust of over an asset, but you are the sole beneficiary of the trust and absolutely entitled to the asset as against the trustee. Paragraph 104-60(5)(a) serves an analogous function in relation to CGT Event E2.
Relevant asset and event
Lindgren J concluded that the relevant CGT assets were the half interests of each taxpayer in the property and that the relevant CGT Event was CGT event E1. As each respective interest in the property was the first property subjected to the corresponding trust, there were no transfers to existing trusts which is why CGT event E2 was not relevant.
Absolute entitlement exception not satisfied
Lindgren J then determined that the taxpayers did not meet the exception to CGT Event E1 in paragraph 104-55(5)(a) as neither taxpayer was the sole beneficiary of their respective trust and, moreover, neither taxpayer was absolutely entitled to the asset of their trust as against the trustees.
Absolute entitlement exception - sole beneficiary
His Honour noted that the term beneficiary as used in the absolute entitlement exception to CGT Event E1 is not defined in the Act and takes its ordinary meaning. As such, a beneficiary of a trust is any person for whose benefit the trust is to be administered and who is entitled to enforce the trustee's obligations to administer the trust according to its terms (paragraph 42). A person may have no interest in the trust property and may never have an interest in the property yet still be a beneficiary (paragraph 43). For example, although the objects of a discretionary trust do not have beneficial interests in any property of the trust, the objects may be described as beneficiaries of the trust.
Focusing on the deed for The Helen Kafataris Superannuation Fund, his Honour observed that the deed conferred upon the trustee the power to pay benefits to dependants, spouse and relatives of members.
Helen Kafataris was a member, and hence a beneficiary, of the fund. Her five children satisfied the deed definition of a Dependant and therefore they were also beneficiaries of the fund (clause 23.3).
Further, Peter Kafataris and the 15 grandchildren of Helen Kafataris were also beneficiaries of the fund because the trustee was:
- permitted under the deed to pay Peter Kafataris a pension on the death of Helen Kafataris (clause 34.4(d)); and
- required in certain circumstances to pay benefits to relatives of Helen Kafataris on her death (clause 34.6).
Therefore, The Helen Kafataris Superannuation Fund did not have a sole beneficiary. Likewise The Peter Kafataris Superannuation Fund did not have a sole beneficiary (paragraph 53).
His Honour also noted that it remained possible as at the relevant date, namely 28 June 2002, that additional persons would, at a later date, fall within the definition of 'Relative', for example, further lineal descendants of Helen (paragraph 51). Though he said this did not matter - presumably because he had already concluded for other reasons that each fund had more than one beneficiary.
Absolute entitlement exception - entitlement to an asset as against the trustee
As to the meaning to be given to the notion of 'absolutely entitled to the asset as against the trustee', His Honour concluded that the test 'is intended to describe a situation in which the beneficiary of a trust has a vested, indefeasible and absolute interest in trust property and is entitled to require the trustee to deal with the trust property as the beneficiary directs' (paragraph 61).
Lindgren J concluded that clauses 34.12 (b) and (c) of the two trust deeds were 'fatal' to the taxpayers' case (paragraph 63). The former clause permitted but did not mandate in specie distributions of assets by the trustee. The latter clause stated a general rule that no member had or acquired a beneficial or other interest in any specific asset of the relevant fund or the assets of the fund as a whole.
His Honour also found that even if the taxpayers had an interest in an asset of their respective fund (which they did not), that interest would have been defeasible by reason of the trustee having the power under clause 8.4 to sell and vary investments (paragraph 65).
In summary, Helen Kafataris was not entitled to her half interest in the property once it was subjected to the terms of the Helen Kafataris Superannuation Fund: her only entitlement was to require the trustee to pay her money once the conditions of her entitlement were satisfied (paragraph 66). An analogous conclusion applied to Peter Kafataris in respect of his fund.
Lindgren J noted that whether the taxpayers were absolutely entitled to their interests in the property as against the trustees depended on the terms of the relevant deed and on general law principles (paragraph 73).
As an aside, his Honour highlighted the problem at the heart of the taxpayers' submissions: the taxpayers fundamentally were arguing inconsistent positions:
First, they contend that the interposition of the Trusts had the effect that the sale to Marriott for $4,000,000 was not a sale by them as joint tenants and as beneficial owners of the entire interest in the Property as they had been prior to the establishment of the Trusts. They also contend that the sale was not two sales by them separately of their respective half interests. Rather, they contend that the sale was by the Trustees of the two half interests that were the subject of the respective Trusts. The CGT event that resulted from the sale of the Property to Marriott was treated as having arisen in respect of each Fund, not the applicants personally, in their assessable incomes for the 2002-2003 year.
On the other hand, in order to bring themselves within subs (5) of s 104-55 ..., they must contend that they are each absolutely entitled as against the Trustees to the half interest in the Property the subject of the relevant Trust. But if this last contention is upheld, s 106-50 has the effect that [the CGT provisions of the Act] apply to the Trustees' sales of the respective half interests to Marriott as if Helen and Peter respectively had sold them to Marriott - the very result that Helen and Peter have sought to avoid.
