Edited version of private ruling

Authorisation Number: 1011724738506

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Ruling

Subject: Income Tax: Settlement proceeds

Questions:

1. Are the settlement proceeds received by the applicant trustee in respect of the taxpayer's investment in the retirement village schemes ("settlement proceeds") taxable as:

(a) ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997);

(b) assessable recoupments under Division 20 of the ITAA 1997; or

(c) capital gains under section 102-5 of the ITAA 1997

and on what basis?

Answer: Yes, taxed as ordinary income.

2. Are the settlement proceeds derived:

(a) when the right to receive the settlement proceeds arises; or

(b) on the receipt of payment of such settlement proceeds.

Answer: Yes, derived on receipt.

3. If the Commissioner determines that the settlement proceeds are ordinary income (pursuant to section 6-5 of the ITAA 1997) or assessable recoupments (pursuant to Division 20 of the ITAA 1997), is the applicant trustee considered to have derived and be liable to pay tax on the settlement proceeds under Division 6 or section 254 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer: Yes, Division 6 of the ITAA 1936.

4. If the Commissioner determines that the settlement proceeds are capital gains (pursuant to section 102-5 of the ITAA 1997), is the taxpayer considered to have derived and be liable to pay tax on the settlement proceeds received from the winding up of retirement village schemes pursuant to section 106-30?

Answer: Not applicable.

5. If the Commissioner determines that the settlement proceeds are capital gains (pursuant to section 102-5 of the ITAA 1997), will the applicant trustee be treated as having derived and be liable to pay tax on the settlement proceeds under section 254 of the ITAA 1936?

Answer: Not applicable.

6. If the Commissioner determines that the settlement proceeds are capital gains (pursuant to section 102-5 of the ITAA 1997), is the 50% capital gains tax discount available to reduce the relevant capital gain?

Answer: Not applicable.

7. If the Commissioner determines that the settlement proceeds are assessable to the applicant trustee under Division 6 of the ITAA 1936, will the Commissioner exercise his discretion in section 99A(2) of the ITAA 1936 not to apply section 99A of the ITAA 1936 to the taxation of the applicant trustee on the settlement proceeds?

Answer: Yes.

This ruling applies for the following periods:

1 July 2006 to 30 June 2007

1 July 2007 to 30 June 2008

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

The scheme commences on:

30 June 1999

Relevant facts and circumstances

In 1999 and 2000, the taxpayer acquired partnership interests in two retirement village schemes (referred to as the Retirement Village Schemes) for the purpose of purchasing, constructing, selling, managing and/or operating specified retirement villages.

Taxpayer made investments in the following income years:

1998/1999

1999/2000

1999/2000

Relying on former Taxation Ruling TR 94/24, taxpayer deducted the whole value of their retirement village investments on the basis that they had incurred a liability to pay this whole value, even though their cash outlay was less. They believed that under the contracts entered into by the partnerships, of which they were a partner, they were fully committed to paying the whole value of such investments.

TR 94/24 was subsequently withdrawn by the Commissioner on 19 April 2000 and replaced with Taxation Ruling TR 2000/D5 which was later finalised as Taxation Ruling TR 2002/14 on 28 June 2002. However, the Commissioner indicated in TR 2002/14 that a partner who has acquired their retirement village interest prior to 19 April 2000 can continue to rely on TR 94/24.

The Commissioner disallowed part of the deductions claimed by the taxpayer on the basis that they could only deduct that part of the investment which had actually been paid. As a result, the Commissioner issued the taxpayer with amended income tax assessments for the 1999, 2000, 2001 and 2002 income year. The full Federal Court case of FCT v Malouf (2009) FCAF 44 provides support for the Commissioner's disallowance of these deductions.

In 2005, taxpayer was declared bankrupt by a debtor's petition and a trustee was appointed as their trustee in bankruptcy. Taxpayer's bankruptcy was annulled pursuant to section 74 of the Bankruptcy Act 1966 in 2008.

After the taxpayer was declared a bankrupt, proceedings were brought by Australian Securities and investments Commission (ASIC) against the operators of the two retirement village schemes which were held to be illegally managed investment schemes and were subsequently wound up by order of the Federal Court. Deed of settlement was entered into pursuant to which settlement proceeds were paid to the trustee on the following dates:

In 2008, taxpayer's creditors passed a special resolution accepting a composition proposal made by taxpayer pursuant to section 73 of the Bankruptcy Act 1966 (Cth) (Composition) as a full and final satisfaction of their debts. The composition comprises:

First retirement village investment

In 1999, taxpayer executed a partnership agreement whereby they acquired a partnership interest in a partnership in return for an initial payment. In the same year, this Partnership together with other partnerships (collectively referred to as the "these partnership"), executed agreements as tenants in common with a company for a retirement village development.

Under the sale contract, the company agreed to sell the retirement village once it had been developed and completed to the Partnership for a certain agreed amount.

By 2005, the retirement village had been completed. In June 2006, the Federal court ordered the retirement village managed investment scheme to be wound up in response to an ASIC application.

The sale contract was not settled. Instead, in 2007, a Deed of Settlement was entered into between all parties including the company and the manager of the partnership in which the taxpayer was a partner.

Neither the taxpayer nor the trustee were parties to the Deed of Settlement. Rather the manager of the Partnership, executed the Deed of Settlement in 2007. The trustee raised no objection to the Deed of Settlement being signed by the manager and received the amounts of money on behalf of the taxpayer.

Second retirement village investment

In return of making an initial payment in 2000, taxpayer acquired interests in two partnerships which together with two other partnerships formed the second retirement village syndicate. There was a trustee and manager of this syndicate. In 2000, the trustee entered into agreements with a developing company in relation to a retirement village development (known as the "second retirement village").

