Decision impact statement
Colonial First State Investments Ltd v Commissioner of Taxation
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 FCA 16
2011 ATC 20-235
81 ATR 772
(2011) 192 FCR 298
Venue: Federal Court of Australia
Venue Reference No: NSD 1190 of 2009
Judge Name: Justice Stone
Judgment date: 18 January 2011
Appeals on foot: No.
Decision Outcome: Partly Adverse
Impacted AdviceRelevant Rulings/Determinations:
redemption of units
managed investment fund
retail and wholesale funds
The ATO's response to this case which concerned the tax treatment of payments made by the trustee of a unit trust on the redemption of units; in particular whether redeeming unitholders would be assessed on trust capital gains apportioned to them.
Brief summary of facts
The taxpayer, Colonial First State Investments Limited (Colonial), is the trustee and Responsible Entity of a retail unit trust (the Retail Fund). The Retail Fund is a managed investment scheme pursuant to Chapter 5C of the Corporations Act 2001.
In its capacity as trustee of the Retail Fund, Colonial invested in units in a wholesale unit trust (the Wholesale Fund). To comply with the requirement in the Corporations Act 2001 that the property of a managed investment scheme be held separately from property of the Responsible Entity, the units in the Wholesale Fund were held by a Custodian on behalf of Colonial. The units were the only asset held by the Custodian.
The terms on which the Wholesale Fund was administered were set out in its constitution which, for present purposes, may be equated to a trust deed.
Colonial sought a private ruling from the ATO as to the tax consequences of proposed amendments to the constitution of the Wholesale Fund.
Clause 12 of the constitution entitled a redeeming unitholder to a 'redemption amount' on making a redemption application. The proposed amendments sought to confer on the Responsible Entity of the Wholesale Fund an absolute discretion to appropriate the redemption amount from three accounts:
- an account representing the corpus of the Wholesale Fund
- an account to which has been credited the Wholesale Fund's short term capital gains (ie. those calculated for tax purposes which did not qualify for the CGT discount)
- an account to which has been credited the Wholesale Fund's long term capital gains (ie. those calculated for tax purposes which qualified for the CGT discount).
Relevantly, the proposed amendments also provided:
The Responsible Entity may decide to which accounts of the Trust a Redemption Amount should be debited after the end of the financial year during which the entitlement to that Redemption Amount arises....
The stated purpose of the amendments was to achieve fairness between long term and short term investors in the Wholesale Fund. That is, through the exercise of its power of appointment, the Responsible Entity would direct short term capital gains to investors who held their investment for less than 12 months and long term capital gains to investors who held their investment for more than 12 months. It was intended that an allocation of capital gains in this manner would constitute a present entitlement to income of the trust estate for the purposes of section 97 of the Income Tax Assessment Act 1936 (ITAA 1936). All references are to the ITAA 1936 unless otherwise indicated.
Specifically, such allocations were intended to result in the tax on capital gains made by the trustee of the Wholesale Fund in disposing of assets for the purposes of paying out redeeming unitholders being borne by those unitholders (rather than the liability being spread amongst the unitholders remaining at the end of the income year).
The private ruling addressed a series of questions raised in the ruling application. Each question was the subject of review in this case.
Issues decided by the court
Whether Colonial was a beneficiary of the Wholesale Fund (the Custodian issue)?
The Court rejected the Commissioner's submission that Colonial (as trustee of the Retail Fund) was not a beneficiary of the Wholesale Fund.
The Court agreed that Colonial did not have 'title' to the units in the Wholesale Fund as they were held by the Custodian on a sub-trust for Colonial. However, the Court concluded that, while the Custodian was the conduit through which payment of the redemption amount must flow, it was Colonial to whom the redemption amount must be paid. The Court further concluded that Colonial was entitled to enforce the obligation of the trustee of the Wholesale Fund to administer the trust according to its terms. [paragraphs 19-20]
Whether Colonial is presently entitled to a share of the income of the Wholesale Fund (the present entitlement issue)?
