Decision impact statement

Cajkusic & Ors v Commissioner of Taxation


Court Citation(s):
[2006] FCAFC 164
2006 ATC 4752
(2006) 64 ATR 676
(2006) 155 FCR 430

Venue: Federal Court
Venue Reference No: VID 279 of 2006
Judge Name: Sundberg, Kiefel and Edmonds JJ
Judgment date: 24 November 2006
Appeals on foot:
No.

Impacted Advice

Relevant Rulings/Determinations:
  • None

Subject References:

trustees
where trust deed empowered trustee to determine whether receipts and outgoings were on revenue or capital account
where trustee determined certain outgoings to be on revenue account
where same outgoings not allowable deductions for tax purposes
where no distributable net income of the trust for trust law purposes but section 95 'net income' for tax purposes
whether beneficiaries presently entitled to the 'income of the trust estate'
the meaning of the 'income of the trust estate' in section 97 and 'income of a trust estate' in section 101.

Note: the comments in the DIS relating to the meaning of "income of the trust estate" as that term is used in section 97 ITAA 1936 no longer correctly articulate the Commissioner's view. In Bamford the High Court held that the term takes its meaning from the law of trusts. The Commissioner's understanding of what this means is explained in the Bamford DIS.

Exclamation This document is not a public ruling, but provides a statement of the Commissioner's position in relation to the decision and how the law will be administered as a consequence of the decision. Any proposals for changes in the law are matters for government and it is not appropriate for the Commissioner to comment.

Précis

The appeal by the taxpayers to the Federal Court concerned the meaning of the phrases 'income of the trust estate' in section 97 and 'income of a trust estate' in section 101 of the Income Tax Assessment Act 1936.

Brief summary of facts

In its income tax return for the 1998 year of income the Cajkusic Family Trust (the trust) returned nil net income and a carry forward loss of $26,141 based on taxable income for the year of $28,697 and prior year tax losses of $54,838.

The 1998 trust accounts were identical to the income tax return and showed a net profit for the year of $28,697, accumulated prior year losses of $54,838, and accumulated losses of $26,141 as at 30 June 1998.

The Commissioner disallowed deductions claimed for $190,000 said to have been paid to an employee benefits trust, a further $7,125 as related costs, and the prior year tax losses claim of $54,838. The Commissioner considered that the deductions disallowed for income tax purposes were not proper expenses of the trust such that the section 95 net income of the trust and the net accounting income of the trust properly determined both amounted to $225,822. As the appellants were default income beneficiaries of the trust, and as there was no trustee income resolution, the Commissioner included the section 95 net income of the trust in the assessable income of each of the appellants in accordance with section 97.

The taxpayers disputed their assessments initially at the Administrative Appeals Tribunal (AAT) and subsequently on appeal to the Federal Court on the basis that there was no 'income of the trust estate' to which they could be presently entitled for the purposes of section 97.

The AAT decision of 17 February 2006 was favourable to the Commissioner (although the trust income assessed to each of the three trust beneficiaries was reduced to one-third of the section 95 net income). Deputy President Olney 'assumed that the payments said to have been made ... were in fact made' (paragraph 5), but concluded that the payments 'served no business purpose,' were made solely to obtain 'the tax saving the applicants sought to achieve' (paragraph 10), and were not allowable deductions. The AAT did not make any finding of fact in relation to 'the income of the trust estate' and seems to have assumed that it equalled the section 95 net income - see paragraph 18 of the Full Court's decision.

The taxpayers appealed to the Federal Court. The appeal was heard by a Full Court pursuant to paragraph 44(3)(b) of the Administrative Appeals Tribunal Act 1975. In the Full Court the Commissioner relied on section 101 as an alternative ground to support the assessments consistent with the AAT's finding that the amount contributed was 'said to have been ... $65,000 on behalf of Brancka Cajkusic, $60,000 on behalf of Daniel Cajkusic and $65,000 on behalf of Milivoj Cajkusic (being a total contribution of $190,000)' (paragraph 6).

