BARGWANNA & ANOR (AS TRUSTEE OF THE KALOS METRON CHARITABLE TRUST) v FC of T

Judges:
Dowsett J
Kenny J
Middleton J

Court:
Full Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2010] FCAFC 126

Judgment date: 8 October 2010

Dowsett, Kenny and Middleton JJ

Legislation

1. Pursuant to s 50-1 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act) the ordinary and statutory income of certain charitable and other entities is exempt from income tax. Some of the exempt entities are set out in s 50-5 as follows:

Item Exempt entity Special conditions
1.1 charitable institution see sections 50-50 and 50-52
1.2 religious institution see section 50-50
1.3 scientific institution see section 50-55
1.4 public educational institution see section 50-55
1.5 fund established for public charitable purposes by will before 1 July 1997 see sections 50-52 and 50-57
1.5A trust covered by paragraph 50-80(1)(c) see sections 50-52 and 50-60
1.5B fund established in Australia for public charitable purposes by will or instrument of trust (and not covered by item 1.5 or 1.5A) see sections 50-52 and 50-60
1.6 fund established to enable scientific research to be conducted by or in conjunction with a public university or public hospital see section 50-65
1.7 society, association or club established for the encouragement of science see section 50-70

2. We are presently concerned with item 1.5B. The exemption applies subject to the conditions in the right hand column of the table. For item 1.5B, the conditions are contained in ss 50-52 and 50-60. Section 50-52 provides:

50-52(1) An entity covered by item … 1.5B … is not exempt from income tax unless the entity is endorsed as exempt from income tax under Subdivision 50-B.
50.52(2) (Repealed …)
50.52(3) This section has effect despite all the other sections of this Subdivision.

3. The section first took effect in this form in the 2005-2006 income year. In earlier years, it was in a slightly different form. The amendments are not presently relevant.

4. Section 50-60 provides:

"A fund covered by item … 1.5B is not exempt from income tax unless the fund is applied for the purposes for which it was established and:

  • (a) incurs, and has at all times since 1 July 1997 incurred, its expenditure principally in Australia and pursues, and has at all times since 1 July 1997 pursued, its charitable purposes solely in Australia; or
  • (b) is a fund which is referred to in a table in subdivision 30-B or item 2 of the table in section 30-15; or
  • (c) distributes solely, and has at all times since 1 July 1997 distributed solely, to a charitable fund, foundation or institution which, to the best of the trustee's knowledge, is located in Australia and incurs its expenditure principally in Australia and pursues its charitable purposes solely in Australia; or
  • (d) distributes solely, and has at all times since 1 July 1997 distributed solely, to a charitable fund, foundation or institution that, to the best of the trustee's knowledge, meets the description and requirements in item 1 or 2 of the table in section 30-15."

5. Again, the section in this form first applied in the 2005-2006 income year, but the amendments are irrelevant.

6. Subdivision 50-B sets out the procedure for endorsing charitable entities as exempt from income tax. Section 50-105 provides:

"The Commissioner must endorse an entity as exempt from income tax if the entity:

  • (a) is entitled to be endorsed as exempt from income tax; and
  • (b) has applied for endorsement."

7. Section 50-110 provides:

"General rule

  • (1) An entity is entitled to be endorsed as exempt from income tax if the entity meets all the relevant requirements of this section.
Which entities are entitled to be endorsed?
  • (2) To be entitled, the entity must be an entity covered by item 1.1, 1.5, 1.5A or 1.5B of the table in section 50-5.
Requirement for ABN
  • (3) To be entitled, the entity must have an ABN.
  • (4) …
Requirement to meet special conditions:
  • (5) To be entitled, either:
    • (a) the entity must meet the relevant conditions referred to in the column headed 'Special Conditions' …; or
    • (b) both the following conditions must be met:
      • (i) the entity must not have carried on any activities as a charitable institution (if the entity is covered by item 1.1 of the table in section 50-5) or for public charitable purposes (if the entity is covered by item … 1.5B of that table);
      • (ii) there must be reasonable grounds for believing that the entity will meet the relevant conditions referred to in the column headed 'Special conditions' of … the table in section 50-5 …; or
    • (c) …
  • (6) To avoid doubt, the condition set out in section 50-52 (requiring the entity to be endorsed under this subdivision) is not a relevant condition for the purposes of section 5.

An 'ABN' is an Australian Business Number."

8. Section 50-115 provides for applications for endorsement. Section 50-120 deals with the way in which the respondent (the "Commissioner") is to deal with such applications. Section 50-130 provides that any endorsement is to have effect from a date specified by the Commissioner. That date may be before the date of endorsement and before the applicant acquired an ABN. Section 50-135 provides for review of any refusal by the Commissioner to grant endorsement. Section 50-140 authorizes the Commissioner to request an endorsed entity to provide information relevant to its entitlement. The entity must comply with such a request. Pursuant to s 50-145 an endorsed entity must advise the Commissioner if it ceases to be entitled to endorsement. Section 50-155 deals with revocation of endorsement. Section 50-160 provides for review of a decision for revocation.

History

9. The appellants (the "Trustees") are husband and wife. They are the trustees of the Kalos Metron Charitable Trust (the "Fund"). Ms Bargwanna was also the settlor. The Fund was established on 14 October 1997. Clause 3 provides:

The Trustees shall stand possessed of the Trust Fund and the income thereof IN TRUST for such public charitable purposes as the Trustees shall from time to time determine.

