Decision impact statement
The Trustee for MH Ghali Superannuation Fund and Commissioner of Taxation
Court Citation(s):
[2012] AATA 527
2012 ATC 10-266
89 ATR 963
Venue: Administrative Appeals Tribunal
Venue Reference No: 2010/4923-4924
Judge Name: SM Fice
Judgment date: 10 August 2012
Appeals on foot:No
Decision Outcome: Favourable to Commissioner
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Superannuation fund
Unit trust
Fixed entitlement
Arm's length income
Special income
Distributions of income
Précis
Outlines the ATO's response to this case which concerned a superannuation fund that received distributions of income from a unit trust. The question before the AAT was whether those distributions were special income under s 273(6) or (7) of the ITAA36.
Brief summary of facts and Issues
The MH Ghali Superannuation Fund (the Super Fund) held units in the Ghali Unit Trust (the Unit Trust) and derived income as a beneficiary of the Unit Trust. The main question for resolution in the case was whether such income of the Super Fund was 'special income' (otherwise known as non-arm's length income) and so taxable at the rate applicable to the special component of the income of a complying superannuation fund.
There were two bases on which the income could be special income. The first was if the income was derived 'other than by virtue of holding a fixed entitlement to the income' (s 273(6) of the Income Tax Assessment Act 1936 (ITAA36)).
The trust deed relevantly provided at clause 2.7 for:
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- the Trust Fund initially to be divided into a number of $1 units classified as A Class, B Class, C Class and D Class units;
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- A Class units [of which the Super Fund was the majority holder] to carry an entitlement to a share in the capital of the Trust Fund upon the termination of the trust;
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- the distribution of the income of the trust in accordance with the provisions of clause 12;
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- the right to one vote in respect of each unit held; and
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- the right to resolve by unanimous agreement with other A Class unit holders the amount of the income to be distributed to the holders of B, C and D Class units.
The trust deed also provided certain discretions to the Trustee in respect of the income, including:
12.3.1 The Trustee may subject to the provisions in this clause and subject to any special rights or restrictions provided in clause 2.7 in relation to units of any class distribute at any time to any one or more of the classes of Unitholders or to any one or more of the unitholders within a particular class to the exclusion of other unitholders such of the income of the Trust Fund as the Trustee may in its absolute and uncontrolled discretion decide.
...
12.3.11 The Trustee shall in its absolute discretion determine which class of Unitholders shall be presently entitled to such Income of the Trust Fund as is agreed upon in accordance with the requirements of clause 12.3.1 and in default of such determination the Unitholders in the same proportions as they hold units in the Trust Fund shall notwithstanding classification be presently so entitled.
The second basis on which the income would be special income was if a fixed entitlement to the income (or the income itself) was derived under an arrangement some or all of the parties to which were not dealing at arm's length and the amount of income was greater than might have been expected to have been derived if the parties had been dealing at arm's length (s 273(7) of the ITAA36).
The Tribunal made findings of fact concerning the circumstances in which units were acquired and circumstances in which the income was distributed. In broad terms, the Tribunal considered that there was non-arm's length dealing.
There were two further issues in the case that are not discussed in detail in this Decision Impact Statement. One was whether a capital gain was properly taken into account in the 2006 year in calculating the net income of the Unit Trust, and hence assessable income of the Super Fund. The other was the application of shortfall penalties.
Issues decided by the tribunal
The Tribunal decided that:
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- The Super Fund held a fixed entitlement to income for the purposes of s 273. The Tribunal considered that fixed entitlement was defined in Schedule 2F to the ITAA36, and that relevantly the Super Fund held a vested and indefeasible interest.
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- The Super Fund did not acquire the fixed entitlement, or derive the income, pursuant to an arrangement where the parties were dealing at arm's length, and the income was more than might have been expected had the parties been dealing at arm's length. Accordingly, the Tribunal concluded that the relevant amounts were 'special income' of the Super Fund.
