Case E39

Members:
AM Donovan Ch
GR Thompson M
RK Todd M

Tribunal:
Board of Review No. 2

Decision date: 18 September 1973. Received from the Board 24 September 1973.

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A.M. Donovan (Chairman); G.R. Thompson and R.K. Todd (Members): In the circumstances of these references it will be adequate for the purposes of the parties and of readers of the report if we state the facts in a simplified and summarised form. In point of fact the administration of the trusts in question and of their bank accounts can only be described as disorderly, and it would be an unnecessary and tedious task to sort out in detail the various discrepancies and inconsistencies that have occurred. Further, the issues in relation to the 1966 and 1967 years of income are of importance only to the parties and involve no point of general interest.

2. I and H are trustees pursuant to the provisions of two settlements, each made by M, under one of which L is the principal beneficiary and under the other of which R is the principal beneficiary. Both L and R were at all material times infants, and were the children of the trustees. Pursuant to the trusts I and H conduct a business, and each of the trusts is entitled to a one-half share in the capital and profits of that business. During the years of income ended 30 June 1966, 1967 and 1969 respectively, profits were made by the business and one-half thereof was duly returned as being part of the net income of each of the trusts. In relation to the 1966 and 1967 years the trustees claim to have paid or applied the relevant share of income to or for the benefit of the respective beneficiaries within the meaning of sec. 101 of the Act, and that the beneficiaries were in consequence presently entitled to the income in question. If this were found not to be so, the conclusion to which the Commissioner had in fact come, namely that the case was not one in which it was unreasonable that sec. 99A of the Act should apply, was assailed. In relation to the 1969 year, present entitlement was conceded by the

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Commissioner, but in this instance what the trustees challenge is the Commissioner's decision to assess the trusts pursuant to sec. 94 of the Act upon the basis that in carrying on the business the trustees were in fact carrying on business in partnership and that the income which they derived in the circumstances was partnership income. This being so, and the other constituent elements of sec. 94(4) being satisfied, the Commissioner's assessment was such as to impose tax at the rate of 50 cents in the dollar.

3. It should be mentioned that it was suggested that a finding of present entitlement should at least be made in relation to two items which appeared in the accounts. One was a sum of $104 which was left unexplained and as such cannot be relied upon. The other was a sum which appears to have represented a disbursement made in relation to the discharge of the trustees' liability to income tax in respect of a previous year and assessed under sec. 98. This is not a payment or application to or for the benefit of a beneficiary in any relevant sense so that this point does not assist the taxpayers.

4. As far as the 1966 and 1967 years are concerned, we have no hesitation in finding that the Commissioner's decision was in each case correct. Counsel for the trustees relied upon
Commr. of I.R. (N.Z.) v. Ward (1969) 69 ATC 6050, and contended that decisions taken by the trustees in June of each of the relevant years amounted to decisions which effectively vested income in the beneficiaries. The evidence of this aspect of the matter was not convincing. In the first year the composition of the meeting at which the decision was taken appears to have been incorrect, in that it anticipated a retirement of one trustee and the appointment of another which had not at that point occurred. The minute of the meeting was unsigned and had never been confirmed. No person who gave evidence appeared to have any independent recollection of the meeting, or to be able to refresh his memory by reading the minute. The meeting may well have taken place, but we cannot be satisfied about the matter on the balance of probabilities as the evidence stood at the conclusion of the hearing. However, even if the decision was taken in the form recorded in the minute in the 1966 year, the case for the trustees is not advanced, as the decision taken fell far short, in point of the particularity of its terms, of the resolution which was in question in Ward's case (supra). The same is true of the uncontested resolution which was recorded in minutes relating to the 1967 year. This being so, it becomes necessary to decide whether it would be unreasonable for sec. 99A of the Act to apply. Again, we have no hesitation in concluding that it would not be so unreasonable. We accept the evidence of I, the father of the beneficiaries, that the intention in bringing the trusts into existence was to benefit the children, and indeed his evidence really carried the impression that it had been intended to accumulate the income for them. However this may be, the trusts have been administered in a way which has led to their funds being diverted in at least one major instance to the use of the trustees in circumstances which were improper. This conclusion is not softened by the fact that what was done was contrary to the instructions of the trustees. The assessments in relation to those years must be confirmed.