10. The appeal book contains an application for endorsement dated 14 July 2003. It seems, however, that it was submitted to the Commissioner under cover of a letter dated 22 November 2004. On 13 January 2005 the Commissioner advised the Trustees that the application had been refused. On 2 March 2005 Mr David Craik ("Mr Craik") wrote to the Commissioner seeking review of that decision. Mr Craik is Ms Bargwanna's father. He has also been the principal benefactor of the Fund, performed administrative functions concerning it and advised the Trustees concerning its affairs. On 4 April 2005 the Commissioner wrote to Mr Craik confirming the decision to refuse endorsement. On 16 May 2005 Mr Craik lodged a notice of objection. On 9 September 2005 the Commissioner advised that the objection had been disallowed. On 1 November 2005 Mr Craik applied to the Administrative Appeals Tribunal (the "Tribunal") for review of the decision. The matter was heard by the Tribunal in October and November 2007. On 7 April 2008 the Tribunal set aside the Commissioner's decision, substituting for it a determination that the Fund was entitled to be endorsed as exempt from income tax as at 9 September 2005 and with effect from 1 July 2000.

11. The Commissioner then appealed to this Court pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) (the "AAT Act"). On 12 June 2009 Edmonds J upheld the appeal upon the ground that the Tribunal had "erred in the test it applied in determining whether the Fund was applied for the purposes for which it was established". His Honour set aside the Tribunal's decision. The Trustees now appeal against his Honour's orders. For reasons which will become apparent the proceedings at first instance must be considered in light of the way in which the Commissioner has dealt with the application for endorsement since it was first made. Thus it will be necessary to canvass, in some detail, the various decisions. The Commissioner has not always adopted the language of the table in s 50-5. In particular, he has sometimes used the word "trust" rather than the word "fund" which is used in item 1.5B. Further, the words "trust" or "fund" have sometimes been used where the words "trustees" may have been more appropriate. This irregularity in terminology may not matter.

The original decision

12. In the original decision notified on 13 January 2005 the Commissioner indicated that in order that the Fund secure endorsement, it must:

13. The Commissioner accepted that the Fund had an ABN number. As to s 50-5, the Commissioner considered that pursuant to certain guidelines, the Fund would satisfy this condition if the following conditions were met:

14. The Commissioner was satisfied as to the second and third conditions. As to the first condition, he considered that:

As the trust deed does not contain acceptable clauses which prevent the distribution of profits or assets for non charitable purposes, we consider this condition being not satisfied.

15. Concerning the fourth condition (d) he observed:

Regarding condition (d), the trust will satisfy this condition if it uses its income and property only for charitable purposes.

The financial statements provided for the years 2002 and 2003 indicate that all the funds available have been accumulated and not applied for any purpose. Accordingly, we consider that this requirement is not satisfied.

16. As to s 50-52 and 50-60 the Commissioner considered that the Fund had to satisfy at least one of the following tests:

17. The Commissioner considered that the Trust did not satisfy the second test, and that there was insufficient information available to determine whether it satisfied any of the other tests. However he concluded that as the Fund had not satisfied the requirements of s 50-5, it was not necessary that he further address the question of its compliance with s 50-52 and 50-60.

The decision on review

18. In his reasons for refusing to review the decision (dated 4 April 2005) the Commissioner observed that he had received further information from the "applicant". He now accepted that the fund met the non-profit requirement (s 50-5) and the "in Australia" requirement (presumably a reference to s 50-60(a) and 50-60(c)). However he observed:

"Endorsement as an income tax exempt charity is reviewable annually. At the end of each year of income, an entity is required to self-assess its charitable purposes and activities so as to determine whether it are [sic] entitled to continue its endorsement as an income tax exempt charity. It will only be exempt from income tax if it falls within the income tax exempt category in the tables of division 50-A of the [1997 Act] and meets the special conditions for it.

To be endorsed as an income tax exempt charity, the distributions for charitable purposes must meet the special conditions under s 50-60 of [the 1997 Act] in which it states that:

'A fund covered by item 1.5A or 1.5B is not exempt from income tax unless the fund is applied for the purposes for which it was established.'"

19. The Commissioner then noted that the Fund had been established for public charitable purposes and referred to para 21 of Taxation Ruling TR 2000/11 which states:

"For a charitable fund to be entitled to endorsement it must be applied for the purposes for which it was established: sections 50-57 and 50-60. Investment in a manner to benefit private entities or excessive accumulation of investment income are not the applying of a fund for its purposes. We regard distribution of a substantial part of the income (but not necessarily capital gains) as essential. However, we accept that a charitable fund may use some of its income to acquire assets which, in future, will produce more income for charitable purposes, and may accumulate some of its income for later distribution. Distributions for non-charitable purposes also indicate that a fund is not being applied for its purposes."

20. The Commissioner continued:

"In 2002, the Trust had income of $2,306 and no expenditure. In 2003, income was $110,371, with no distribution to charities. The applicant has argued that prior year distribution should be taken into account. As mentioned above, endorsement as an income tax exempt charity is reviewable annually. It is possible that in prior years, the Trust was eligible for endorsement. Information relating to the income and expenditure in prior years will need to be examined to determine that.

The applicant also states that $10000 was paid to the 'Baptist Union of NSW Kids Ministry', but that it was not physically paid out in the 2003 year, and paid out in 2004 'together with other distributions paid in that year'.

Against an income in excess of $100000, a distribution to charity of $10000 does not represent distribution of a substantial part of the income.

As discussed in Taxation Ruling TR 2000/11, accumulation is acceptable. However, a substantial part of the income is still required to be distributed. The applicant states that there is a plan to accumulate to reach a capital base of $1 million dollars, within the next five years. It would appear that a plan of this nature is inconsistent with the requirement to distribute a substantial part of the income.

A charitable fund should mainly manage trust property, or hold trust property to make distributions to other entities or people. This Trust earns 'Consultancy fees' of $100000 in 2003. This income is payment for professional services provided by the Chartered Accountant, Mr David Craik.

