DWIGHT v FC of TJudges:
The applicant, Mr Peter Dwight, is a partner in the firm of Baker & McKenzie, Solicitors, practising, inter alia, in New South Wales. He appeals against assessments of income tax in respect of the years of income ended 30 June 1982 to 30 June 1989 inclusive, issued by the respondent Commissioner of Taxation addressed to ``Mr Andrew G Robinson, the Trustee for A Robinson and P Dwight in trust for US Surgical Corp''. Mr Robinson did not object against the assessments but no point is taken about this. The case has proceeded on the basis that the assessments were assessments against Mr Dwight; that he was entitled to object against them and, those objections being disallowed, to request the Commissioner to refer the decision on the objections to this court.
The background to the assessments
From 1980, Baker & McKenzie acted in litigation commenced in New South Wales by United States Surgical Corporation (``United States Surgical''). That company, it is conceded, was at all relevant times a company incorporated and resident in the United States of America and had no permanent establishment in Australia.
Three sets of proceedings were commenced by United States Surgical. The first set of proceedings was commenced in this court against Hospital Products International Pty Limited and others. These proceedings are referred to as the ``Federal Court proceedings''. The second set of proceedings was commenced in the Common Law Division of the Supreme Court of New South Wales solely against Hospital Products International Pty Limited. These proceedings are referred to as ``the Detinue Proceedings''. The final set of proceedings was commenced in the Equity Division of the Supreme Court of New South Wales against Hospital Products International Pty Limited, the first defendant, Mr Blackman, the second defendant, Hospital Products Limited, the third defendant, IRD Engineering Services Pty Limited, the fourth defendant, and Surgeons Choice Inc, the fifth defendant. These last proceedings are referred to as ``the Equity Proceedings''. They ultimately went to the High Court and the judgment of that court is reported as
Hospital Products Limited v United States Surgical Corporation and Others (1984) 156 CLR 41.
On 10 October 1980, Deane J, then a judge of this court, made an order relating to security
ATC 4194for costs in the Federal Court proceedings. His Honour ordered that United States Surgical:
``... provide security for costs that may be awarded against it in the sum of $10,000 by paying the said amount into a bank account to be opened in the joint names of Messrs Freehill, Hollingdale & Page and Messrs Baker & McKenzie, such amount to be paid into the said bank account on or before October 24 1980.''
These proceedings ultimately were removed to the High Court which gave judgment on various jurisdictional issues in February 1981. The judgment of the High Court on these issues is reported as
United States Surgical Corporation v Hospital Products International Proprietary Limited & Ors (1981) 148 CLR 457. The balance of the proceedings was thereafter remitted back to this court. On 11 August 1981, Ellicott J, then a judge of this court, ordered United States Surgical to provide a further amount of $5,000 by way of security for costs. Thereafter the proceedings in this court became inactive and remain, so it would seem, undecided.
The Detinue Proceedings were commenced on 23 December 1980. It seems that in those proceedings a further sum of $5,000 was deposited to the joint account to which the $10,000 deposited for security in the Federal Court proceedings had been lodged. So far as the evidence discloses the Detinue Proceedings thereafter became dormant.
Security for costs was also sought in the Equity Proceedings. On 1 July 1981, Kearney J ordered security for costs to be provided in stages, the first of $5,000 to be paid by 3 July 1981, a further $10,000 to be paid at the time of giving Notice of Discovery, and $44,000 to be lodged not later than one month prior to the date fixed for hearing of the proceedings. This order was expressed to be security for the costs of the first, second and fourth defendants in the Equity Proceedings. Subsequently, Hospital Products Limited became a party and McLelland J, during an interlocutory hearing, noted the agreement of the parties that the order for security would also he treated as having been made in favour of the third defendant.
A total of five amounts were deposited as security for costs in the Equity Proceedings between July 1981 and the close of evidence in June 1982. The amounts in question totalled $395,115. It seems that some of the amounts were paid by agreement without the necessity of further court orders being made. The trial of the Equity Proceedings commenced in November 1981 and continued until June 1982 over approximately 90 hearing days. All of the deposits in question were paid into an account with the Australia and New Zealand Banking Group Limited at its Pitt and Hunter Street branch. The co-signatories of the account were initially a Mr Channon, a partner of Freehill Hollingdale & Page, who then acted for United States Surgical in the Equity Proceedings, and Mr Dwight. Subsequently, when another firm of solicitors acted for United States Surgical in these proceedings, Mr Robinson of that firm became a signatory. This account was the same account which had been established pursuant to the directions of Mr Justice Deane in the Federal Court proceedings. The sum of $15,000 deposited to the credit of this account, in reference to the Federal Court proceedings and the Detinue Proceedings, was additional to the amount of $395,115. The account and investments represented by it are hereafter referred to as ``the security account''. The various amounts deposited were invested from time to time in term deposits with the same co- signatories and were ultimately consolidated into a single term deposit with the bank.