Issues decided by the court or tribunal

The Full Federal Court Decision

On 24 November 2006 the Full Court (Kiefel, Sundberg and Edmonds JJ) allowed the taxpayers' appeals against the AAT's decision.

The taxpayers argued that three requirements must be satisfied for a beneficiary to be assessed under section 97. Those requirements were (paragraph 14):

(1)
There must be income of the trust estate in the sense of a distributable net income.
(2)
A beneficiary must be presently entitled to a share of that income.
(3)
There must be net income of the trust estate within the meaning of s 95 of the 1936 Act ....

The Full Court found that the trust did not have any distributable net income in the 1998 year of income:

(a)
as evidenced by the financial accounts of the trust for the 1998 year, the trustee, consistent with the power vested in it by clause 8(u) of the trust deed, treated the outgoings as being on revenue account (paragraph 20)
(b)
the accounts properly disclosed a distributable net income (before a carry forward loss from the 1997 year) on the basis that the payments had been properly applied against the gross income of the trust for the purposes of determining its distributable net income on a stand alone basis for the 1998 year (paragraph 30)
(c)
in the absence of any contrary direction in the trust instrument the loss from the 1997 year must be made up out of profits of the 1998 year and not out of capital so that there can be no profits properly distributable in cash until all past losses are paid (paragraph 31); and
(d)
therefore, there was no distributable net income for the 1998 year.

As the distributable net income of the trust for 1998 was negative, the Full Court concluded that none of the beneficiaries was presently entitled to anything. The consequence of this was that the liability for tax on the section 95 'net income' fell wholly on the trustee under section 99A of the ITAA 1936 (paragraph 31).

The Full Court also rejected the Commissioner's argument that the taxpayers were deemed to be presently entitled to income of the trust estate under section 101, on the basis that what was contributed to the employee benefit trust was paid out of the gross income of the Family Trust and then finished up in the hands of the taxpayers (paragraph 32). The Full Court considered that the reference to 'income of a trust estate' in section 101 is a reference to the distributable net income, i.e., the same income to which section 97 refers. As there was no net distributable income of the trust for the 1998 year, the Full Court concluded that there was nothing to which section 101 could apply for the 1998 year (paragraph 34).

The Commissioner's application for special leave to appeal to the High Court was refused on 24 April 2007.

Tax Office view of Decision

The Tax Office accepts the decision as an application of conventional tax law principles in determining when a beneficiary of a trust is presently entitled to the income of a trust estate.

Specifically, a basic step in the reasoning of the Full Federal Court was that the terms of the particular trust deed under consideration (especially the first part of clause 8(u)) had the effect that there was no income of the trust estate to which the beneficiaries could be presently entitled. This was because the trustee had properly applied all of the income of the trust to meet both current year expenditures the trustee was authorised under the authority of the deed to make and also to make good prior year losses that were, in the absence of a contrary direction in the deed, properly to be made up out of income of subsequent years (see paragraphs 30 - 31). This was essentially a factual conclusion based on an inference, drawn from the way the trust accounts were prepared, that the relevant expenditures and losses were properly subtracted in computing whether the beneficiaries were entitled to any of the income of the trust estate in the relevant year.

Meaning of the words 'the income of the trust estate' in subsection 97(1)

In various places in their reasons their Honours spoke of the 'income of the trust estate' as being the 'net distributable income' (eg., paragraph 18, paragraphs 27-30 and paragraph 34). The Commissioner does not understand the Full Court to have meant these comments in the sense that the 'net distributable income' of the trust was, as a matter of principle, to be substituted directly for the words used in the statute; rather, the 'net distributable income' was to be used in determining whether the beneficiaries were presently entitled to the 'income of the trust estate'.

The expression 'presently entitled to a share of the income of the trust estate' is a composite expression, the meaning of which depends upon the application of authorities concerning 'present entitlement' and those concerning 'income of the trust estate'.