The Trusts assets include "Other - $302956", and there is a borrowing of $120,943. Mr Craik advised that the assets are secured loans to private companies.

These activities are inconsistent with a 'charitable fund', which should mainly manage trust property, or hold trust property to make distributions to other entities or people. The activities are in the nature of a commercial enterprise.

For these reasons it is not accepted that the fund is a charitable fund."

21. Clearly enough, there was a significant difference between the original reasons for refusing endorsement and the reasons for maintaining the decision on review. Undoubtedly, the change in position was partly caused by the "further information", which must have answered most of the Commissioner's concerns, prompting the need to examine other aspects of the application.

The notice of objection

22. As we have observed, Mr Craik then lodged a notice of objection, the grounds of which were that:

The objection decision

23. In his reasons for disallowing the objection the Commissioner said:

"Section 50-110 of the [1997 Act] states that the [Fund] (a charitable trust) is entitled to be endorsed as a Tax Concession Charity if the following conditions are satisfied:

  • (1) It has an ABN;
  • (2) It satisfies the requirements of item 1.5B of section 50-5 of the [1997 Act]; and
  • (3) It fulfils the special conditions contained in sections 50-52 and 50-60 of the [1997 Act].

The [Fund] has satisfied condition (1).

  • (2) will be satisfied if all of the following conditions are met:
    • (a) The [Fund] is a non-profit entity
    • (b) The taxpayer's governing document and the [Fund's] activities demonstrate that the [Fund] is carried on for the public benefit or for the relief of poverty
    • (c) The [Fund] has a sole purpose which is charitable in nature.
  • (a) this condition is satisfied.

Regarding (b), as the trust deed indicates that the [Fund is] utilised for 'public' charitable purposes, this condition is deemed to be satisfied.

Regarding (c), the [Fund's] sole purpose must be charitable, any purpose [which] when viewed in isolation, would not be charitable, must be incidental or ancillary to the charitable purpose. Charitable purposes are those which the law regards as charitable. The Courts have decided that a purpose is charitable if it is within the spirit and intendment of the Statute of Charitable Uses 1601. In
Income Tax Special Commissioners v Pemsel (1891) AC 531, the relief of poverty and sickness, the advancement of education, religion and other purposes beneficial to the community (sic).

The consultancy fees received by the trust in the 2003-2005 years were the result of accountancy, corporate secretarial services and general financial consultancy advice rendered to an Australian resident company, albeit at arms length. This arrangement is pursuant to a contract to provide those services between the Trustees and that company. These services were subcontracted to David Craik & Co. The practice provided the services on a pro bono basis to the [Fund].

Taxation Ruling TR 2005/D6 states at paragraphs 177-179:

'For a fund to be a charitable fund it must be established for public charitable purposes. The charitable purposes must be the only purposes for which it is established. If a fund can be applied for purposes that are not charitable it is not a charitable fund. Any objects which, if viewed in isolation, would not be charitable, must be merely incidental to the charitable purposes.

Various State Acts operate to save trusts that would otherwise be invalid as having both charitable and non-charitable purposes. A trust to which the State legislation applies is construed and given effect as if no trust funds could be applied for a non-charitable purpose. The application of these provisions causes a trust to be exclusively charitable for taxation purposes, so long as the valid purposes fall within the technical legal meaning of charitable.

Because the purpose of a charitable fund is found by reference to the terms of its constitutive documents and any relevant legislation, activities carried on by the trustees subsequent to establishment are not relevant. In this respect, charitable funds are different to charitable institutions, for which the activities of the institution can be relevant in determining its purposes (see paragraphs 162 to 171). Nonetheless, the activities of a charitable fund are relevant to income tax exemption because the fund must be applied for the purposes for which it was established. Accordingly, if a fund was not being applied for its charitable purposes (for example it was being used to provide private benefits to the trustee's family), it would continue to be a charitable fund but it would fail to qualify for income tax exemption.'

TR 2005/D6 also states at paragraph 126 which is concerned with commercial arrangements that:

'The motives of the promoters are not sufficient to convert a commercial purpose into a charitable purpose. Nor will the use of the profits from a commercial enterprise change it into the carrying out of a charitable purpose. It is necessary to have regard to and weigh the various features and attributes in deciding whether the purpose is charitable.'

It is considered that the commercial nature of the services conducted by the [Fund] are a business concern in their own right. As such these commercial arrangements would prohibit the [Fund] to be [sic] considered to be a charitable fund. As a result, condition (2) above has not been fully satisfied and it is considered that for these reasons the objection cannot be allowed.

As condition (2) has not been satisfied, it is considered that condition (3) need not be considered."

24. Clearly, the Commissioner's reasons for rejecting the application had changed again, now focussing solely upon the source of funds as being sufficient to deny tax-exempt status.

Proceedings in the tribunal

25. In his amended statement of facts and contentions in the Tribunal the Commissioner identified the following issues and contentions:

"ISSUES

  • 18. Whether the [Fund] is an entity which is entitled, for the purposes of s 50 - 110 of the Act, to be endorsed as exempt from income tax; and in particular:
    • a) whether it is a fund established in Australia for public charitable purposes by will or instrument of trust and so satisfies item 1.5B of s 50-5 of the Act.
    • (b) whether the special conditions in s 50-60 of the Act are met, being relevantly:
      • (i.) that the Trust Fund … is applied for the purposes for which it was established;
      • (ii.) that the Trust Fund has, at all times since its inception, incurred its expenditure principally in Australia and pursued its charitable purposes solely in Australia;
      • (iii.) that the [Fund] has at all times since 1 July 1997 distributed solely to a charitable fund which, to the best of the [Trustees'] knowledge, is located in Australia and incurs its expenditure principally in Australia and pursues its charitable purposes solely in Australia.
  • 19. Whether the entitlement of the [Fund] to be endorsed as exempt from income tax under s 50-10 of the Act after 9 September 2005 is a matter that is properly before the Tribunal.