By agreement between the parties, a further sum of $50,000 was deposited to the credit of this account on 21 August 1981 as security for an undertaking given by United States Surgical as to damages in respect of certain interlocutory undertakings given by it to the court. That amount was ultimately paid out to United States Surgical in September 1983.
On 10 September 1982, a conversation took place between Mr Ford, an employed solicitor of Freehill Hollingdale & Page, acting for United States Surgical, and Mr McClintock, then an associate with Baker & McKenzie, having the conduct of the litigation, concerning the security account. In the course of that conversation, Mr Ford asked Mr McClintock whether he agreed that the interest on the moneys deposited in the fund belonged to United States Surgical. Mr McClintock expressed his agreement. The conversation was in the context of a question that had arisen as to whether withholding tax should have been paid upon interest derived from the fund. Following the conversation, Mr Ford wrote a letter
ATC 4195confirming what had been discussed. It said in part:
``We confirm that the following points were agreed...
- 1. That the monies deposited with the ANZ Bank by our client as security for costs in respect of the various proceedings between your clients and our client together with all interest accruing upon those monies belong in fact to our client until and unless an Order of the Court is made as to their payment to another party.''
Judgment in the Equity Proceedings was handed down by McLelland J in August 1982. The defendants in the Equity Proceedings moved the New South Wales Court of Appeal for orders for security of the costs of the appeal by United States Surgical. The formal orders of the Court of Appeal, made on 29 November 1982 and as contained in a Short Minutes of Order signed by counsel for the parties, provided as follows:
``1. Note that pursuant to orders made by McLelland, J. directing the Appellant (Plaintiff) to provide security for costs an amount of $395,115.00 and, pursuant to another order of McLelland, J. directing the Appellant (Plaintiff) to provide an undertaking as to damages, an amount of $50,000.00, have been deposited with the Australia and New Zealand Banking Group Limited and are held in the joint names of the Solicitors for the parties upon trust for the Appellant and the First Respondent.
2. Note that the moneys referred to in paragraph 1 above have as at 26th November, 1982 accrued interest in the total sum of $36,390.99 after payment of withholding tax of approximately $4,430.45.
3. Order that by way of further security for costs the moneys referred to in paragraph 2 above, together with any interest which accrues thereon, and on the moneys referred to in paragraph 1, from the date hereof until further order, including compound interest but less any amounts which are paid or payable in respect of withholding tax liabilities of the Appellant, be held by the Solicitors for the parties upon the same trusts as those referred to in paragraph 1 above.''
In August 1983, the Court of Appeal handed down its judgment and Hospital Products Limited thereafter appealed, ultimately successfully, to the High Court. No further orders were made as to security for costs. The money in the security account, other than the $50,000 as security for the undertakings as to damages, continued to be invested at interest.
The appeal of Hospital Products Limited was successful and the High Court ordered United States Surgical to pay the costs of the appeal of Hospital Products Limited as well as the costs of its own cross-appeal. There were other cost orders which are not presently relevant. A bill of costs has been prepared for taxation of the costs of the High Court proceedings but that bill has not yet been taxed. No bill has been taxed in respect of the Equity Proceedings in the Supreme Court.
The appeals presently before me concern the income derived from the investment of the security account by way of interest in the relevant years. It might be mentioned that in respect of some of the period in question, but not all, amounts were remitted by the bank to the Commissioner for withholding tax.
The submissions of the applicant
For the applicant it was submitted that Mr Dwight, as trustee of the security fund, held the assets of that fund upon trust for United States Surgical, which company had a vested and indefeasible interest in the fund and the income of it. Accordingly, by force of the provisions of s. 95A(2) of the Income Tax Assessment Act 1936 (as amended) (``the Act''), United States Surgical was deemed to be presently entitled to the income of that fund.
The Commissioner, on the other hand, submitted that no person was presently entitled to the income of the security fund in any of the years of income, with the consequence that Mr Dwight, as trustee, was liable to be assessed and to pay tax in accordance with the provisions of s. 99A of the Act.
