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Ruling

Subject: liquidator obligations

Questions

1. Will the amounts of Loan Interest recovered by the Liquidator, be assessable income of the company in its own right under section 6-5 of the ITAA 1997?

Answer:

No

2. If the company holds the Interest as trustee will the recovery of the interest be a recovery of trust property, and therefore not assessable to the trustee on recovery?

Answer:

Yes

3. If the interest recovered is assessable income of the company in its own right, will it be entitled to a deduction under section 8-1 of the ITAA 1997 for the legal costs incurred in seeking directions to determine his entitlement to recover such funds?

Answer:

No

4. If the company is entitled to a deduction for legal fee, can the loss be offset against interest income derived from holding the Loan recoveries on interest bearing deposit?

Answer:

Not applicable

This ruling applies for the following period

Year ended 20 June 2000 to year ended 30 June 2012

The scheme commenced on

1 July 1999

Relevant facts and circumstances

The company obtained funds from unknown sources and on lent them to individuals who invested that money in managed investment schemes. The company went into liquidation. The liquidator was given direction by the court to retrieve the funds and interest incurred on the funds. The court directed that the money retrieved be held in trust until it is known who the funds belong to. The courts eventually ruled that the company owned the funds in its own right. Interest was earned on the funds whilst in trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1936 section 95A

Income Tax Assessment Act 1997 paragraph 40-880(1)(g)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

1. Will the amounts of Loan Interest recovered by the Liquidator, be assessable income of the company in its own right under section 6-5 of the ITAA 1997?

The term "trustee" is defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as follows:

Trustee in addition to every person appointed or constituted trustee by act of parties, by order, or declaration of a court, or by operation of law, includes:

(a) An executor or administrator, guardian, committee, receiver, or liquidator; and

(b) every person having or taking upon himself the administration or control of income affected by any express or implied trust, or acting in any fiduciary capacity, or having the possession, control or management of the income of a person under any legal or other disability;

As court appointed Liquidator owing fiduciary obligations to the company and its shareholders, the Liquidator is a trustee for the purposes of the ITAA 1936 and ITAA 1997.

The Liquidator is also considered to be a trustee for the purposes of the ITAA 1936 and ITAA 1997 in relation to the Loan Proceeds.

Division 6 of Part III of the ITAA 1936 provides the principal taxing provisions of income of trusts. The object of Division 6 was identified by Latham CJ in Tindal v. Federal Commissioner of Taxation (1946) 72 CLR 608 at 618; (1946) 8 ATD 152 at 155 as being to:

secure payment of tax upon the whole of the net income of a trust estate, either from a beneficiary or the trustee, whether or not the income is paid over to or on account of the beneficiary.

As the income of the trust is derived for the benefit of the beneficiaries, it is generally the beneficiary who is entitled to that income and will therefore be assessed on their share. In certain circumstances, however, it is more appropriate to assess the trustee of the trust in relation to that income.

The principle trust income assessing provisions are contained in sections 97, 98, 99 and 99A of the ITAA 1936. The provisions apportion liability for the payment of income tax on the "net income" of a trust estate between the trustee of the trust estate and the beneficiaries.

The net income of a trust estate is broadly determined by calculating the total assessable income that the trustee would have if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions.

The apportionment of net income is made by reference to a beneficiary's "present entitlement" to the "income of the trust estate", which is the amount that would be treated as income of the trust estate according to trust law principles (as affected by the terms of the trust deed, if any). Section 96 of the ITAA 1936 emphasises that unless provided in the ITAA, a trustee is not liable, in their capacity as trustee, to pay income tax on the trust law income of a trust estate.

Broadly, these provisions operate to assess the net income of the trust estate as follows:

· where a beneficiary is presently entitled to a share of the income of the trust estate and not under a legal disability section 97 of the ITAA 1936 applies to assess the beneficiary

· where a beneficiary is presently entitled to a share of the income of the trust estate but under a legal disability section 98 of the ITAA 1936 applies to assess the trustee on the beneficiary's share, and

· where there is an amount of trust income to which no beneficiary is presently entitled section 99 or section 99A of the ITAA 1936 applies to assess the trustee on this amount.

