The impact of this case on ATO policy is discussed in Decision Impact Statement: Bargwanna, Graham & Melinda as trustees of the Kalos Metron Charitable Trust (S284/2011 ).
FC of T v BARGWANNA & ANOR (AS TRUSTEES OF THE KALOS METRON CHARITABLE TRUST)Judges:
Full High Court
MEDIA NEUTRAL CITATION:
 HCA 11
French CJ, Gummow, Hayne and Crennan JJ
1. The respondents, Mr and Mrs Bargwanna, are husband and wife who reside in New South Wales and were, at all material times, the trustees of a deed executed on 14 October 1997 ("the Deed"). The Deed was an instrument of thirteen clauses. Clause 3 stated that the trustees hold "the Trust Fund", being the trust assets and the income thereof, "in trust for such public charitable purposes as [they] shall from time to time determine". The trusts of the Deed were styled the "Kalos Metron Charitable Trust" ("the Trust").
2. Clause 12 of the Deed was expressed in terms having the effect of selecting the law in force in New South Wales as the proper law. Further, the evidence shows that the seat of the administration of the Trust was in that State.
3. Between 2003 and 2007 the trustees distributed a total of $293,914.55 to numerous charitable causes.
4. This litigation concerns the construction and operation of Div 50 of Pt 2-15, headed "Exempt income", of the Income Tax Assessment Act 1997 (Cth) ("the Act"). The dispute begins with the application made on 22 November 2004 for endorsement by the appellant ("the Commissioner") of the Trust with effect from 1 July 2000, as "a fund established in Australia for public charitable purposes by ... instrument of trust". The endorsement would qualify the Trust as an entity exempt from income tax, within the operation of Div 50 of Pt 2-15, but the exemption from income tax would only apply if "the fund is applied for the purposes for which it was established" (s 50-60). It is important to note that income tax is payable in respect of each income year (ss 3-5, 4-10), so that the existence of an exemption will fall annually for consideration and application.
5. The endorsement application made in November 2004 was refused and on 13 January 2005 the Commissioner wrote advising of that decision. An objection was disallowed by the Commissioner on 9 September 2005. On an application to the Administrative Appeals Tribunal (Mr PW Taylor SC) ("the AAT") for review of that decision, the Commissioner contended that between 2002 and 2007 there had been a number of applications of the assets of the Trust (called "the Fund") which were not for the purposes for which it was established. However, that application was successful. On 7 April 2008, the AAT gave detailed reasons for setting aside the disallowance decision of the Commissioner of 9 September 2005 and substituting a determination that, as at 9 September 2005, the Fund was entitled to endorsement as exempt from income tax with effect from 1 July 2000.
The administration of the Trust
6. An appreciation of the issues arising under the Act is assisted by consideration of the matters of general law, concerning in particular the administration of charitable trusts, which are engaged by those issues of revenue law.
7. First, it may be observed that in many respects the administration of a charitable trust does not differ from that of a private trust. A critical distinction is that a trust for charitable purposes lacks the individual beneficiaries who commonly hold the beneficial interest in the trust assets.
8. When delivering the reasons of the Privy Council in
Latimer v Commissioner of Inland Revenue
"It is of the essence of a charitable trust that it is a trust for the promotion or advancement of social purposes rather than a trust for individual beneficiaries. Of course, individuals may benefit from the application of trust moneys, but they are not, as individuals, the beneficiaries of the trust and may not enforce its terms. If the purposes of the trust are charitable, they may be enforced by the Attorney-General; if they are not charitable then, with certain anomalous exceptions, they are not enforceable and the trust is not valid. Whether the purposes of the trust are charitable does not depend on the subjective intentions or motives of the settlor, but on the legal effect of the language he has used. The question is not, [w]hat was the settlor's purpose in establishing the trust? [B]ut, [w]hat are the purposes for which trust money may be applied?"
9. The reference to enforcement by the Attorney-General requires some qualification with reference to the statute law of New South Wales. Proceedings with respect to an alleged breach of charitable trust or its administration may be brought by the Attorney-General, with or without a relator, or by another authorised person, as provided by s 6 of the Charitable Trusts Act 1993 (NSW) ("the Charitable Trusts Act").
10. In considering the issues of revenue law on this appeal, it is particularly important to note that general principles of trust law obliged the respondents as trustees strictly to conform to and carry out the terms of the Deed
Scott v National Trust for Places of Historic Interest or Natural Beauty
"They must inform themselves, before making a decision, of matters which are relevant to the decision. These matters may not be limited to simple matters of fact but will, on occasion (indeed, quite often) include taking advice from appropriate experts, whether the experts are lawyers, accountants, actuaries, surveyors, scientists or whomsoever. It is however for advisers to advise and for trustees to decide: trustees may not (except in so far as they are authorised to do so) delegate the exercise of their discretions, even to experts."