In the original objections, Mr Dwight made no reference to, and accordingly did not rely upon, the provisions of the Double Tax Agreement between Australia and the United States. Before me he sought leave, pursuant to s. 190(b) of the Act, to rely upon the further ground that Article 11 of that Double Tax Agreement limited the applicable rate of tax to which Mr Dwight could be assessed to 10%.
ATC 4196The Commissioner consented to this course and accordingly I ordered that Mr Dwight be given leave to amend his grounds of objection to include, as an additional ground, that Article 11 of the Australia/United States Double Taxation Treaty limited the applicable rate of tax to 10%.
Issues for determination
The parties agreed that the issues arising for determination could be summarised as follows:
``1. Whether the Applicant was a `trustee' (for the purpose of Division 6 of the Income Tax Assessment Act) of the Security Fund and the interest income which accrued in respect of it?
2. In the event that the Applicant derived income in respect of the Security Fund in the capacity of a trustee, whether there was in each of the years in dispute net income of the trust estate to which no beneficiary was presently entitled?
3.(a) Whether USSC was presently entitled, or deemed to be presently entitled, to a share of the income of the trust estate?
- (b) If so, to what share of the income of the trust estate was it presently entitled or deemed to be presently entitled?
4. In the event that the Applicant derived income in respect of the Security Fund in the capacity of a trustee, whether such interest income was liable to withholding tax pursuant to the provisions of Division 11A of Part III of the Income Tax Assessment Act?
6.... in respect of Article 11 of the Convention:-
- (a) whether USSC was a resident of the United States beneficially entitled to the interest income which accrued in respect of the Security Fund?
- (b) whether the tax payable in respect of such income was limited by Article 11(2) to not more than 10% of the gross amount of the interest?''
Counsel for Mr Dwight submitted faintly that his client was not a trustee for the purposes of Division 6 of Part III of the Act. He offered no explanation for why this was so and indeed it appears unarguable that, in the ordinary legal use of the word, the partners of Freehill Hollingdale & Page and Baker & McKenzie, or alternatively Mr Dwight and either Mr Channon or Mr Robinson as Mr Channon's successor, were trustees when moneys in their name were invested with the Australia and New Zealand Banking Group Limited. As such, the income from those investments was income of a trust estate to which the provisions of Division 6 of the Act applied. The parties were in agreement that if I should find that the income from the security account was income to which United States Surgical was presently entitled, Mr Dwight was entitled to succeed in the appeals. If, on the other hand, in the relevant years, United States Surgical was not presently entitled to the whole of that income, then, subject to an argument based upon Article 11 of the Double Tax Treaty, it was conceded that the appeals should be dismissed. The separate argument based on the Double Tax Treaty depended upon whether, in the years in question, United States Surgical could be held to have, for the purposes of Article 11, a beneficial interest in the income of the security fund. If it did, then it was conceded that the tax payable by Mr Dwight should be limited to 10%.
The applicable law
The scheme of Division 6 of Part III of the Act
The scheme of Division 6 of the Act, albeit in part modified from time to time by amendments designed to overcome particular tax avoidance practices, remains much as it was in 1936. The identification of the relevant taxpayer and the share of the net income (defined in s. 95(1)) upon which tax is payable, depends upon whether there is a beneficiary of a trust estate who is presently entitled to a share of the trust law income of that trust estate. Where there are beneficiaries who, alone or together, are presently entitled to the whole of the income (ie trust law income) of the trust estate, then subject to territorial matters, not presently relevant, there will be no liability upon the trustee of that trust estate and the beneficiary, or each of the beneficiaries as the case may be, who is presently entitled to a share of the trust law income will have included in his assessable income his proportionate share of the net income (ss. 96 and 97).
Where, however, that beneficiary or beneficiaries are presently entitled, alone or together, to the whole of the trust law income but the beneficiary, or one or more of the
ATC 4197beneficiaries, is under a legal disability, the trustee is obliged to pay the tax on a proportionate share of the net income correlative to that beneficiary's share of the trust law income: s. 98.
Where there is a part of the trust law income to which no beneficiary is presently entitled, the trustee will be liable to pay the tax in respect of a proportionate share of the net income corresponding to the share of the trust law income to which no person is presently entitled: s. 99A or s. 99. Where s. 99A applies, tax is payable at a special rate, which generally speaking equates to the maximum rate of tax. Where s. 98 applies, the rate of tax is, in general terms, assessed as if it were the income of the beneficiary under a disability but not subject to deductions other than concessional deductions, if any, that would have been allowable to that beneficiary.