The Court rejected the Commissioner's submission that the test of present entitlement prescribed in Harmer v Federal Commissioner of Taxation must be satisfied at the time relevant income is received by the trustee. The Court instead held that the test will be satisfied if an entitlement arises by the end of an income year.
However, on the facts before it, the Court concluded that it would be impossible for Colonial to be presently entitled to a particular redemption amount within a relevant tax year, it being only after the end of the relevant financial year that the trustee of the Wholesale Fund would decide the extent to which a redemption amount will be sourced from any particular account. [paragraphs 28-38]
[Note that the Court decided in any event that the capital gains were not income of the Wholesale Fund (see discussion below). It follows that even if Colonial was presently entitled to the funds from which the 'gain part' of a redemption amount was sourced (being that part of the redemption payment that exceeded the amount subscribed), that present entitlement would not be present entitlement to income of the trust estate for the purposes of section 97.]
Whether the short term or long term capital gains ('gain part') form part of the income of the Wholesale Fund trust estate under section 97 (the income of the trust estate issue)?
The Court rejected Colonial's submission that the Wholesale Fund's constitution effectively treated the Fund's capital gains as distributable income.
The Wholesale Fund's constitution at clause 32 provided that each unitholder at midnight on 30 June was presently entitled, in proportion to its unitholding, to a share of so much of the distributable income for the corresponding year as had not previously been distributed. For these purposes distributable income was defined, broadly speaking, to be the amount the trustee had to distribute to ensure the lowest amount of tax payable. Clause 32 further gave the trustee the power to elect to distribute 'any amount (capital or income)' and to decide which part of a redemption amount should be treated as a distribution from, respectively, the capital gains tax and corpus accounts.
Colonial's submission was that the definition of distributable income implied that capital gains had to form part of the distributable income of the trust as this would ensure the lowest amount of tax payable. By contrast, the Commissioner noted that in providing for part of a redemption amount to be treated as a distribution, the deed preserved the distinction between income and capital: the deed did not purport to treat the gain part of a redemption payment as being a distribution of income as opposed to capital.
The Court agreed with the Commissioner that that portion of the deed that provided for the distribution to unitholders of income not previously distributed was not concerned with redemptions or the composition of a redemption amount. Moreover, having emphasised at paragraph  the importance of a careful construction of the trust instrument, the Court concluded that a proper construction of the Wholesale Fund's constitution did not reveal any provision that had the effect of treating capital receipts as income of the trust estate. In doing so, the Court contrasted the terms of the Wholesale Fund's constitution with those of the trust deed in Commissioner of Taxation v Bamford (Bamford) which was held by the High Court to empower the trustee to allocate receipts to capital or income. [paragraph 49]
Whether the 'gain part' should be included in the assessable income of the redeeming unitholder as the redeeming unitholder's 'share' of the section 95 net income of the Wholesale Fund (the share of net income issue)?
The Court rejected Colonial's attempt to distinguish Bamford and confirmed that the meaning of share in 'share of the net income' in section 97 is a proportion not an amount.
Therefore the Court agreed with the Commissioner that what would be included in a redeeming unitholder's assessable income (assuming they were presently entitled to a share of trust income) depends on the ratio which a gain part bears to the total income available for distribution after provision for the trustee's expenses. [paragraphs 50-56]
Put differently, even if the effect of a redemption had been to make a redeeming unitholder presently entitled to income from which the gain part of the redemption payment was sourced, it would not follow that the gain part was the amount that was included in the assessable income of the redeeming unitholder under section 97.
Similarly, the Court rejected Colonial's argument that the amount assessed to remaining unitholders would not include the gain part paid to a redeeming unitholder.