12. Part 2, Div 2 (ss 14-63) of the Trustee Act 1925 (NSW) ("the Trustee Act") contains various provisions respecting investments which applied subject to the terms of the Deed. Section 63 enabled the respondents as trustees to apply to the Supreme Court for an opinion, advice or direction on any question respecting the management or administration of the trust property, or respecting the interpretation of the Deed.
13. Clauses 4 and 5 of the Deed conferred widely expressed powers of investment. Clause 6 stated that every discretion and power conferred on the trustees "shall be an absolute and uncontrolled discretion or power". Clause 6 further provided that no trustee is to be held liable for any loss or damage accruing as a result of concurring in any exercise of any such discretion or power. But "trustee exemption" clauses of this nature are to be construed no more widely than their language on a fair reading requires
14. The personal liability as trustees to which the respondents were exposed was mitigated by the power conferred by s 85 of the Trustee Act upon the Supreme Court wholly or partly to relieve trustees of personal liability for breach of trust where it appeared to the Court that they had "acted honestly and reasonably" and that they "ought fairly to be excused"
15. The moneys comprising the Trust Fund were held in two bank accounts which may be identified as "the MLC cash management account" and "the David Craik and Co Trust Account" ("Mr Craik's Trust Account").
16. Mr David Craik is the father of Mrs Bargwanna. He conducted at Chatswood a practice as a chartered accountant under the style "David Craik & Co". Mr Craik advised the trustees concerning the affairs of the Trust, performed administrative functions in that regard, and was the principal benefactor of the Trust. In 2002 he settled $160,000 upon the Trust. Subsequently, the Trust received $547,198. This included $509,000 generated by the provision of accounting services by Mr Craik pursuant to an arrangement whereby his fees for services were paid by the client not to Mr Craik personally but into Mr Craik's Trust Account. The balance of $38,198 was investment income.
17. The exemption was sought with effect from 1 July 2000, but the Commissioner relies upon various acts of maladministration of the Trust between 2002 and 2007. In particular, over this period Trust moneys were paid into Mr Craik's Trust Account where, in breach of trust, they were mixed with moneys held by him on behalf of others. Moreover, the interest generated by this mixed account was credited not to clients but to a separate bank account. This separate account was described by Mr Craik as his "practice account", which provided him with a means of defraying the costs of maintaining his trust account and its related requirements. The AAT accepted that there was a "standard arrangement" with clients that this interest was foregone by them. The evidence did not specify the amount of interest generated by the funds in Mr Craik's Trust Account to which the Trust was entitled but which was foregone in this way. However, as the Commissioner submits, it cannot have been insubstantial.
18. Further, in March 2004, the respondents in their personal capacities obtained a housing loan from a bank. As partial consideration for that advance, the sum of $210,000, which at the time represented almost half of the net assets of the Trust, was transferred by the respondents into a non-interest bearing account with the bank which was maintained by the respondents in their personal capacity; by this means the interest on the housing loan was reduced. The respondents made payments into this account from other sources, but, overall, the sums withdrawn from the account exceeded the total of those other payments, the excess representing assets of the Trust. Late in the piece, in June 2007, Mr Craik credited to the Trust ledger account some $40,954, which he regarded as representing a "shortfall" in the assets of the Trust. In September 2007 he paid a further $6,706.22 into the Trust bank account as "compensation".
19. The AAT held that these activities of Mr Craik manifested "the basic and dominant" purpose of pursuing those of the Trust and that the administration of the Trust "in a real sense" was conducted for those purposes. The AAT found that there was no evidence that the respondents, as trustees of the Trust, authorised, condoned, suspected or even contemplated "the kinds of accounting irregularities the evidence revealed", albeit "they typically acted on the accountant's advice and recommendations". Further, the AAT held that within the meaning of s 50-60, there would be an application for the purposes for which the Trust was established if the Trust was administered "substantially in accordance with its constituent terms". This, as the Commissioner correctly submits in this Court, was an error of law which coloured the fact finding by the AAT.
20. An "appeal" by the Commissioner under s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) to the Federal Court (Edmonds J)
21. The Full Court remitted the proceedings to the AAT for determination of such further facts as it deemed necessary. In this Court the respondents seek special leave to cross-appeal against that remitter order and to achieve a result that the litigation is at an end by dismissal of the appeal from the AAT. However, if the Commissioner succeeds in this Court, no occasion to entertain the proposed cross-appeal will be presented and the application should be dismissed.
22. In Div 50 of Pt 2-15 of the Act, a distinction is drawn between the establishment by will or instrument of trust of a fund for charitable purposes, and the actual application thereafter of the fund for those purposes. It is with this latter requirement that the appeal is concerned.