A modification to that scheme introduced by Act No. 14 of 1983, s. 18, is s. 98(3) which applies where there is a beneficiary of a trust estate who is presently entitled to a share of the trust law income of that trust estate but is a company which is a non-resident. Generally speaking in such a case, the trustee of the trust estate is to be assessed for tax in respect of the proportionate share of the net income of that trust estate at a special rate declared by Parliament to apply.
The Act does not define present entitlement as such. However, s. 95A(2), which was introduced into the Act by Act No. 19 of 1980, s. 9(1), provides:
``For the purposes of this Act, where a beneficiary has a vested and indefeasible interest in any of the income of a trust estate but is not presently entitled to that income, the beneficiary shall be deemed to be presently entitled to that income of the trust estate.''
The interest withholding tax provisions
There is a special regime concerned with the payment of tax on dividends and interest paid to non-residents: Division 11A of Part III of the Act. Income to which that division applies, subject to exemptions not presently relevant, is not included in the assessable income of a person: s. 128D. Rather, a person who pays or applies dividend or interest income in favour of a non-resident is obliged to deduct income tax which is imposed upon that person at a rate declared by Parliament: s. 128B(4) and (5). The rate of tax appropriate to interest paid or applied in these circumstances is 10%.
Section 128A(3) provides, for the purposes of Division 11A, that a beneficiary presently entitled, inter alia, to interest included in the income of a trust estate is deemed to have derived income consisting of that interest. Thus, if a non-resident beneficiary were presently entitled to the whole of the income of a trust estate and that income included interest, then, for the purposes of the withholding tax provisions, payment or application of that interest to the beneficiary requires the trustee to pay withholding tax at the 10% rate. This is subject to the provisions of s. 128B(3) which ensures that income in respect of which a trustee is liable to be assessed under s. 99 or s. 99A is excluded from the withholding tax regime. The trustee is thus ordinarily liable to pay the maximum rate of tax appropriate to assessments under s. 99A.
The Double Tax Agreement
Finally, reference should be made to Article 11 of the Double Tax Agreement between Australia and the United States. That agreement was signed on 6 August 1982 and for relevant purposes the parties agree had no effect in respect of the year of income ended 30 June 1982. It was in operation in respect of each of the remaining years of income in question. Article 11 of that treaty provides relevantly as follows:
``(1) Interest from sources in one of the Contracting States, being interest to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State.
(2) Such interest may be taxed in the Contracting State in which it has its source, and according to the law of that State, but the tax so charged shall not exceed 10 percent of the gross amount of the interest.''
That Article has the effect that if the interest in the present case is interest to which United States Surgical was, in the years of income 1983 and following ``beneficially entitled'', the rate of tax applicable was not to exceed 10%, despite any other provision of the Act.
In applying the Double Tax Treaty, reference must also be made to the provisions of the Income Tax (International Agreements) Act 1953 (``the International Agreements Act''),
ATC 4198which Act, inter alia, gives the force of law to the double tax conventions which are scheduled to it, including the United States Convention. The International Agreements Act provides, subject to exceptions not presently material, that the provisions of the treaties adopted into municipal law by it prevail over the provisions of the Income Tax Assessment Act. Section 3(3) and s. 3(4) of the International Agreements Act provide as follows:
``3(3) For the purposes of this Act, an amount of income derived by a person, being income other than interest or royalties, shall be deemed to be income attributable to interest or royalties, as the case may be-
- (a) if the person derived the amount of income by reason of being beneficially entitled to an amount representing the interest or royalties; or
- (b) if the person derived the amount of income as a beneficiary in a trust estate and the amount of income can be attributed, directly or indirectly, to the interest or royalties...
3(4) Where a beneficiary in a trust estate... is presently entitled to income of the trust estate, that income shall, for the purposes of this Act, be deemed to be an amount of income derived by the person.''
The effect of an order for security for costs
Since at least 1786, English courts have ordered security for costs against plaintiffs ordinarily resident out of the jurisdiction:
Pray v Edie (1786) 1 Term Rep 267. Today, the rules of court, or relevant legislation applicable to the Supreme Courts of the various States in Australia and to the Federal Court, empower the making of orders requiring security for costs: see, eg Supreme Court Rules 1970 (NSW) Part 53 Division 1; Federal Court of Australia Act 1976, s. 56; Federal Court Rules Order 28. Even in the absence of rules of court or express statutory provision, however, the making of such orders is within the inherent jurisdiction of a court:
Rajski & Anor v Computer Manufacture & Design Pty Ltd  2 NSWLR 122 (Court of Appeal) at 124-125 per Moffitt P.