Whether the 'gain part' is treated, by reason of Subdivision 115-C of the Income Tax Assessment Act 1997 (ITAA 1997), as a capital gain to be taken into account in calculating the assessable income of the redeeming unit holder and whether subsection 115-215(6) of the ITAA 1997 gives the redeeming unit holder a corresponding deduction (the 115-C issue)?
Having rejected Colonial's contention that the gain part of a redemption amount payable to a redeeming unitholder would be assessable to the unitholder as a share of the net income of the Wholesale Fund, the Court likewise rejected the next step in Colonial's analysis, namely that Subdivision 115-C of the ITAA 1997 would operate to characterise the share of net income so brought to account as a capital gain.
In this context the Court emphasised that even if a share of the net income of the Wholesale Fund had been included in the assessable income of a redeeming unitholder under section 97 (which was not the case), the amount of deemed capital gain recognised under Subdivision 115-C of the ITAA 1997 would not equal the gain part. Rather, Subdivsion 115-C of the ITAA 1997 would require an enquiry into how much of the proportionate share of the net income of the fund assessed to the unitholder was attributable to a capital gain made by the fund. [paragraphs 58-64].
To the extent that a redeeming unitholder would be taken to make a capital gain under Subdivision 115-C of the ITAA 1997, they would be entitled to a deduction under subsection 115-215(6) of the ITAA 1997 to offset the corresponding amount assessed under section 97. [paragraphs 91-93]
Whether a redeeming unitholder makes a capital gain from CGT event C2 happening upon redemption of the units (the C2 issue)?
The Court rejected Colonial's argument that the capital proceeds from the redemption of a unit was limited to that part of the redemption payment representing the initial subscription price paid for the unit.
The consequence of Colonial's argument would have been that no capital gain arose on redemption as the capital proceeds paid did not exceed the initial subscription price. However, the Court found that the entire redemption payment in respect of a unit (that is, including the gain part) represented capital proceeds from the ending of that unit. [paragraph 68]
As the Court had found that no amount received in respect of a redemption was included in the assessable income of unitholder under section 97, it considered that section 118-20 of the ITAA 1997 would not operate to reduce any capital gain arising by reason of CGT event C2 happening on that redemption. [paragraph 70]
Whether remaining unitholders were entitled to that part of the net income of the Wholesale Fund not distributed to redeeming unitholders (the distributable income issue)?
The Court adopted the Commissioner's reasoning in finding that in working out the distributable income of the Wholesale Fund (that is, the income of the trust estate for section 97 purposes), a range of amounts may be included in section 95 net income which 'are not capable of being recognised for accounting purposes, let alone founding an entitlement: eg franking credits, attributed foreign investment income, amounts included by operation of Pt IVA of the 1936 Act or deemed capital gains included by operation of the market substitution rule'. [paragraph 88]
Whether the Wholesale Fund is a fixed trust for the purposes of section 272-65 in Schedule 2F (the fixed entitlement issue)?
The Court found that the Wholesale Fund was not a 'fixed trust' for the purposes of section 272-65 of Schedule 2F as the interests of unitholders in income and capital of the trust were defeasible.
The Commissioner submitted that clause 43 of the constitution (which permitted the Responsible Entity to make any modification, addition or deletion to the constitution) was capable of being used to defeat any interests in the income and capital of the Wholesale Fund which the unitholders may enjoy.
The Court noted that the Commissioner's position failed to take account of paragraph 601GC(1)(b) of the Corporations Act 2001 which permits a Responsible Entity to change its constitution only if they consider the change will not adversely affect members' rights. However, the Court left open the question of whether there was any circumstance in which the Responsible Entity could terminate, invalidate or annul Colonial's entitlement to a share of the income or capital of the Wholesale Fund and reasonably consider that the change would not affect members' rights. [paragraphs 99-100]
Ultimately the Court held that the interests of unitholders in income and capital of the Wholesale Fund could be defeated by the unitholders exercising the powers granted to them under paragraph 601GC(1)(a) of the Corporations Act 2001 to modify, replace or repeal the constitution by special resolution. [paragraphs 103-106]
Tax Office view of Decision
Where a CGT asset is held on trust and a beneficiary is absolutely entitled to that asset as against the trustee, the beneficiary will effectively be treated as being the owner of that asset for the purposes of the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.