23. The relevant effect of s 50-1 and Item 1.5B of s 50-5 (which are found in Sub-div 50-A headed "Various exempt entities") is that the total ordinary income and statutory income of an "exempt entity", being a "fund established in Australia for public charitable purposes by will or instrument of trust", is exempt from income tax. The exemption conferred by these provisions is subject to two special conditions. First, the entity is not exempt from income tax unless it is endorsed by the Commissioner as so exempt under Sub-div 50-B. Section 50-52 so provides. Secondly, there is no exemption "unless the fund is applied for the purposes for which it was established". Section 50-60 so states.
24. When dealing with an application, the Commissioner may request the applicant to give specified information and documents (s 50-120(1)). The Commissioner must endorse an entity as exempt from income tax if it is so entitled and has applied for endorsement (s 50-105). To be entitled it was necessary that the Trust be "covered" by Item 1.5B as described above, and that the two special conditions described above be satisfied (s 50-110).
25. An endorsement has effect from a date specified by the Commissioner. This may be a date preceding that of the application (s 50-130), a matter reflected in the present case in the terms of the decision of the AAT set out above
26. An unsuccessful applicant may object against the refusal in the manner set out in Pt IVC of the Taxation Administration Act 1953 (Cth). This was the path to the AAT in the present case.
27. The Commissioner may revoke, from a day specified by the Commissioner, an endorsement if (a) the entity "is not entitled to be endorsed as exempt from income tax", or (b) the entity has failed to provide information or a document which is relevant to its entitlement to endorsement and which has been requested by the Commissioner (s 50-155).
28. Provisions in revenue law such as s 50-60 of the Act have a lengthy provenance. The effect of Sched C to s 88 of the Income Tax Act 1842 (UK)
"which according to the Rules or Regulations established by ... Deed of Trust, or Will, shall be applicable ... by any Trustee, to charitable Purposes only, and in so far as the same shall be applied to charitable Purposes only".
It will be seen that the distinction was drawn here between the terms of the deed of trust or will and the application thereafter of the fund to charitable purposes. Both conditions had to be satisfied to enliven the exemption from income tax. It has long been established that a provision in a will or settlement for the "application" of moneys to a designated end requires that the moneys be devoted to or employed for that special purpose
29. In Australia, s 11(1)(f) of the Income Tax Assessment Act 1915 (Cth), as amended by s 4 of the Income Tax Assessment Act (No 2) 1916 (Cth), conferred an exemption upon:
"... the income of a fund established by any will or instrument of trust for public charitable purposes if the Commissioner is satisfied that the fund is being applied by the trustees to public charitable purposes".
This formulation of the exemption presented questions of construction of the phrase "is being applied". In
Trustees, Executors and Agency Co Ltd v Acting Federal Commissioner of Taxation
30. A submission along these lines was unsuccessfully put to the AAT by the Commissioner, but was not renewed in this Court. As Dixon and Evatt JJ pointed out in
Attorney-General (NSW) v Perpetual Trustee Co (Ltd)
31. To the submission in Trustees, Executors Isaacs J responded that
"a distinction is made between the 'income' and the 'fund', and 'applied' is attached to 'fund' and not to 'income'. Further, the words are 'the fund is being applied' - not simply 'applied'. I agree that some elasticity must be given to the phrase."
His Honour continued:
"[I]f a fund were established to purchase radium for free curative purposes, and if it were found that (say) £20,000 were required as a minimum, but the fund could accumulate only at the rate of £5000 a year, and the Commissioner were satisfied that each year's income was deposited in a bank for the special purpose of getting together £20,000, and buying the radium, he could well say he was satisfied the fund was 'being applied' to the charitable purpose."
This, Isaacs J indicated, was an example of the "elasticity" which was to be given to the expression in s 11(1)(f), "the fund is being applied". But it may be assumed that in the example given the accumulation of income to provide the fund to purchase the radium was not in breach of the terms of the trust.
32. However, the reasons given by the AAT relied upon the notion of "elasticity" used by Isaacs J in the above case, and in this Court counsel for the respondents referred to its adoption by Owen J at first instance in
Mahoney v Commissioner of Taxation
33. It was a requirement for the exemption provided by s 23(j) of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") that a provident, benefit or superannuation fund established for the benefit of employees "is being applied for the purpose for which it was established". Section 23(j) was considered by Owen J in Mahony and on appeal by Kitto J, Taylor J and Windeyer J
"The statutory requirement that the fund 'is being applied' for the purposes for which it was established was the subject of some discussion during the course of the argument. It does not cause me any great difficulty in this case. If a fund answering the statutory description was not being administered according to the trusts thereof, the statutory requirement of due application would not be met."