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- The capital gain was properly included in the net income of the Unit Trust in the 2006 income year.
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- The 25% shortfall penalty was not unjust or excessive.
ATO view of Decision
The case concerned the application of the 'special income' rules in s 273 of the ITAA36. That section has now been replaced by the 'non-arm's length income' rules in s 295-550 of the Income Tax Assessment Act 1997 (ITAA97). The new section is relevantly in the same terms. Accordingly, while the comments below concern s 273, they are equally applicable to s 295-550.
The Commissioner was successful in this case because the Tribunal considered that the relevant trust entitlement was acquired, and income derived, through non-arm's length dealing.
However, the Tribunal's reasoning differed from the Commissioner's on one issue, namely whether the income derived by the Super Fund was by virtue of a fixed entitlement to income.
In that regard, there are two aspects of the Tribunal's reasoning that warrant further comment:
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- The Tribunal considered that 'fixed entitlement' in s 273 takes the meaning provided in s 272-5 in Schedule 2F to the ITAA36. This is contrary to, and would be less favourable to taxpayers than, the Commissioner's existing approach.
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- Section 272-5 of Schedule 2F provides that if a beneficiary has a vested and indefeasible interest in a share of income of a trust that the trust derives from time to time, the beneficiary has a fixed entitlement to that share of income. The Tribunal made some observations regarding the nature of that test which are discussed further below. Because of the way the case was argued, the Tribunal did not have the benefit of submissions on the way in which the test operates including relevant case law.
Because the Commissioner's objection decision was affirmed, the Commissioner could not appeal and seek to have these issues considered further by the Federal Court.
The meaning of 'fixed entitlement' in s 273
The Commissioner's view set out in TR 2006/7 is that a superannuation fund has a fixed entitlement to income 'if the entity's entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion.' (TR 2006/7, paragraph 102)
The Tribunal concluded that 'fixed entitlement' in s 273 took its meaning from the definition in Schedule 2F to the 1936 Act. However, because neither party advanced the view that the Schedule 2F definition was applicable, the Tribunal did not have the benefit of submissions about the elements of the definition of fixed entitlement in Schedule 2F.
Section 272-140 says that 'in this Schedule [2F]' fixed entitlement has the meaning given by Subdivision 272-A. Fixed entitlement is not defined in s 6 of the 1936 Act, and there is nothing in s 273 that suggests that the Schedule 2F definition applies. On that basis, the Commissioner respectfully maintains the view that the definition does not apply for the purposes of s 273. The Commissioner considers that this is a more favourable approach for superannuation funds, because the fixed entitlement test as set out in TR 2006/7 might be expected to be satisfied in more circumstances than the Schedule 2F test.
In light of recent authority, it might be said that the fixed entitlement test in Schedule 2F is relatively difficult to satisfy. See, for example, Colonial First State Investments Ltd v FCT, and the Commissioner's Decision Impact Statement in respect of that case. Having regard to the strictness of that test, the Commissioner perceives that the adoption of the Schedule 2F definition for the purposes of s 273 (or its successor, s 295-550) would give rise to adverse and unintended impacts on superannuation funds that hold arm's length trust investments.
The Commissioner proposes to adhere to his existing view that the Schedule 2F definition is inapplicable for the purposes of s 273. Although not considered by the Tribunal, we note that the Commissioner's view is that the Schedule 2F definition also does not apply for the purposes of s 295-550: see TR 2006/7 and the minutes to NTLG Superannuation Subcommittee meeting of March 2010.
The Tribunal's application of the Schedule 2F definition
In accordance with its decision regarding the Schedule 2F definition, the Tribunal analysed whether the interest in the trust estate was vested and indefeasible as required by the definition. As noted above, the Commissioner considers that that definition does not apply for s 273 purposes.