In summary, if the trust estate is a resident trust estate, then a tax liability is only imposed on the trustee of a trust estate for a portion of the net income of that trust estate in the following circumstances:

· Where a beneficiary is under a legal disability and is presently entitled to a share of the income of the trust estate.

· Where a natural person is deemed to be presently entitled to a share of the income of the trust estate under section 95A (2) of the ITAA 1936 in certain circumstances.

· Where a beneficiary who is a non-resident at the end of the year of income is presently entitled to a share of the income of the trust estate in certain circumstances.

· Where no beneficiary is presently entitled to a share of the income of the trust estate.

In this instance paragraphs (g), (h), (i) and (j) do not apply, therefore if the Truste is considered to be presently entitled to the Loan Interest, then the Liquidator cannot be liable for tax as trustee.

The phrase "presently entitled" was discussed in Harmer v FCT (1991) 173 CLR 264, at 271 as follows:

The parties are agreed that the cases establish that a beneficiary is "presently entitled" to a share of the income of a trust estate if, but only if: (a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

Subsequent cases such as Dwight v FCT (1992) 107 ALR 407, at 421 have suggested that a present legal right to demand and receive payment of the income may not be necessary in all circumstances.

Subsection 95A (2) of the ITAA 1936 deems a beneficiary to be presently entitled to income of a trust estate in circumstances where the beneficiary has a vested and indefeasible interest in that income. Therefore, it is not necessary to decide whether the requirement that the receivers apply for further orders before distributing amounts held in the receivership account prevented the Investor Partners from having such a present legal right.

The phrase "vested and indefeasible" was explained as follows in Dwight v FCT (1992) 107 ALR 407, at 422 per Hill J:

The words "vested and "indefeasible" in the context of trust law are technical legal words of limitation, which have a well understood meaning to property conveyancers. Estates may be vested in interest or vested in possession, the difference being between a present fixed right of future enjoyment where the estate is said to be vested in interest and a present right or present enjoyment of the right, where the estate is said to be vested in possession: Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with an interest in remainder, subject to a pre-existing life interest, has an interest which is vested in interest, but being a future interest is not yet vested in possession. That person's interest will vest in possession on the death of the life tenant. In the present context the word "vested" is used in contradistinction to contingent.

An interest is said to be defeasible where it can be brought to an end and indefeasible where it can not

A procedural condition or a lien or charge over funds will not prevent an interest being vested and indefeasible as per Dwight v FCT (1992) 107 ALR 407 (Dwight's case). Further, the fact that funds, subject to a pre-existing trust, are paid into a court ordered account does not displace an otherwise vested and indefeasible interest, although it may also give rise to an interest in favour of a claimant to the funds as per Dwight's case. However, in Harmer v FCT (1991) 173 CLR 264 it was concluded that a beneficiary will not have a vested and indefeasible interest if ownership of that interest in the trust fund depends on an event (such as a decision by a court).

These current circumstances can be distinguished from Dwight's case in that the distribution of the funds by the Liquidator was not simply subject to the authorisation of the court (Dwight's case) but rather any interest at all was contingent upon the court's decision. The challenge to the company's claim on the funds went beyond a mere procedural condition or lien.

2 If the company holds the Interest as trustee will the recovery of the interest be a recovery of trust property, and therefore not assessable to the trustee on recovery?

As such, the interest that was recovered and paid into the trust is not assessable income of the trust estate, but merely property of the newly created trust estate.

3 If the interest recovered is assessable income of the company in its own right, will it be entitled to a deduction under section 8-1 of the ITAA 1997 for the legal costs incurred in seeking directions to determine their entitlement to recover such funds?

Expenditure in relation to the winding up of a company or partnership is capital in nature, and as such, no deduction is allowable under section 8-1 of the ITAA 1997.

4. If the company is entitled to a deduction for legal fee, can the loss be offset against interest income derived from holding the Loan recoveries on interest bearing deposit?

Not applicable as the legal fees are not deductible under section 8-1 of the ITAA 1997.

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