Outside of these CGT provisions, the ATO has consistently been of the view that assets held on trust for beneficiaries form part of the relevant trust estate, the net income of which is subject to Division 6 of Part III. This view is consistent with other authority. For example, in Harmer v Federal Commissioner of Taxation (1991) 173 CLR 264 the High Court accepted that Division 6 would apply in respect of money held by the applicants as bare trustees (as discussed by the Federal Court - see Harmer v FC of T 89 ATC 5180 at 5187-5189). Also, in the Federal Court decision of Di Lorenzo Ceramics Pty Ltd & Anor v FC of T 2007 ATC 4662, Lindgren J, in considering a deemed dividend received by a trust in respect of shares accepted as being held on bare trust, noted that the shareholder of those shares would be the trustee and not the beneficiaries of that bare trust, stating (at 4678):
110. If Tile held shares in Ceramics on a bare trust for Ceramics as to three quarters and Fresta as to one quarter, and Ceramics declared a dividend, the applicants would still face the difficulty that they now face. Tile would have received, as trustee, a dividend... Tile would be required to disclose the income as income of the trust estate, although it would not be liable as trustee to pay income tax upon it (s 96 of the Act). However, Ceramics and Fresta would be liable to do so as beneficiaries of the trust estate who were not under any legal disability and were presently entitled to shares of the income of the trust estate (s 97 of the Act).
111. It would not be to the point for Ceramics and Fresta to complain that the substance of the matter was that they were shareholders receiving the dividend declared. By reason of the structure adopted, they would have made it impossible for themselves to be regarded as the shareholders.
However, the ATO now accepts that, in situations with facts materially the same as those in Colonial First State Investments Ltd v Commissioner of Taxation, a retail fund is a beneficiary of a wholesale fund in respect of units in the wholesale fund that a custodian holds as trustee of a sub-trust for the retail fund. In this case, the Retail Fund was a resident. Its status as a beneficiary of the Custodian was known to the trustee of the Wholesale Fund.
This means that in these situations the net income of the wholesale fund in respect of the relevant units is dealt with on the basis that the retail fund, not the custodian sub-trust, is the beneficiary in respect of those units.
However, the fact that a custodian may not be a beneficiary of a wholesale fund in these circumstances does not have the effect of removing the custodian sub-trust or its net income or tax losses (if any), calculated apart from the relevant units, from the operation of Division 6 of Part III. Consistent with the authorities mentioned above, the net income of all trust estates, irrespective of their nature, is subject to Division 6 unless a specific legislative exclusion applies. There is no inconsistency between the decision in this case and that proposition.
Present entitlement issue
The ATO accepts that the test of present entitlement in Division 6 is not one that must be satisfied at the time income is derived by a trustee. However, for all trusts, the test is one that must be satisfied by the end of the relevant income year.
Income of the trust estate and share of net income issues
The decision in respect of these issues is in accordance with the ATO's understanding, following the High Court decision in Bamford, of the way in which the trust assessing provisions apply.
The decision in respect of this issue is consistent with the ATO's understanding of the operation of Subdivision 115-C of the ITAA 1997.
That is, under the proportionate approach confirmed in Bamford, the amount included in a beneficiary's assessable income under section 97 consists of an un-dissected proportionate share of the entirety of the trust's net income (that is a blended amount).
Accordingly, the part of a beneficiary's share of the trust's net income that is attributable to a particular capital gain made by the trustee of a trust estate is simply the beneficiary's proportionate share of so much of that gain as is reflected in the trust's net income. Stone J's decision that, to determine the amount included in a beneficiary's assessable income under subsection 97(1), the proportion of the income of the trust to which a beneficiary is presently entitled must be applied to 'the whole of the net income' of the trust supports this view. [See at paragraphs 54 to 56].