CONTENTIONS

  • 20. The [Fund] is not entitled to be endorsed by the [Commissioner] as exempt from income tax pursuant to s 50-105.
  • 21. The [Fund] was not established for public charitable purposes and is not a trust of the kind described in item 1.5B of s 50-5 of the Act.
  • 22. If the [Fund] was established for public charitable purposes, the special conditions contained in section 50-60 of the [1997 Act] are not satisfied … because:
    • (a) the Trust Fund is not, and has not been, applied for the purposes for which it was established;
    • (b) the [Fund] has not, at all times since its inception, incurred its expenditure principally in Australia and pursued its charitable purposes solely in Australia;
    • (c) the [Fund] has made distributions to persons and/or entitles not being a charitable fund, foundation or institution which is located in Australia and that pursues its charitable purposes solely in Australia.
  • 23. The entitlement of the [Fund] to be endorsed as exempt from income tax under s 50-105 of the Act after 9 September 2005 is not a matter that is properly before the Tribunal.
  • 24. The respondent contends that the [Fund] has failed to prove that the objection decision should not have been made or should have been made differently."

26. In their further amended statement of facts and contentions, the Trustees asserted that:

27. We will consider the decision in Word at a later stage. The above reference is to the decision in the Full Court of this Court. The High Court upheld that decision. See
Commissioner of Taxation of the Commonwealth of Australia v Word Investments Ltd (2008) 236 CLR 204.

28. As we have observed, the Tribunal set aside the Commissioner's decision, ordering that the Fund be endorsed as exempt from income tax with effect from 1 July 2000. The Tribunal gave lengthy and details reasons for so doing. It seems that at least initially, the Commissioner had adhered to the contention that the Fund was not a trust for public charitable purposes, relying upon the source of funds and the way in which moneys had been applied. However that position was abandoned in the course of the hearing. The Tribunal concluded that the Commissioner had correctly accepted that the Fund was "'for public charitable purposes' established in Australia by a trust instrument". The Tribunal then observed that:

"[The Fund] bore the ultimate onus of satisfying the Tribunal that the objection decision 'should not have been made or should have been made differently'. … But the fact that the Commissioner ultimately did not seek to support the actual basis for the disallowance decision resulted in attention being directed to the Commissioner's other contentions as to why [the Fund] had not made out its exemption entitlement."

29. The Commissioner continued to assert that the Fund had not pursued its charitable purposes solely in Australia, it having distributed funds to an Australian charity operating in Bangladesh. The Commissioner also asserted that the Fund "was not applied for the purposes for which it was established". As to the latter allegation the Commissioner contended that:

30. The Tribunal addressed these matters individually. As to the activities in Bangladesh, the Tribunal concluded that the provision of funds to an Australian organization conducting programmes for orphaned and under-privileged children in Bangladesh was within s 50-60(a). The Tribunal then considered the policy of accumulations which had been adopted. It concluded at para 53 that:

"In my opinion the trustees' policy of accumulating part of [the Fund's] reported income, for the purpose of reaching a fund total of $1 million before adopting a practice of implementing full distribution of annual income, does apply the fund for the purpose for which it was established.

31. The Commissioner asserted that funds had been applied to two uncommercial loans to D Pty Ltd and R Pty Ltd. As to the first loan, the Tribunal concluded at para 110 that the transaction involved an application of funds for the purpose for which the Fund was established. As to the second loan, the Tribunal concluded at para 115:

"In these circumstances, whilst objective assessment of the … advance suggests that its commerciality was questionable and its favourable resolution perhaps fortuitous, the evidence does not warrant rejection of the accountant's evidence that he regarded it a proper investment in conformity with the trust purposes. The circumstances of the loan do not evidence that the [Fund] was applied other than for the purposes for which it was established."

32. At para 117 the Tribunal concluded that certain distributions to individuals associated with charitable organizations operating in Bangladesh were for the established purpose of the fund.

33. None of these matters was addressed in the proceedings before Edmonds J, nor were they addressed in the appeal. The matters relevant before us are those dealt with by the Tribunal under the headings "The trust funds being held in a non interest bearing account", "The occurrence of 'debit balances' within the accountant's trust bank account ledgers", "The use of the trust funds in an 'interest offset' transaction concerning the trustees" and "Over payment to the trustees". Below, we set out the Tribunal's approach to, and conclusions concerning these matters.

The trust funds being held in a non-interest bearing account

34. At para 56, 57 and 58, the Tribunal said:

35. The Tribunal concluded that until the end of the 2005 financial year the amounts of foregone interest "must have been very small". In subsequent years the amount of cash increased significantly so that in those three years approximately 10%, 20% and 25% respectively of the Fund's total moneys were in the account. At para 64 the Tribunal concluded:

I do not accept the Commissioner's contention that the fact the trustees allowed the accountant to administer [the Fund's] accounting records through his practice trust bank account relevantly informs an assessment of the purpose for which [the Fund was] applied. Neither do I consider that the level of [the Fund's] reported "cash on hand and at bank" is significant in characterising the purpose for which [the Fund was] applied. … The trustees' purpose in allowing the accountant to be responsible for maintaining [the Fund's] accounting records was to facilitate the investment and growth of the [Fund]. The irregularities that have occurred in the accountant's management of [the Fund] do demonstrate deficiencies in the extent to which he diligently and properly carried out that purpose. But the basic, and dominant purpose of his administration remained those for which [the Fund] was established. … Earlier in these reasons I expressed the view that the characterisation required by the "is applied" criterion is essentially directed towards an assessment whether the [Fund] was "in a real sense" being applied for the required purpose …. I also said that the assessment required by the criterion is not determined by finding particular instances of deficiency, by the trustees or those acting on their behalf, in the diligent pursuit of the [Fund's] best interests. In my opinion, the evidence of the totality of [the funds], and the general manner of their administration, does show that [the Fund] was "in a real sense" applied for the purposes for which it was established.