Power in a court to order security for costs to be given where a corporation is a plaintiff was in the relevant years to be found in s. 363 of the Companies Act 1961 (NSW) and in its successor, s. 533 of the Companies (NSW) Code 1981.
The form which such security will take is a matter for the court, see eg, Part 53 Rule 3 of the Rules of the Supreme Court of NSW. It might, as here, take the form of cash which could be ordered to be paid into court to abide the outcome of the proceedings, or be invested in the joint names of the solicitors for the parties. It might take the form of a guarantee, or it might take the form of a security over other property, real or personal. In whatever form it is ordered, the property the subject of the security will continue to be the general property of the party who has given the security, and once an order of costs be made in favour of, say, the defendant against the plaintiff, the defendant will become, in all respects, a secured creditor: cf
Sherratt (WA) Ltd v John Bromley (Church Stretton) Ltd  1 QB 1038. Pending the resolution of the dispute between the parties and the making of a cost order, the defendant would have no proprietary interest in the property forming the security, but at best would have a right, in the nature of an equitable charge, giving him, after a cost order has been made and the costs taxed or agreed, recourse to the fund to satisfy the terms of the judgment: cf
Halvanon Insurance Co Ltd v Central Reinsurance Corp & Anor  1 WLR 1122 at 1127-1128 per Hobhouse J.
Where the security takes the form of an order that moneys be deposited in the names of the solicitors of the parties, the moneys will be held, at least until the time a cost order is made (and perhaps until a bill of costs has been prepared and taxed, in default of agreement between the parties as to the quantum of costs), in trust for the plaintiff who has deposited them with the trustees. However, the trustees will be affected by, and bound to have regard to, the equitable rights of the defendant, which rights are co-extensive with his rights to have the fund held pending the determination of the proceedings and the making of a cost order, and if that order be in his favour, pending his having recourse to the fund to the extent of the costs taxed or agreed. In other words, the defendant has rights in the nature of a lien over the fund to secure reimbursement to himself, if an order of costs be made in his favour, out of the security fund.
I do not think that anything turns upon the differences in wording of the various security
ATC 4199for cost orders which were made in the present case. Indeed the parties agreed that no different result should be taken to flow in respect of the period prior to the making of the order by the Court of Appeal on 29 November 1982 as flowed thereafter. This is not to say that the prior orders are completely irrelevant; they provide the background for understanding the later order. The conversation between the solicitors for the parties in September 1982, however, adds little or nothing to the question.
Although the Court of Appeal Order referred to the moneys in the account as being held by the solicitors ``upon trust for the Appellant and the First Respondent'', that form of wording does not assist in the resolution of the present problem. It is clear that the court was not intending to order that the money in the fund be held for the parties, as beneficiaries in equal shares, for example. The only work those words perform, in my opinion, is to reflect the position which would have prevailed had they not been used, namely that the moneys in question were to be held by the solicitors as trustees for the appellant as security for any order of costs ultimately made in favour of the respondent against the appellant, who, if such an order was made, would have a right to resort to the fund to satisfy his claim for costs.
In this respect the security fund in the present case may stand in a different position to moneys which are paid into court by an interpleading party to abide the outcome of the litigation, as was the case in
Harmer & Ors v FC of T 91 ATC 5000; (1991) 66 ALJR 89 which it will be necessary to consider shortly.
Counsel for the Commissioner submitted that there were four possible constructions which could be given to the trust created by the payment of moneys by United States Surgical into the security account.
The first was that the trust was a trust to pay the fund to such persons as the court would ultimately order, having regard to the ultimate cost order to be made. This was said to bring the case squarely within Harmer. However, if the defendant were successful, the court would not order payment of the moneys in the fund to the successful defendant as such. The fund was established as security for the payment of whatever cost order was made.
The second, which was conceded to be ``less likely'', was that the trust was to pay the fund in accordance with such cost order as was ultimately made. The difficulty with this construction of the trust was, as the Commissioner's submissions conceded, that the parties would have been conscious of the possibility of competing orders for costs, which would need to be set off under Part 52 Rule 58 of the Supreme Court Rules, and of disputes as to whether one set of costs should be paid while other proceedings which might produce cross- orders remained on foot.
The third possibility was, it was said, that the moneys were held on trust for all the parties on terms that they be disbursed as agreed or, in the absence of agreement, in accordance with the order of the court. That formulation clearly required some modification, because it would be open for United States Surgical to pay the costs independently, if an order against it were made and then, the security being no longer required, it would be entitled to have the money returned to it. No intervention of the court, or agreement, would be required in such a case. Nor, indeed, would such intervention be required if ultimately no order of costs were made against the plaintiff.