5. In relation to the 1969 year the point involved is one of principle. For the Commissioner it was argued that the trustees, in carrying on the business, were so carrying it on in partnership and that notwithstanding the maintenance of their status as trustees the income which they derived as trustees was partnership income. As stated previously, sec. 94(4) of the Act would then apply and the trustees be taxed at the rate of 50 cents in the dollar.

6. Section 6 of the Act provides -

``In this Act, unless the contrary intention appears -

`partnership' means an association of persons carrying on business as partners or in receipt of income jointly...''

Section 92(1) of the Act provides -

``The assessable income of a partner shall include his individual interest in the net income of the partnership of the year of income, and his individual interest in a

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partnership loss incurred in the year of income shall be an allowable deduction.''

7. At first glance it might appear possible to conclude that trustees fall within the statutory definition because they are ``an association of persons... in receipt of income jointly''. If such a conclusion did not appear shocking in the case of trustees whose principal activity in relation to the trust committed to them is to carry on a business, it certainly would so appear in the case of trustees who simply receive income from investments in the ordinary sense. Other anomalous features of the Commissioner's contention were alluded to by the trustees' counsel. For instance, if the Commissioner were correct, the taxation consequences and the procedures of returns and assessments leading to such consequences would depend, in the case of a trust, upon whether there was but one trustee or more than one.

8. That these anomalies would exist is hardly surprising, for in our view the submission is based upon a fundamental misconception. The relationship between partners is one of contract. Partnership involves a contract between persons to engage in business with a view to profit. The relationship between trustees inter se is not one of contract at all. The trustees hold property pursuant to the terms of the trust and in consequence a wide range of duties is imposed upon them. They also have certain powers, and they have some limited rights, notably rights of reimbursement, contribution and indemnity, the right to a discharge on completion of the trusteeship, and the right to pay trust funds into Court under certain circumstances. These duties, powers and rights are the creations partly of statute and partly of the Court of Chancery and its successors. The provisions of individual trust instruments may vary them. But the relationship between trustees is not consensual. We conclude that trustees are not to be regarded as being, as between themselves, in a relationship of partnership, with all the consequences that would then flow. The fact that trustees who carry on a business pursuant to the terms of their trust may, as against those with whom they deal, acquire rights and incur liabilities in such a way as to assimilate their position, by estoppel, vis-a-vis those outsiders, to that of those who carry on business in partnership does not in any way affect the conclusion to which we have come to their position inter se.

9. The basic nature of trusteeship also leads in our opinion to a denial of the proposition referred to in para. 7 of these reasons, namely that the trustees should be regarded as partners because they are ``in receipt of income jointly''. In our opinion the definition in sec. 6 is speaking of beneficial receipt of income. The trustee has but the legal interest. He is bound to hold or apply that interest for the beneficiary who has the beneficial interest. As a result he has no relevant interest in the property. The conferment upon him of the legal interest is merely for the purpose of enabling him to hold and apply the trust property for the beneficiaries.

10. Counsel for the Commissioner made a valiant attempt to rescue the argument by asserting that the existence in this case of two trusts produced the conclusion that the trustees were to be regarded as being in a relationship of partnership. In our opinion this argument must fail. The quality of the relationship between trustees is not affected by the number of beneficiaries in whose favour the trust property is administered or by the fact that more than one trust instrument is involved.

11. Two citations may be made which illustrate the dangers involved in attempting to equate the principles relating to the creation of a trust to those relating to the creation of a contract. In Pollock, ``Principles of Contract'', 13th Ed. (1950), at pp. 166-167, the following passage appears -

``Trusts are sometimes regarded as deriving their origin from a contract between the author of the trust and the trustee. This point of view may for some purposes be useful. The Scottish institutional writers (who follow the Roman arrangement in the learning of Obligations as elsewhere) consider trust as a species of real contract under the head of depositation. Conversely

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deposits, bailments, and the contract implied by law, which is the foundation of the action for money received, are spoken of in English books as analogous to trusts.