The occurrence of "debit balances" within the accountant's trust bank account ledgers

36. At para 65-67 the Tribunal said:

37. The Tribunal then considered the amounts of Fund moneys in the account and the duration of any debit balances in the client accounts. At paras 91 and 92, the Tribunal said:

38. At para 94 the Tribunal said:

"According to the Commissioner the question of application is determined by an objective examination of the way the funds were in fact used. In the circumstances this requires the conclusion that [the Fund was] applied, at least to some extent, for the benefit of short term loans to the accountant's other clients. Furthermore the trust ledger account irregularities cannot be quarantined as the accountant's idiosyncratic defaults that do not inform an assessment of how [the Fund] was applied. The Commissioner says that the husband and wife delegated the whole of [the Fund's] accounting management and administration to the accountant. Consequently his conduct is relevantly attributable to the trustees, in relation to the 'is applied' criterion in [the 1997 Act] s 50-60."

39. The Tribunal noted that Mr Craik had disavowed any general authority to conduct transactions on behalf of the Trustees or to invest or distribute the Fund moneys without express instructions from them. The Trustees considered that they personally made all investment and distribution decisions, although they acted on his advice and recommendations. The Tribunal concluded at para 95 that:

"There was simply no evidence that they authorised, condoned, suspected or even contemplated the kinds of accounting irregularities the evidence revealed. In my opinion the accountant himself bears the entire personal culpability for them. His conduct in endeavouring to compensate the [Fund] acknowledges that culpability, and his consequential liability to the trustees."

40. At para 96 the Tribunal observed that:

"(T)he question of the application of the [Fund] should properly be determined by the conduct of the trustees themselves. They are not implicated in the accountant's apparent failure to apply the funds in his trust bank account exclusively for the benefit of each of the persons entitled to them. Consequently that failure does not contradict the inference, otherwise required by the general evidence about the conduct of [the Fund's] affairs, that the [Fund] was applied for the purposes for which it was established."

41. The Tribunal also observed that:

"In these circumstances I do not consider that the occurrence of those debit balances, or the shortfalls revealed in the spreadsheet exercise, evidence that [the Fund] was applied for purposes other than those for which it was established. Given the general evidence about the nature, purpose and extent of [the Fund's] investment and administration, including the accountant's acknowledgement of his obligation to compensate [the Fund] for his irregular administration, I consider the proper conclusion is that [the Fund] was applied for the purposes of its establishment."

The use of the trust funds in an "interest offset" transaction concerning the trustees

42. At paras 97-101 the Tribunal said:

43. At paras 104 and 105, the Tribunal concluded:

Overpayment to the trustees

44. At para 106 the Tribunal said:

45. Having dealt with each of these matters individually, the Tribunal then considered "the jurisdictional issues". This involved the Tribunal's capacity to grant retrospective endorsement. That matter is not presently relevant. The Tribunal also considered "the effective date of endorsement", deciding that the endorsement should take effect from the date sought by the Trustees, namely 1 July 2000. The Tribunal then ordered that the Commissioner's decision be set aside and that the Fund be endorsed as exempt from income tax with effect from 1 July 2000.

An overall assessment

46. The Tribunal carefully analysed the evidence, going far beyond the above summary, but it did so under the various headings to which we have referred. At numerous points it observed that the conduct with which it was then particularly concerned was to be considered having regard to other evidence in the case. Absent from the reasons is an overall assessment of the evidence to determine whether or not the cumulative effect is that the Fund has not been applied for the prescribed purpose. We will return to this matter at a later stage.

The notice of appeal before the primary judge

47. Pursuant to s 44 of the AAT Act a party to a proceeding before the Tribunal may appeal to the Federal Court of Australia, on a question of law. The "questions of law" identified in the initial notice of appeal are as follows:

48. The Commissioner then identifies eight "grounds", numbered 5 to 12 as follows:

49. Before Edmonds J, grounds 5, 6 and 12 were abandoned. At [9] his Honour observed, concerning the grounds of appeal:

"Significantly, there was no ground that directly raised what seemed to be, if the Commissioner's written and oral submissions can be taken as a guide, at the forefront of the Commissioner's challenge to the Tribunal's decision: the criteria or test applied by the Tribunal in determining whether the primary facts satisfy the conclusion required to be drawn for exemption from income tax under s 50-60, namely, that the fund 'is applied' for the purposes for which it was established, although arguable it underlies all remaining live grounds. The Commissioner submitted that whether or not one can draw that conclusion is a matter of objective fact untrammelled by the subjective intentions of the trustees or others having the carriage of the administration of the Fund. He challenged the approach of the Tribunal which is perhaps best summarised at [50] and [51] of its reasons:

  • 50 … But I do consider that at least in its application to conduct involving the management and administration of the fund the 'is applied' criterion is directed towards an overall characterisation of the conduct of the fund and does not require satisfaction about the appropriateness of every action of the trustees and those administering the trust on their behalf. Where the conduct under consideration is of this kind (that is the administration, as distinct from the distribution, of the fund) an examination of the purpose for which it has been undertaken is necessarily of a general kind, and must properly take into account the totality of the fund's activities. This does not give priority to the trustee's merely subjective intentions, motives and beliefs but, contrary to the Commissioner's contention, neither are they wholly irrelevant. The permissible breadth of relevant considerations recognises that ultimate purposes may be pursued in different ways and with different degrees of immediacy. It also recognises that particular shortcomings in the administration of a fund, including some kinds of failure to comply with the terms of the trust, will not necessarily require, and may not even justify, a conclusion that the fund is applied for purposes other than those for which it was established.
  • 51 Returning to what I have described as the competing generalities, it is appropriate to apply the 'is applied' criterion by enquiring whether the fund is administered substantially in accordance with its constituent terms. Substantial compliance will ordinarily provide some evidence that the fund is being held for its intended purpose and, at least in the absence of contrary indications, justify an inference that the fund 'is applied' for its established purposes. The strength of the inference in any particular case will depend on the degree of compliance and the nature, extent and reason for any non-compliance. This approach to the 'is applied' criterion is essentially that adopted by Oliver J in
    IRC v Helen Slater Charitable Trust Ltd [1981] Ch 79; [1982] Ch 49. It is also accords with the view that where a transaction or conduct is within the powers of trustees or directors, it will not result in a relevant misapplication of property under their control unless the court is satisfied that it has an intended operation 'other than ancillary to the conferring of benefits upon the objects of the trust' or the purposes of the company:
    Bray v The Commissioner of Taxation 78 ATC 4179; (1977-1978) 140 CLR 560 at 577 per Jacobs J; see also
    Ngurli Ltd v McCann (1953) 90 CLR 425 at 440; and the circumstances tend to indicate a clear purpose of achieving some other extraneous benefit: see
    Case X60 (1990) ATC 438 at 446. The difficulty of arriving at such a conclusion, and the extent to which its appropriateness is likely to be influenced by impressionistic assessment of the overall good faith of the trustee, is illustrated by comparison of the comments made by Taylor J in
    Driclad Pty Ltd v Federal Commissioner of Taxation (1966-1968) 121 CLR 45 at 61 with the same judge's comments in the context of the different circumstances in
    Compton v The Commissioner of Taxation (1965) 116 CLR 233 at 239. The difficulty is not avoided, even where the legislative criterion requires exclusivity of purpose, merely by demonstrating that parts of the fund has been invested in breach of the terms of the constituent trust:
    Case X60 (1990) ATC 438 at 447. A breach of trust is a relevant, but not necessarily decisive, consideration in determining whether the fund 'is applied' for the required purposes: per Owen J in
    Mahoney v Commissioner of Taxation (1965) 39 ALJR at 64."

50. In argument before Edmonds J the Commissioner focussed upon the following issues:

His honour's reasons

51. His Honour commenced his analysis of the case by reference to authorities concerning the construction of legislation, recognizing that where legislation was enacted for the purpose of encouraging, rewarding or protecting some class of activity, it should be given a liberal, rather than a narrow construction. However his Honour also considered that:

"(I)n the case of a provision which confers an exemption upon a particular kind of body or fund which meets certain requirements, Parliament's purpose is not promoted by construing the provision in a manner favourable to the body or fund referred to in it."

52. His Honour continued:

"Indeed, there is much to be said for the view that the privileged status of exemption from income tax on the income of a fund which aspires to that status demands strict adherence to the requirements that must be met before that status is conferred; in the present case, the requirements of s 50-5, item 1.5B and s 50-60. General or holistic examination or assessments of compliance with, or satisfaction of, those requirements 'directed towards an overall characterisation of the conduct of a fund' ([50] of the Tribunal's reasons) runs the risk of detracting from, rather than promoting, Parliament's purpose."

53. There is potentially a tension between the liberal and stringent approaches identified by his Honour. As in the present case, the particular form of encouragement, reward or protection for a class of activity may be exemption from taxation liability. It is difficult to avoid the conclusion that in exempting the various entities identified in s 50-5 from tax obligations, Parliament intended to encourage the various public purposes identified in that section. However, for present purposes, we need not resolve any such tension.

54. His Honour continued at [29]:

55. At [33] Edmonds J concluded that the conduct concerning the interest offset account was "the misapplication of the Fund's funds to purposes other than purposes for which the Fund was established." His Honour then considered the keeping of funds in Mr Craik's trust account and his dealings with them, "(p)utting to one side the 'irregularities' in his recording of his trust account which made it impossible to ascertain what amount of money was available to answer the Fund's claims …." His Honour concluded that the "failure to pay interest and Mr Craik's application of trust account funds to payment of debit balances recorded in such accounts, even if small as found by the Tribunal '… over the whole four year period was less than $1000 …' and, albeit late in the peace [sic], compensated by Mr Craik, does not, in my view, cure or exculpate the intentional misapplication of the funds, even if Mr Craik did not intend to benefit himself".

56. With respect to the Rocfish loan, Edmonds J considered that there were aspects which "call into question whether it involves an application of the [Fund's] funds for the purposes for which it was established". However his Honour considered that, "(i)f it were the only assailed transaction, I would not be prepared to answer that issue in the negative. In the circumstances of my view in relation to the other assailed transactions in particular the interest-offset transaction, my view of the transaction does not matter." For these reasons his Honour allowed the appeal and set aside the Tribunal's decision, presumably intending that the Commissioner's original decision stand.

The appeal

57. The present grounds of appeal are as follows:

Endorsement and the proper construction of s 50-60

58. The mechanism for achieving the relevant tax exemption is, in one respect, circuitous. Pursuant to s 50-52 an entity is not exempt from income tax unless it is endorsed as exempt pursuant to subdiv B. However, pursuant to s 50-110(5) in order to be entitled to endorsement, a fund must comply with the relevant special conditions identified in the table in s 50-5. One such condition is compliance with s 50-52. It seems that s 50-110(6) was inserted to deal with this problem. For present purposes the relevant question arises out of the introductory words in s 50-60 namely:

A fund covered by item … 1.5B is not exempt from income tax unless the fund is applied for the purposes for which it was established ….