The Commissioner accepts that the interest of the Super Fund in the income of the Unit Trust could be described as 'vested in interest' on the basis of the default clause in Clause 12.3.11 of the Unit Trust Deed. [See at paragraph 39]
In seeking to resolve the question of whether the interest was 'indefeasible', the Tribunal appears at [41] to [43] to have focussed its enquiry on whether the beneficiary's interest in the trust (i.e. the units themselves) was indefeasible. The Commissioner considers that the definition requires an analysis of whether the interest in a share of the income of the trust is indefeasible (s 272-5 of Schedule 2F; compare with Colonial First State Investments Ltd v FCT [2011] FCA 16 at paragraph [103]).
In relation to the nature of a fund's interest in the income of a trust, the Commissioner notes that there is a body of case law relating to whether the fund's interest in a share of the income is indefeasible. Having regard to the way the matter was argued, that case law was not explored in argument before the Tribunal.
The relevant cases include Colonial First State Investments Ltd v FCT [2011] FCA 16 [see at paragraph 106] , Kent v The Vessel 'Maria Luisa' [2003] FCAFC 93 [see at paragraph 71] and Dwight v FCT (1992) 23 ATR 236.
In Colonial First State Investments Ltd v FCT [2011] FCA 16, Stone J considered whether there was a fixed entitlement to a share of the income and capital of a trust for the purposes of Schedule 2F. Her Honour concluded (at [106]) that the fact members could vote to terminate the present right to a share of income or capital meant that the relevant rights were defeasible.
In Dwight v FCT (1992) 23 ATR 236, Hill J said:
An interest is said to be defeasible where it can be brought to an end and indefeasible where it can not. Thus, a beneficiary with an interest which is not contingent but which interest may be brought to an end by the exercise of a power of appointment, would be said to have a vested but defeasible interest...
Accordingly, where a trustee has a discretion to distribute income amongst unitholders in whatever proportion the trustee may in its absolute discretion determine, the Commissioner does not consider that the interest of a default beneficiary in income could be described as 'indefeasible': whatever interest in the income of the trust a default beneficiary would have is liable to be defeated by the trustee exercising its discretion to appoint the income to others.
However, as discussed above, the Commissioner's view is that the s 272-5 test does not apply for the purposes of s 273 and s 295-550. Rather the 'fixed entitlement' test in s 273 and s 295-550 operates in the manner described in TR 2006/7.
Unless or until the meaning of fixed entitlement for the purposes of s 273 or s 295-550 is further tested in the courts or the Tribunal, the Commissioner proposes to adhere to his existing view that the Schedule 2F definition is inapplicable for the purposes of s 273 and s 295-550. The Commissioner will continue to apply the view set out in TR 2006/7 that a superannuation fund has a fixed entitlement to income 'if the entity's entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion'.
The Commissioner does not propose to amend TR 2006/7 as a result of this decision.
The Commissioner does not consider that the decision has an impact on any other rulings.
Administrative Treatment
Implications on current Public Rulings & Determinations
None
Implications on Law Administration Practice Statements
None.
Legislative References:
Income Tax Assessment Act 1936
97
273
272-5 of Schedule 2F
Income Tax Assessment Act 1997
295-550
995-1
Case References:
Allen and Another v Federal Commissioner of Taxation
[2011] FCAFC 118
195 FCR 416
2011 ATC 20-277
Colonial First State Investments Ltd v Federal Commissioner of Taxation
[2011] FCA 16
2011 ATC 20-235
81 ATR 772
Dwight v Federal Commissioner of Taxation
(1992) 23 ATR 236
92 ATC 4192
Glenn and others v The Federal Commissioner of Land Tax
(1915) 20 CLR 490
Harmer v Federal Commissioner of Taxation
[1991] HCA 51
173 CLR 264
22 ATR 726
91 ATC 5000
Kent v The Vessel 'Maria Luisa'
[2003] FCAFC 93
130 FCR 12
Walsh Bay Developments Pty Ltd and Another v Federal Commissioner of Taxation
(1995) 31 ATR 15
95 ATC 4378