In FC of T v Totledge 40 ALR 385 at 394 a differently constituted Full Court of the Federal Court held that the composite expression 'present entitlement to a share of the income of the trust estate' was a reference to 'a present vested right to demand and receive payment of the whole or part of what has been received by the trustee as income and, retaining that character in his hands, is legally available to be distributed to those entitled to it as beneficiaries'. This view was in our opinion endorsed by the High Court in Harmer v F Cof T [1991] 173 CLR 264 at 271 and is fully consistent with the decision of the High Court in Commissioner of Taxation v Australia and New Zealand Savings Bank (1998) 194 CLR 328.

The Full Court in Cajkusic neither dealt with nor appears to have intended to raise any question about the authority of the passage referred to from Totledge. Further, in the factual circumstances in Cajkusic, the conclusion reached by the Full Court is wholly consistent with an application of the principles as outlined in Totledge. That is, although what was received by the Cajkusic Family Trust in the relevant year was received as income of the trust estate, no part of it was legally available to be distributed to beneficiaries because the trustee, acting under the authority of the deed, was required to apply that income to meet current year expenditures and prior year losses of the trust.

Effect of trust instrument on 'income of the trust estate''

Notwithstanding some broad observations made by their Honours about the effect of trust instruments (e.g., paragraphs 18 and 27 - 30), the question before them did not involve the characterisation of a receipt and, unlike some commentators, the Commissioner does not understand the case to be authority for the proposition that the terms of a trust instrument can govern what is income, for the purposes of subsection 97(1), in the hands of the trustee.

The Commissioner considers he must continue to follow what he understands to be the reasoning of the High Court in the ANZ Savings Bank decision (see per Gleeson CJ, paragraphs 14 and 15; cf/ Full Court in Cajkusic at paragraph 29).

In ANZ Savings Bank, the High Court decided that the provisions in the trust deed dealing with the entitlements of unit holders did not alter what was the character of certain amounts in the hands of the trustee. In reaching this decision the Court explicitly adopted what had been said by the Full Federal Court in the case. The Full Federal Court said that the whole of an annuity amount, including the deductible part, was income of the trust estate 'within the meaning of the opening lines of s97(1)' notwithstanding that the deductible amount was exempt income of the trust for tax purposes and was treated as capital under the deed.

Given, however, the observations made by the Full Court in Cajkusic have created some uncertainty in relation to this issue the Commissioner will seek to further test the issue in the appellate courts as soon as the opportunity arises.

Trust Losses

We note the view expressed by the Full Federal Court that losses in one year must, in the absence of any contrary direction in the trust instrument, be made up out of profits of subsequent years and not out of capital (paragraph 31).

The correctness of this view is the subject of the taxpayer's appeal to the High Court in Raftland Pty Ltd v Commissioner of Taxation.

Administrative Treatment

Implications for current Public Rulings & Determinations

Consideration will be given to whether there are any implications for public rulings or determinations.

Implications for general administration

The Commissioner does not propose to conduct active compliance activities targeted at this issue. If the issue arises in an audit or if the Tax Office is asked to rule on a specific case in the context of a private or class ruling, then the Commissioner will have no alternative but to apply the law as he understands it to operate.

As noted above, in view of some uncertainty about this issue the Commissioner will seek to further test the issue in the court as soon as the opportunity arises.

Implications for Law Administration Practice Statements

Under general consideration; however, the decision will have no impact on PS LA 2005/1 (GA) which deals with capital gains of trusts.

Legislative References:
Income Tax Assessment Act 1936 (Cth)
95
97
99A
101

Case References:
Commissioner of Taxation v ANZ Savings Bank Ltd
(1998) 194 CLR 328
98 ATC 4850
39 ATR 419

H. R. Lancey Shipping Co. Pty Ltd v Federal Commissioner of Taxation
(1951) 9 ATD 267

McBride v Hudson
(1961) 107 CLR 604

Thornley v Boyd
(1925) 36 CLR 52

Union Fidelity Trustee Co. of Australia Ltd v FC of T
(1969) 119 CLR 177
69 ATC 4084
1 ATR 200

Upton v Brown
(1884) 26 Ch D 588

Zeta Force Pty Ltd v FCT
(1998) 84 FCR 70
98 ATC 4681
39 ATR 277