The decision confirms the ATO view on this issue.
Distributable income issue
Stone J's observations in respect of this issue support the Commissioner's view that notional amounts, to the extent they are not represented by any net accretion to the trust estate, such as franking credits, cannot form part of the distributable income of a trust estate. The consequence of this is that such amounts do not form part of the 'income of the trust estate' for Division 6 purposes.
Fixed entitlement issue
The decision confirms the ATO view that very few trusts satisfy the definition of 'fixed trust' in section 272-65 of Schedule 2F in the absence of the exercise of the Commissioner's discretion (essentially because beneficiary entitlements to income or capital are generally liable to be defeated by the exercise of a power in the deed or by a statutory power).
Implications for ATO Precedential documents (Public Rulings & Determinations etc)
Present entitlement issue
Taxation Rulings IT 328 and 329 indicate that the Commissioner accepts that a payment or application of income within two months of the close of an income year can give rise to a present entitlement to income as at year end.
The practice was introduced because of difficulties trustees encountered in calculating, by year end, the amount of business income available for distribution to beneficiaries. This was in an environment when resolutions generally quantified the amount of each beneficiary's entitlement rather than allocating a proportion of that income to them.
These Rulings were also published at a time before 'default beneficiary' clauses were in common usage. Those clauses are now commonly used in trust deeds in an attempt to ensure that beneficiaries are presently entitled to all of the income of a trust as at the end of the income year, with the result that no amount of the trust's net income is assessable to the trustee under section 99A.
For practical purposes the rulings can only ever have relevance in the case of a trust that does not require the trustee to appoint income by 30 June. For all trusts, a payment or application must be made in accordance with the trust deed and it is not and cannot be the practice of the Commissioner to advocate or sanction a breach of trust by accepting a distribution of income pursuant to a resolution made after the time prescribed by a deed.
Nevertheless, the decision in this case now makes it clear that the administrative practice is unsustainable in any case. If a beneficiary were to take the point that a resolution made after the end of the income year could not operate to confer a present entitlement by the end of an income year, the Commissioner might be obliged to concede any assessment based on it.
Accordingly the Commissioner intends to withdraw these rulings. However, in recognition that this advice has come so late in the 2010-11 income year, these rulings will not be withdrawn until after 31 August 2011.
Income of the trust estate, share of net income, 115-C and distributable income issues
On 2 June 2011 the Government introduced into Parliament a Bill containing amendments to the law to enable the streaming of capital gains and franked distributions in appropriate cases, with effect from the 2010-11 income year.
The ATO will assess the need for rulings on the current law (and their content) and on the new provisions following the passage of these amendments.
The Government has also announced changes will be made to the law to better align the concept of 'income of the trust estate' with 'net income of the trust estate' as part of the broader process of updating the trust income tax provisions and rewriting them into the ITAA 1997.
Fixed entitlement issue
The ATO has previously considered issuing a public ruling about the fixed entitlement test in the trust loss provisions in Schedule 2F. The ATO has previously concluded that, even on a purposive and contextual interpretation of the actual words used in the legislation, an interpretative position could not be reached that aligned with industry expectations. The indefeasibility requirement was significant in that respect.
The issue was also considered by the Board of Taxation as part of its review of the taxation arrangements applying to Managed Investment Trusts (MIT). The ATO does not propose to prioritise the fixed entitlement matter as a ruling topic while work on the MIT reforms is being undertaken.
In that regard the Government response to that review indicated:
The Board recommends that a trust which qualifies as a Regime MIT will be deemed to be a fixed trust for all other provisions of the taxation law.
The Government agrees to this recommendation in principle in respect of MITs that have clearly defined entitlements. The design details, including appropriate integrity rules, will be developed in the context of developing the new MIT regime.