It is certain that by the creation of a trust duties are often imposed on and undertaken by the trustee which persons not parties to the transaction, or even not in existence at its date, may afterwards enforce. And the relation of a trustee to his cestui que trust is in some ways analogous to that of a debtor to his creditor. Thus the transfer of equitable rights of any kind is subject, as regards the perfection of the transferee's title, to precisely the same conditions as the transfer of rights under a contract. And the true way to understand the nature and incidents of equitable ownership is to start with the notion not of a real ownership which is protected only in a court of equity, but of an obligation of the legal owner which (in the case of trusts properly so called) cannot be enforced at all, or (in the case of constructive trusts, such as that which arises on a contract for the sale of land) cannot be enforced completely, except in a court of equity.

However, although every trust may be said in this sense to include a contract, it includes so much more, and the purposes for which the machinery of trusts is employed are of so different a kind, that trusts are distinct in a marked way not merely from every other species of contract, but from all contracts as a genus. The complex relations involved in a trust cannot be reduced to the ordinary elements of contract. Trust, in fact, is a legal category sui generis and found only in English-speaking communities or under the influence of English law.''

It will be noted that even the limited analogy drawn between trust and contract for the purposes of analysing the relationship between settlor and trustee, and between trustee and beneficiary, is not in any way referred to by the learned author in relation to the relationship between trustees.

12. The theme is taken up in Underhill's Law of Trusts and Trustees, 10th Ed., p. 5, Notes to Article 1 -

``The late Sir Frederick Pollock, in his learned work on Contracts, considers that a trust is, in its inception, a form of contract; but admits that the complex relations involved in a trust cannot be conveniently reduced to the ordinary elements of a contract, and that there is sufficient justification for the course adopted by all English writers of treating trusts as a separate branch of law. There is, however, a radical distinction between contracts and trusts, namely, that an executed trust (as distinguished from a contract to create a trust) can only be enforced by a person for whose benefit it was made, and can neither be enforced nor released by the person who created it, unless he be also a beneficiary. On the other hand, as is shown later on in Art. 8, a contract as a rule can be enforced or released only by the parties to it. A trust once finally created is in fact the equitable equivalent of a common law gift, and leaves no right in the creator of it, as such, to enforce it. Thus -

if A. vests property in B. in trust to pay the income to C. for life and after C.'s death to divide the capital among X., Y., and Z., then C., X., Y., and Z., being persons of full age and sui juris, can together (if unanimous) insist on the trustee dividing the property between them at once, notwithstanding the protests of A.

This quality of a trust is one which foreign lawyers find great difficulty in grasping. It fell to Sir Arthur Underhill's lot to give evidence of the English Law of Trusts for use in French courts, which had a great tendency to regard a trust as a mandate or agency created by the settlor and revocable by him, whereas the very opposite is the case, the trustee being rather the agent of the beneficiaries collectively and having no duty whatever to the settlor. In truth, the latter is a donor, the beneficiaries collectively the donees, and the trustee a sort of stakeholder for them.''

13. The passages set out above have various relevant applications to these cases. In view of certain aspects of the evidence

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given at the hearing, in which we heard of a previous trust for the two children jointly being ``ceased'' and of trustees in various trusts being assembled towards the end of the financial year so as to, inter alia, ``supply them with a list of the beneficiaries and in what proportion they shall be entitled to the income'', the last paragraph of the passage cited from Underhill is worth noting. It is also worth observing that while the principles of equity and thus of the law of trusts did not, like the rules of the common law, stand still but were and are capable of change and development (see per Sir George Jessel, M. R., in
Re Hallett's Estate, Knatchbull v. Hallett (1880) 13 Ch. 710D. at p. 710), those who seek to employ the principles of the trust (not, be it noted, of the ``trust device'') for the undoubtedly legitimate purpose of fending off the revenue in changing situations do so at their peril if they do not absorb the principles of the law of trusts as opposed to merely an assortment of some of its outward manifestations.

14. In relation to the 1969 year therefore the objections succeed and the assessments should be amended accordingly.

Claims allowed in part