The fourth, and fall-back possibility, was that the money was held on trust for United States Surgical, subject to an equitable charge for such sums as should be ordered against it for costs. It was said that even if this were the correct analysis, the decision in Harmer's case required the same result to flow, namely that United States Surgical would not be presently entitled to the income of the security account. In my view, this last possibility is the proper construction of the trusts which were created by the deposit of moneys to the security account in pursuance of the various security for costs orders.
The decision in Harmer's case
In Harmer, a company obliged to pay moneys to another was faced with competing claims to that money and commenced interpleader proceedings, paying the money owing into court. An order of the court was made that the sum paid into court be paid out to solicitors and invested, the moneys to be held in trust by them pending the determination of the proceedings. The question arose whether there was any person or group of persons who was presently entitled, within the meaning of those words in s. 97 of the Act, or deemed to be presently entitled, pursuant to s. 95A(2) of the Act, to the income of the trust constituted by the
ATC 4200investment of the money. The High Court unanimously (Mason CJ, Deane, Dawson, Toohey and McHugh JJ) held that no person was presently entitled to the income, with the result that an assessment of that income to tax under s. 99A of the Act was upheld.
Harmer differs from the present case in two respects. The first is that there was no suggestion in Harmer, nor could there have been, that the income was income of the party paying the money into court, or formed part of the general property of that person. The argument was a different one. It was submitted that the income was income to which the ultimately successful parties to the litigation were presently entitled, albeit that the identity of those parties and the quantum of their entitlement was ascertained only after the litigation ended. The second is that the moneys in Harmer were held not as security for costs which a party may ultimately be entitled to, but to be dealt with in accordance with the order of the court consequent upon its determination of the conflicting claims to the moneys. Both of these matters were critical to the outcome in Harmer.
Thus in Harmer, the court noted (at ATC 5005; ALJR 92) that:
``After payment in, the claimants acquired an interest in the moneys in the sense that they were entitled to insist that they be properly administered and applied for the purposes for which they were paid in. However, no claimant was beneficially entitled to either the whole or any part of the moneys paid into court or of the interest earned thereon. (See, eg,
Official Receiver in Bankruptcy v Schultz & Anor (1990) 170 C.L.R. 306 at 312-314). The moneys were received and held by the Accountant to be applied in accordance with the orders ultimately made by the Supreme Court. The respective interests of the individual claimants were, at best, contingent. None had an entitlement to the capital or the income of the fund which was vested either in interest or in possession. A fortiori, none had a present legal right to demand or receive payment of either capital or income. It follows that none of the claimants was `presently entitled' to the income of the fund for the purposes of s 99A of the Act during the period between the time of the payment in of the moneys and the time when they were received by In Residence's solicitors to be deposited with the Building Society.''
Present entitlement and deemed present entitlement
The meaning of ``present entitlement'' has been explored in a number of cases, viz:
FC of T v Whiting (1943) 7 ATD 179 at 183; (1942-1943) 68 CLR 199 at 215-216, 219-220;
Taylor & Anor v FC of T 70 ATC 4026 at 4029-4030; (1970) 119 CLR 444 at 450-452;
Totledge Pty Limited v FC of T 80 ATC 4432 at 4435, 4437-4438; (1980) 31 ALR 657 at 661, 664 and
FC of T v Totledge Pty Ltd 82 ATC 4168 at 4174-4176; (1982) 60 FLR 149 at 159-161. These cases were distilled by the High Court in Harmer as establishing 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.''
Whiting was concerned with whether there was present entitlement to income in the period between grant and completion of administra- tion. In that period, a residuary beneficiary has no interest in the assets of the estate, nor, for the same reason in the income derived from those assets, notwithstanding that the beneficiary may be entitled under the will to a vested interest. Such a beneficiary may be "entitled" but will not be presently entitled: Whiting at ATC 183; CLR 216. As to the nature of the rights of a beneficiary in an unadministered estate, see
Official Receiver in Bankruptcy v Schultz & Anor (1990) 170 CLR 306 at 312-314.