In sum, if, as the applicant's contend, the exception allowed by subs (5) of s 104-55 ... applies, s 106-50 also operates, and the applicants are taken to have sold their respective half interests in the Property to Marriott in the 2002-2003 year. If that subsection, and therefore s 106-50, does not apply, the applicants are caught by the primary provision of s 104-55 ... in the 2001-2002 year.
Tax Office view of Decision
The decision of Justice Lindgren confirms the correctness of the Commissioner's approach to what is meant by absolute entitlement in the context of the CGT provisions, including section 106-50 of the ITAA 1997. To be absolutely entitled to an asset as against the trustee, the beneficiary must have both a vested and an indefeasible interest in the asset and be able to demand transfer of the asset by the trustee. It does not suffice for the beneficiary merely to have an entitlement under the deed to be paid a benefit. The beneficiary must have an immediate entitlement to demand transfer of the particular asset in circumstances where that entitlement cannot be defeated.
The decision of Justice Lindgren also confirms that any enquiry into the quality of a beneficiary's interest in an asset of the trust requires close and careful examination of the constituent document of the trust. This is consistent with the observation by the High Court in CPT Custodian Pty Ltd v Commissioner of State Revenue (Vic) 2005 ATC 4925 where the High Court emphasised in the context of resolving the application of the particular statutory provision then in issue to the trust under examination that:
All depends, as Tamberlin and Hely JJ put it in Kent v SS ``Maria Luisa'' (No 2), upon the terms of the particular trust' (at paragraph 15 of the joint judgement).
In particular, the presence in the particular deed of a clause that gives the trustee power to sell and vary investments, will be inconsistent with the existence of absolute entitlement; as will be the presence of a clause stating that no beneficiary of the trust has a beneficial interest in any asset of the trust.
TR 2004/D25 sets out the Tax Office's current administrative treatment of the meaning of the words 'absolutely entitled to a CGT asset as against the trustee' as used in the CGT provisions. (As noted in the header to the ruling, that ruling will remain a draft while consultation with Treasury continues concerning certain problems that arise in the practical application of the provisions.) The draft ruling does not apply to members of a superannuation fund in respect of assets held by a fund (paragraph 6).
We consider that the approach taken by Lindgren J aligns with the 'core principle' adopted in the ruling at paragraph 10. 'The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction' aligns with his Honour's approach expressed at paragraph 61 of the judgment: "the expression 'absolutely entitled to the asset as against the trustee' ... as the beneficiary directs." to the construction of the exception to CGT Event E1.
The ruling makes further propositions which were not necessary for his Honour to consider (for example, the effect of having multiple beneficiaries). The Commissioner's practice with regard to these propositions will continue as set out in the draft ruling.
Additionally, his Honour made some conclusions not expressed in the draft ruling. These are:
- The existence of a power of sale by the trustee in respect of an asset is inconsistent with absolute entitlement by a beneficiary to the asset as against the trustee;
- A provision in the instrument of trust denying a beneficiary any interest in any particular asset of a trust is inconsistent with absolute entitlement by a beneficiary to any of the assets of the trust.
These conclusions are not inconsistent with our draft ruling and we accept that they are correct.
List of Rulings and Determinations Affected
Draft Income Tax Ruling TR 2004/D25
Implications on current Public Rulings & Determinations
Implications on Law Administration Practice Statements
Income Tax Assessment Act 1997
Australian Securities & Investments Commission v Carey (No 6)
(2006) 58 ACSR 141
 FCA 814
(2006) 233 ALR 475
CPT Custodian Pty Ltd v Commissioner of State Revenue
(2005) 224 CLR 98
 HCA 53
2005 ATC 4925
60 ATR 371
Gartside v Inland Revenue Commissioners
 AC 553
Herdegen v Federal Commissioner of Taxation
(1988) 84 ALR 271
20 ATR 24
88 ATC 4995
In re Gulbenkian's Settlements
 AC 408
Kent v "Maria Luisa (No 2) "
(2003) 130 FCR 12
 FCAFC 93
McPhail v Doulton
 AC 424
Public Curator of Queensland v Union Trustee Company of Australia Ltd
(1922) 31 CLR 66
(1922) 28 ALR 438
 HCA 28
R & I Bank of Western Australia Ltd v Anchorage Investments Pty Ltd
(1992) 10 WAR 59
Re Denley's Trust Deed; Holman v HH Martyn & Co Ltd
 3 All ER 65
 1 Ch 373
Sacks v Gridiger
(1990) 22 NSWLR 502
90 ATC 4299
Saunders v Vautier
 4 Beav 115
Stephenson (HM Inspector of Taxes) v Barclays Bank Trust Co Limited
 1 All ER 625
 1 WLR 882;
Tomlinson (Inspector of Taxes) v Glyns Executor & Trustees Co
 1 All ER 700
Tomlinson (Inspector of Taxes) v Glyns Executor & Trustees Co
 1 All ER 381