59. In Word, at [70], the majority of the High Court identified the purpose of these words. The table in s 50-5 distinguishes between various types of exempt entities including, in particular, charitable institutions and funds established by will or trust deed for public charitable purposes. The majority in the High Court observed that s 50-60 required that such a fund be applied for the purposes for which it was established, whilst there was no such provision requiring that the assets of a charitable institution be so applied. Their Honours concluded that the reason for this distinction was that:

Whether an entity is a "charitable institution" depends in part on its purposes and in part on its activities so far as they carry out those purposes; if its activities involve ceasing to apply its assets to the purposes for which it was established, it ceases to be a charitable institution. In s 50-50 it was thus not necessary to provide in terms that the assets of a charitable institution be "applied for the purposes for which it was established". On the other hand, s 50-60 applies to … item 1.5B …. The trust covered by s 50-60 and the funds covered by s 50-57, 50-60 and 50-65, continue to have their status as a trust or a fund even if the trustees are acting in breach of trust and not applying the assets to the relevant trust or fund purposes. Hence it was necessary to do in relation to s 50-57, 50-60 and 50-65 what it was not necessary to do in relation to s 50-50, namely make express provision for loss of tax exemption where the trust or fund was not applied for the purpose for which it was established ….

….

60. At [29], Edmonds J advanced two propositions, before citing most of the above extract from Word. They were that:

61. His Honour then observed that:

So much is implicit in what was said in the joint judgment in Word ….

62. Our understanding of their Honours' observations is that:

63. We do not understand the High Court to have said that any breach of trust will necessarily lead to that outcome. The words "acting in breach of trust and not applying the assets to the relevant trust or fund purposes" convey an element of continuity. The expression will not generally be apposite to describe a discrete breach of trust, at least if it involves only part of the relevant assets. The trustee must be mis-applying the fund as a whole. Use of the continuous present tense and reference to the assets of the fund or trust suggest something more than one misapplication of a part thereof. We are inclined to the view that s 50-60 should be similarly understood. It is the fund in question which must be applied for relevant charitable purposes. Misapplication of part of it on one occasion may not necessarily lead to the conclusion that the fund as a whole is being (or has been) misapplied.

Conflicting approaches

64. The Tribunal and Edmonds J took different approaches to the construction of the introductory words of s 50-60. After reference to various cases the Tribunal identified two broad topics which it considered to be relevant in determining whether a fund was being applied for the relevant charitable purpose. At para 47 the Tribunal observed:

"The first generality is that administration of the fund consistently with its constituent provisions ordinarily justifies the conclusion that it is being applied for the required purpose. The second generality is that the 'is applied' criterion requires more than, and is not necessarily satisfied by, compliant administration of the fund in accordance with its constituent provisions. In resolving the competition between these generalities it is appropriate to recognize that the … s 50-60 criterion that a fund 'is applied for the purposes for which it was established' expresses a concept where the qualities of application and purpose are related. Inherent in the idea of 'application' is a relationship between conduct and purpose. Conduct or property is relevantly 'applied' when it is directed towards a particular purpose or use …. What will constitute conduct evidencing the 'application' of property for a particular purpose will necessarily depend on the nature of the purpose and the extent to which the conduct is apt to lead to its direct or indirect achievement."

65. At para 49 the Tribunal continued:

"It is also important to take into account that the conduct potentially involved in the application of a fund is not restricted to distributions of income or capital - …. It includes not only episodic events of that kind but also the more mundane and recurrent conduct involved in the ordinary administration of the fund's affairs. This suggests that the characterisation required by the 'is applied' criterion is not directed towards minute examination of the conduct of the fund at any or every particular time. What it is directed to is an inquiry as to whether the fund is 'in a real sense' … being applied for the purposes for which it was established."

66. In para 50, to which we have already referred, the Tribunal concluded:

"But I do consider that at least in its application to conduct involving the management and administration of the fund the 'is applied' criterion is directed towards an overall characterisation of the conduct of the fund and does not require satisfaction about the appropriateness of every action of the trustees and those administering the trust on their behalf."

67. At para 51, to which we have also referred, the Tribunal observed:

"Substantial compliance [with a fund's constituent terms] will ordinarily provide some evidence that the fund is being held for its intended purpose and, at least in the absence of contrary indications, justify an inference that the fund 'is applied' for its established purposes. The strength of the inference in any particular case will depend on the degree of compliance and the nature, extent and reason for any non-compliance."

68. At para 52 the Tribunal noted that the Commissioner had expressly disavowed any intention to suggest that either the trustees or Mr Craik had knowingly set out to misapply the Fund. The Commissioner's written submissions were supplied to us. They may not go quite as far as was suggested by the Tribunal. However there is a statement to that effect with respect to the funds held in Mr Craik's trust account. It is also true that there is no express assertion of any dishonest intention. As we have demonstrated above, the Tribunal considered that the Trustees had entered into particular transactions, or allowed arrangements to be made by Mr Craik, in the belief that such transactions or arrangements were in the best interests of the Fund, or were relatively insignificant. Edmonds J considered that it was insufficient for the purposes of s 50-60 that the Fund was "substantially" or "principally" applied for relevant charitable purposes (at [30]). However, at [31], his Honour seems to have accepted that some degree of "incidental" or "inadvertent" misapplication might be insufficient to deprive the Fund of its eligibility for endorsement. Edmonds J correctly observed that there is no reference in s 50-60 to substantial application, drawing a distinction between that section and s 50-50(a) which speaks of a charitable institution pursuing its objectives "principally in Australia". His Honour considered that the absence of any such qualification in s 50-60 meant that there had to be strict compliance with that section. At [31] his Honour effectively excluded the consideration of the intention of a trustee or manager/administrator (presumably Mr Craik) in answering the question posed in s 50-60 other than in the case of incidental or inadvertent misapplications. His Honour considered that at least some of the misapplications upon which the Commissioner relied could not be so characterized. Edmonds J appears to have concluded that s 50-60 would not generally be satisfied where, in identified transactions, moneys had been misapplied in an objective sense, without regard to the intention with which they were so applied, and without regard to the extent of Fund assets involved.