While the ability to demand and receive payment of income referred to in Whiting and Harmer is an indicia of present entitlement, it may not, with respect to what is said in Harmer, always be a prerequisite of present entitlement. So much appears to have been recognised by Latham CJ and Williams J in Whiting (at ATC 183; CLR 216), where their Honours suggested as an alternative to the right to demand payment, that within the meaning of s. 19 the
ATC 4201trustee may properly reinvest, accumulate, capitalise, carry to any reserve, sinking fund or insurance fund however designated or otherwise deal with it as the beneficiary or on his behalf. This alternative formulation would seldom add much to the test of capacity to demand payment. It would at least, however, accommodate a case where, by force of a contractual obligation to which the beneficiary and perhaps the trustee were parties not creating an equitable interest in another, the trustee was obliged to pay the moneys which constitute trust income vested in the beneficiary to some other person on behalf of the beneficiary. As Taylor illustrates (at ATC 4029; CLR 452 per Kitto J), to accommodate the use of the words ``present entitlement'' in s. 98 of the Act, they must refer:
``... to an interest in possession in an amount of income that is legally ready for distribution so that the beneficiary would have a right to obtain payment of it if he were not under a disability.''
The trust in Harmer was, as the judgment of the High Court noted (at ATC 5006; ALJR 93), analogous to a ``trust for statutory purposes'', that is to say the persons claiming entitlement to the moneys invested were not beneficiaries in the proper sense, but, like the contributors in
Fouche v The Superannuation Fund Board & Ors (1951-1952) 88 CLR 609 at 640, to which the judgment of the High Court in Harmer referred by analogy, had:
``... an interest in the trust fund which would probably give them standing in a court of equity, but they have not such a beneficial interest in the fund as has an ordinary cestuis que trust.''
So it may be said that here the defendants in the three proceedings, in respect of which security was ordered, are in a like sense not beneficiaries in the security fund, albeit that by reason of the charge or lien over the fund for their benefit they have standing in a court of equity, should, for example, the trustees of the fund seek to appropriate the trust assets. The same cannot, however, be said of United States Surgical. The moneys in the fund are its moneys, although they are subject to a charge or lien in favour of the defendants creating an equitable interest co-extensive with the rights which that charge carries with it.
On this basis, therefore, the question becomes whether the existence of that charge or lien brings about the result that there is no present entitlement or deemed present entitlement.
An analogous situation arises in every case where a trustee of a trust fund has incurred a liability in pursuance of carrying out his duties, and not in breach of trust. In such event the trustee is entitled to be indemnified against those liabilities from the trust assets held by him and for the purpose of enforcing the indemnity has a charge or lien over those assets:
Vacuum Oil Company Proprietary Limited v Wiltshire (1945) 72 CLR 319,
Octavo Investments Proprietary Limited v Knight & Anor (1979) 144 CLR 360. As the joint judgment of Stephen, Mason, Aickin and Wilson JJ points out in Octavo (at 367), the charge in such a case applies to the whole range of trust assets in the trustee's possession, save only that it does not extend to assets which the trustee is not authorised to use for the purposes of carrying on the business. The effect of that charge was said in Octavo to be:
``In such a case there are then two classes of persons having a beneficial interest in the trust assets: first, the cestuis que trust, those for whose benefit the business was being carried on; and secondly, the trustee in respect of his right to be indemnified out of the trust assets against personal liabilities incurred in the performance of the trust. The latter interest will be preferred to the former, so that the cestuis que trust are not entitled to call for a distribution of trust assets which are subject to a charge in favour of the trustee until the charge has been satisfied...''
Would it then follow that in each case where the trustee has assumed a personal liability for a trust debt not incurred in breach of trust, whether or not the debt is secured upon the trust assets, that no person is presently entitled to the income of the trust estate? The Commissioner's answer, presumably made on instructions, was in the affirmative. This affirmative response, which is contrary to the Commissioner's practice of at least half a century would, if correct, result in most trust estates in the country having no beneficiary presently entitled to the trust law income. Indeed, it would only be those trust estates where the trustee had no borrowings which would qualify.
I was pressed with the decision of the full court of the Queensland Supreme Court in
Kemtron Industries Pty Ltd v Commissioner of Stamp Duties (Qld) 84 ATC 4380;  1 Qd R 576 and particularly the judgment of McPherson J at ATC 4384; Qd R 585, where it was said that in a case where the trustee is entitled to indemnity out of the trust assets, the trust property, ie that which the beneficiaries are entitled to in equity, is confined to so much of the assets as are available after the liabilities have been provided for. These comments were made in response to an argument, ultimately unsuccessful, that the trustee's lien was to be treated for the purposes of assessment of stamp duty on a transfer of the whole of the units in a unit trust as an encumbrance. In the result, the court held that the property transferred by force of the transfer of the units was the existing balance after providing for the liabilities and had no value, having regard to a large liability secured over the trust assets. The result is, with respect, unexceptionable, but the context of the discussion is so removed from the present that I do not find it helpful. The case was subsequently followed in another stamp duty case in Queensland,
Re Pachet Pty Ltd & Ors 85 ATC 4587; and see
Re Neander Constructions Pty Ltd 88 ATC 4113 at 4115-4116; (1988) 6 ACLC 865 at 867-868.