Compton v Federal Commissioner of Taxation
The decision of the Full Court
35. The conclusions reached by the Full Court respecting the contravention of s 50-60 resemble those of the AAT. The Full Court approached the case on the footing that "[i]t seems unlikely that the purpose of s 50-60 is to deny a fund its exempt status merely because a trustee is inept or makes a mistake", although deliberate misapplication, in the sense of intending to breach the trust, "may justify adverse inferences as to the transaction in question and other transactions". Their Honours considered that the primary judge had erred in finding non-compliance with s 50-60 without treating the explanations of the trustees as relevant and "without regard to the administration of the Fund as a whole"
36. The Full Court
Federal Commissioner of Taxation v Word Investments Ltd
37. The Commissioner correctly submitted on the present appeal, what was said in Word Investments respecting charitable institutions provided no support for the proposition derived by the Full Court respecting the administration of trust funds. This proposition was
The contentions in this Court
38. The respondents submitted that the exemption provisions of Div 50 of Pt 2-15 of the Act with which this appeal is concerned should be interpreted "generously", that is to say to favour the interests of those claiming exemption. This was said to be so because "[c]harity [is] involved". The phrase is that of Barwick CJ in
Ryland v Federal Commissioner of Taxation
39. The Commissioner points to the use elsewhere in Subdiv 50-A
40. Further, the use of the term "a fund" in s 50-60 emphasises the legislative requirement of a discrete entity in respect of which the exemption is to apply; this intersects with the requirement of trust law referred to earlier in these reasons
41. The Commissioner, again correctly, accepts that not all acts or omissions giving rise to maladministration of a trust for charitable purposes will have the result of denying entitlement to exemption under Div 50 of Pt 2.15 of the Act. For example, the trustees may make an unauthorised investment and so be in breach of trust, but still will hold that investment for trust purposes. Further, the Commissioner accepts that allowance may be made for de minimis misapplications of the Trust Fund. In other cases, if there be maladministration of the fund whereby it loses its distinct identity by admixture with other funds, or whereby benefits are derived personally by the trustees or a third party, there is an intersection between the concept of breach of trust and the statutory criterion of application for charitable trust purposes. Where there is misapplication of this nature, it is no answer that upon a proceeding under the Charitable Trusts Act against the trustees for breach of trust, the trustees may have been able to obtain absolution under s 85 of the Trustee Act as having acted honestly and reasonably, and as trustees who ought fairly to be excused.
42. These submissions should be accepted.
43. The relevant provisions of the Act direct attention to the terms of the instrument of trust by which a fund is established in Australia for public charitable purposes. It would appear that too little attention to the terms of the Deed was paid in submissions to the AAT, and to Edmonds J and then to the Full Court. It is by reference to those terms and to the general provisions of the law of trusts that it will be determined whether in a period under consideration by the Commissioner the fund the subject to the charitable trusts of the deed has been duly administered.
44. The terms of s 50-60 of the Act require that this fund be "applied" for those purposes. That term is used in the sense of so administered as to give effect to the trusts established by the relevant instrument. Not all breaches of trust will deny the conclusion that the fund nevertheless has been applied for the relevant "public charitable purposes". But, on the other hand, and contrary to the reasoning of the Full Court, upon which the respondents relied, the term "applied" is not to be understood as if s 50-60 used such an expression as "substantially applied" or "on the whole, applied". The taxpayer seeks to gain a valuable benefit through establishment of exempt status.
45. In the present case, as Edmonds J held, there was misapplication of the funds of the Trust by admixture with other funds in Mr Craik's Trust Account, coupled with the failure of the respondents to obtain interest upon those moneys, together with, by means of the interest off-set account, the reduction in the interest payable by the respondents in their personal capacity upon their home loan. None of these acts of maladministration were referable to the carrying out of the charitable purposes for which the Deed provided.
46. The acts of maladministration of the Trust occurred over the period between 2002 and 2007. The respondents sought exemption in respect of the period beginning 1 July 2000. It was an error for the AAT to substitute a determination that as at 9 September 2005 there was an entitlement to endorsement. The application was correctly refused by the Commissioner. In doing so, it was appropriate to have regard to the whole of the evidence in refusing to grant under s 50-130 any endorsement from a date, 1 July 2000, which preceded the application date of 22 November 2004.
47. The appeal should be allowed and the respondents' application for special leave to cross-appeal should be dismissed. Orders 2, and 3 of the orders of the Full Court made 17 February 2011 should be set aside, and in place thereof the appeal to the Full Court should be dismissed. The costs of the respondents of the appeal to this Court should be paid by the appellant, in accordance with the terms of the grant of special leave.