The Board recommends that a general review of the fixed trust rules be undertaken with the aim of increasing certainty and reducing compliance costs for other unit trusts.
The Government agrees to this recommendation.
Implications for Law Administration Practice Statements
Law Administration Practice Statement PS LA 2000/2 - this Practice Statement relieves certain trustees from the obligation to lodge income tax returns. This dispensation does not however mean that trusts to which the Practice Statement applies are ignored for all tax purposes. That is, it is not intended that Division 6 should be disregarded in working out the income tax consequences for the beneficiary (eg. tax losses made by the trustee cannot be claimed directly by beneficiaries).
The ATO will consider amending the Practice Statement to make it clear that the lodgment exemption does not exempt a trustee from its responsibilities under Division 6. That is, while it does not require a trustee to lodge a return for an income year where the whole of the trust's net income is assessed to beneficiaries under Division 6, a return would be required if the application of Division 6 resulted in an assessment of the trustee under section 98, 99 or 99A. Also, the rules in Division 6 must be applied in determining the share of the trust's net income to be assessed to a beneficiary.
That said, as explained above, the net income of a custodial trust is to be determined by looking only to the property that forms part of the trust estate, and not to any property that is taken to be held by a retail fund beneficiary in situations materially the same as in this case.
Law Administration Practice Statement PS LA 2002/11 - our administrative practice which requires each request for the Commissioner's discretion to treat a trust as a 'fixed trust' to be escalated to the Losses and Capital Gains Tax Centre of Expertise will be maintained.
Corporations Act 2001 (Cth)
Income Tax Assessment Act 1936 (Cth)
Division 6 of Part III
Subdivision 272-A of Schedule 2F
272-5 of Schedule 2F
272-5(1) of Schedule 2F
272-5(2) of Schedule 2F
272-65 of Schedule 2F
Income Tax Assessment Act 1997 (Cth)
Taxation Administration Act 1953 (Cth)
Bamford v Federal Commissioner of Taxation
(2009) 176 FCR 250
2009 ATC 20-105
(2009) 73 ATR 49
Cajkusic v Federal Commissioner of Taxation
(2006) 155 FCR 430
2006 ATC 4752
(2006) 64 ATR 676
Commissioner of Taxation v Bamford
(2010) 240 CLR 481
2010 ATC 20-170
75 ATR 1
Commissioner of Taxation v Indooroopilly Children Services (Qld) Pty Ltd
(2007) 158 FCR 325
2007 ATC 4236
(2007) 65 ATR 369
Corin v Patton
(1990) 169 CLR 540
(1990) 92 ALR 1
Davis v Federal Commissioner of Taxation
(1989) 86 ALR 195
89 ATC 4377
(1989) 20 ATR 548
Harmer v Federal Commissioner of Taxation
(1991) 173 CLR 264
91 ATC 5000
(1991) 22 ATR 726
ING Funds Management Ltd v ANZ Nominees Ltd
 NSWSC 243
Kafataris v Deputy Commissioner of Taxation
(2008) 172 FCR 242
2008 ATC 20-048
(2008) 73 ATR 531
Smith v Permanent Trustee Australia Ltd
(1992) 10 ACLC 906
Zeta Force Pty Ltd v Commissioner of Taxation
(1998) 84 FCR 70
98 ATC 4681
(1998) 39 ATR 277
Although the two month concession was for discretionary trusts with business income, it has been applied to all trusts.
IT 328 was published in May 1966 and its two month administrative practice was endorsed in IT 329 in 1980.
See Assistant Treasurer Media release No. 025 (16 December 2010) 'Farmers benefit with changes to Trust Laws' and Media release No. 052 (13 April 2011) 'Improving the taxation of trust income'.
See Issues Register for NTLG Trust Consultation Sub-group.
See Assistant Treasurer Media Release No. 086 (7 May 2010) 'New Tax System for Managed Investment Trusts'.
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