None of the comments dealing with present entitlement to be found in Whiting, Taylor, Totledge or Harmer were made in the context of an argument that, once trust assets are the subject of a security interest by way of lien or charge which in equity may give the holder of that interest a right to resort to the trust assets and therefore an equitable interest in those assets, present entitlement to income cannot be found. There may be two answers to the proposition. The first is that the right to demand payment of which the courts speak is to be considered without reference to security interests of this kind. This may, perhaps, be accommodated by seeing the trust funds, including the moneys representing the income derived by the trustee, as being applied for the benefit of the beneficiaries who would otherwise, as a matter of trust law, be entitled to that income and presently entitled to it. The alternative, is to concede that ``present entitlement'' in the ordinary sense does not apply, but to then look to whether there is a deemed present entitlement arising under s. 95A(2). It was the latter approach which was taken by counsel for the taxpayer before me. Since I am of the view that Mr Dwight should succeed on this basis, it is unnecessary to reach a concluded view on the question whether, on the present facts, there was present entitlement to the income in the ordinary sense of the words.
The requirement in s. 95A(2) that the beneficiary have a vested and indefeasible interest in income was introduced into the Act in 1980 by Act No 19 of that year. No explanation for the amendment is given in either the explanatory memorandum or second reading speech which introduced the amending legislation. Since it is a prerequisite to the operation of the sub-section that there be no present entitlement in the income, it may, at least, be assumed that the requirement that the beneficiary have a vested and indefeasible interest in the income is different from the requirement that the beneficiary be presently entitled to that income. To put it another way, to the extent that the requirement of ``present entitlement'' requires that the beneficiary be able to call for the income of the trust fund at least by the end of the year of income in all cases, that can be put to one side when considering whether the beneficiary has a vested and indefeasible interest in the income.
In the judgment in
FC of T v Harmer & Ors 90 ATC 4672; (1990) 24 FCR 237 in this court, Wilcox and Lee JJ observed that the Act provided no indication that the words ``vested and indefeasible interest'' were to be understood in other than their ordinary meaning. However, that requirement was not satisfied on the facts of that case. Although the judgment of the High Court affirmed the judgment of the full court, there was no necessity to explore the meaning of the words because in no real sense could it be said that the persons litigating the issue of who was entitled to the money were, in that case, beneficiaries in any real sense; nor, even if they were, could it conceivably be said that they had a vested interest.
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 of present enjoyment of the right,
ATC 4203where the estate is said to be vested in possession:
Glenn & Ors 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 cannot. Thus, a beneficiary with an interest which is not contingent but which interest may be brought to an end by the exercise of a power of appointment, would be said to have a vested but defeasible interest: cf
Queensland Trustees Limited & Ors v Commissioner of Stamp Duties (1952) 88 CLR 54 at 63, and
Re Kilpatrick's Policies Trusts  Ch 730.
An interest may be vested and indefeasible, notwithstanding that it is subject to a security interest in another. The mere existence of a lien or charge over the property does not convert an interest otherwise vested and indefeasible into one that is vested but defeasible, or not vested at all. When United States Surgical paid the moneys into the security account, the moneys remained its property, but became subject to a trust in that they were to be held by the trustees until a cost order had been made, and as security for the payment of costs ordered against it. The income on investments was to be retained by the trustee and held on the same trusts. It never ceased to be the income of United States Surgical, albeit that it could be dealt with by the trustee in the event of a court order for costs being made against United States Surgical, by the trustee paying the moneys to the successful defendants.
In my opinion, the present is a case where United States Surgical had, in the relevant years of income, a vested and indefeasible interest in the income from the security account. For the reasons given in Harmer, the defendants had no such interest and indeed were not beneficiaries. But here, United States Surgical was a beneficiary, indeed the only beneficiary, and the moneys in the fund and the income to be generated from it belonged to that company, subject only to a charge or lien upon it in favour of the defendants to secure future cost orders. In the result, United States Surgical was presently entitled to the whole of the income of the security fund and, accordingly, s. 99A could have no application to assess for tax Mr Dwight. It is unnecessary, therefore, to address the separate argument that Article 11 of that treaty could have application, notwithstanding there was no present entitlement in United States Surgical, because that company was beneficially entitled to the income.
The objection decision must be set aside and the Commissioner will be ordered to pay the applicant's costs.
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