Conclusions

69. Whilst it is true that s 50-60 does not speak of "substantial" application of a fund to its charitable purposes, it also does not speak of misapplication of part of a fund. The relevant words are "the fund is applied". The relevant question seems to be whether, having regard to the whole administration of the relevant fund, it is to be concluded that it "is applied" to the relevant charitable purpose. The question is not limited by concepts of substantiality. Nor does it address individual misapplications of parts of the fund.

70. The word "fund" is used in s 50-5, and elsewhere in Div 50A to denote an "entity". We infer that, in s 50-60, the word is also used in that sense. It is that entity which must be applied for the relevant purpose. It may be accepted that for all presently relevant purposes it is the application of Fund assets, both capital and income, which is to be considered. This approach leads us to conclude that the relevant enquiry is not as to individual transactions, but as to the application of the Fund as a whole. That is not to say that individual transactions are irrelevant. They may provide much of the evidence upon which the ultimate decision will be based. Further, as the Tribunal suggested, an examination of the way in which the Fund has been conducted may be relevant, quite apart from any consideration of particular applications. However such applications will also require detailed examination. The extent of any apparent misapplication may also be relevant, having regard to the size of the overall Fund. The way in which its capital is utilized and protected will also be relevant. Although a small number of misapplications may not be sufficient to justify a conclusion that the Fund has been misapplied, in other cases it may be sufficient. The question will, in all cases, depend upon the circumstances.

71. We consider that at least for some purposes, the Trustees' intentions in entering into a particular transaction may be relevant. Each transaction had to be analyzed in the context of the administration of the Fund as a whole. The Trustees are, after all, charged with the administration of the Fund. It is for them to decide how it should be administered and, in particular, how its assets should be invested and eventually disbursed. A particular appropriation may, prima facie, not be for a relevant purpose. However there is always the possibility of an explanation which justifies it. Trustees are not infrequently called upon to justify their conduct and do so by reference to the purposes which they have sought to achieve. Exercise of a trustee's powers frequently involves questions of judgment. When judgment is questioned, assessment of intention may be relevant. Actual intention may also be relevant to the overall assessment of whether the Fund is being applied for the relevant charitable purposes.

72. It 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. Of course, a deliberate misapplication may justify adverse inferences as to the transaction in question and other transactions. In this context, though, "deliberate" means "intending to breach the trust". A discrete breach may, alone, be sufficient to justify an inference as to intention. Similarly, disposition of a substantial part of the Funds' assets for an unauthorized purpose might also, by itself, justify an adverse inference. As we understand it, his Honour found non-compliance with s 50-60 upon the basis of the interest set-off question and the trust account question, treating the Trustees' explanations as being irrelevant, and without regard to the administration of the Fund as a whole. That approach was erroneous. Those transactions had to be assessed in the light of the wider conduct of the fund, including the subjective evidence from those who acted in its administration.

73. It may be that his Honour's focus on these transactions was the ultimate outcome of the way in which the Commissioner's attitude to the matter has changed over its history. As appears from the reasons, even at first instance in this Court, the focus was changing. As a result, the focus became too narrow. We do not mean to pre-empt any further decision in this matter. However, there was, we think, good reason for suspecting that s 50-60 had not been satisfied. Much of the conduct of the Fund called for detailed explanation.

74. For the reasons which we have given, we conclude that his Honour was correct in concluding that the Tribunal's decision be set aside. As we see it, the Tribunal started with the proposition in para 51 that substantial compliance with the Fund's constituent terms would ordinarily provide some evidence that the Fund was being held for its intended purpose and, at least in the absence of contrary indications, would justify an inference that it "is applied" for its established purposes. That proposition may be substantially true, but it should not have been treated as creating a presumption which the Commissioner had to rebut. In our view the Tribunal so treated it. We say that in light of the fact that it then proceeded to examine the various impugned transactions, concluding that each of them could be seen as justified, discounted or otherwise treated as de minimis. See for example para 105 of the reasons. There appears to be no point at which the Tribunal addressed all of the evidence to determine whether or not the Fund, as a whole, was being applied to the relevant charitable purpose. As there has been no consideration of the proper question, the matter should be remitted to the Tribunal.

75. The Commissioner may have suspected that the Trustees and Mr Craik were treating the Fund as their own, and that this was inconsistent with its being maintained and applied for the relevant charitable purpose. No doubt the Commissioner wished to avoid advancing imputations against character which, given that the Trustees bore the burden of proof, he would not seek to prove. However it is difficult to understand why, by the time the matter reached the Tribunal, and the time it reached this Court, the Commissioner still had not taken a final position concerning the basis upon which he wished to defend his decision to refuse endorsement. When one party to litigation does not take a clear position, there is always the risk that proceedings will miscarry.

Orders

76. We consider that his Honour's decision to set aside the Tribunal's decision was correct, but for the reasons which we have given. Those reasons lead us to the conclusion that the matter should be sent back to the Tribunal for further consideration in accordance with these reasons. We therefore make the following orders:

 

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