In 2006, ASIC obtained Federal Court orders that the second retirement village syndicate would be wound up since it was an unregistered managed investment scheme. At any time only preliminary work had been undertaken in relation to the retirement village development. A trustee, manager and liquidator was appointed for the second syndicate. In 2007, the Federal Court approved a Deed of Settlement which was entered into by parties including the trustee, manager and liquidator of the second syndicate. This Deed of Settlement was executed by September 2007.

The trustee entered into the Deed of Settlement with the consent of a Committee of Investors. Simply put, the trustee entered into the Deed of Settlement for and on behalf of each partner/investor in their capacity as, inter alia, agent for that investor/partner. The taxpayer's trustee in bankruptcy executed the Release to the Deed of Settlement in 2008 and received settlement proceeds on behalf of the taxpayer. The last payment was received by the trustee in their capacity as composition trustee in 2009.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 subsection 6-5(1),

Income Tax Assessment Act 1997 subsection 6-5(2),

Income Tax Assessment Act 1997 Division 20,

Income Tax Assessment Act 1997 Subsection 20-35(1),

Income Tax Assessment Act 1997 section 102-5,

Income Tax Assessment Act 1997 section 106-30,

Income Tax Assessment Act 1936 Division 6,

Income Tax Assessment Act 1936 subsection 6(1),

Income Tax Assessment Act 1936 section 99,

Income Tax Assessment Act 1936 section 99(2),

Income Tax Assessment Act 1936 section 99A,

Income Tax Assessment Act 1936 subsection 99A(2),

Income Tax Assessment Act 1936 paragraph 102AG(2)(c),

Income Tax Assessment Act 1936 section 254,

Income Tax Assessment Act 1936 paragraph 254(1)(a),

Income Tax Assessment Act 1936 paragraph 254(1)(d),

Income Tax Assessment Act 1936 paragraph 254(1)(e),

Bankruptcy Act 1966 section 73 and

Bankruptcy Act 1966 section 74.

Reasons for decision

Question 1

Summary

The settlement proceeds received by the applicant trustee in respect of the taxpayer's investment in the retirement village schemes are taxable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Section 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states that ordinary income is defined as having the meaning given by ITAA 1997. Section 6-5 of the ITAA 1997 sets out some basic rules relating to ordinary income. Section 6-5(1) defines ordinary income to mean income according to ordinary concepts which is included in a taxpayer's assessable income unless it is exempt, or is made non-assessable.

Income according to ordinary concepts is not defined in the income tax legislation. However, principles to determine whether a receipt is income according to ordinary concepts have been developed by case law. Accordingly, in determining whether a receipt is income according to ordinary concepts, it is necessary to apply the relevant principles developed by case law to the facts of the particular case.

In G P International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 at 136, the full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

Typical examples of income include salaries, wages, proceeds of carrying on a business, rent, interest, and dividends. Examples of items which are not generally income include lottery prizes, proceeds from a mere hobby, loans, and gifts. Sale of a capital asset is generally not income though it may be assessable statutory income under the capital gains provisions.

Case law on the topic of ordinary income has identified various factors in determining whether an amount is income according to ordinary concepts which include:

· whether the amount has the characteristics of periodicity, recurrence or regularity

· whether it is convertible into money or money's worth

· whether it is associated with business activities or services rendered, as distinct from the mere sale of property, and

· whether it is solicited, as distinct from a windfall.

The presence of these factors assist in a conclusion that the amount is more likely to be ordinary income though none are exhaustive or conclusive and depends on the circumstances of the case.

In FC of T v Cooke & Sherden (80 ATC 4140), Brennan, Deane and Toohey JJ, in a joint decision of the Full Federal Court in relation to ITAA 1936, stated (at pp 4147-4148):

Whether a receipt is to be treated as income or not is determined according to 'the ordinary concepts and usages of mankind'... except where statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept.

...

... The notion that the items of income are money or are to be reckoned as money accords with the ordinary concepts of income as 'what comes into (the) pocket' to adapt Lord Macnaghten's phrase in Tennant v Smith (1892) AC 150 at p. 164. That is not to say that income must be received as money; it is sufficient if what is received is in the form of money's worth... nor is it necessary that an item of income be paid over to the taxpayer: it is sufficient, according to ordinary concepts and usages, that it be dealt with on their behalf or as he directs...

Explanatory Memorandum to ITAA 1997 (at p 40), states that it has been left to the courts to develop principles for determining what is "ordinary income". There is no complete set of rules for determining this question and the indicia of ordinary income are found in numerous decisions.

Similarly, in FC of T v The Myer Emporium Ltd 87 ATC 4363, the Full High Court (in a joint judgment) said (at p 4370):

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.

In FC of T v Myer Emporium Ltd 87 ATC 4363, the High Court considered circumstances where there was a dispute as to the characterisation of income or capital. The Commissioner assessed a lump sum received by the taxpayer as assessable income in the year of receipt. This case was subject to extensive litigation and in summary it was decided that:

(a) gain from a "one-off' or isolated transaction is income even if the transaction entered into otherwise than in the ordinary course of carrying on a business of the taxpayer, as long as the transaction is entered into with the intention or purpose of making a profit. Californian Copper Syndicate v Harris (1904) 5 TC 159;

(b) where an asset is sold pursuant to a decision to sell existing at the time of acquisition, of profit-making by sale, in the context of carrying on a business, profit made on such a sale is income. London Australia Investment Co Ltd v FCT (1977) 7 ATR 757

(c) the assignment of the interest stream for lump sum and the lump sum received in exchange for the future interest which the taxpayer would have received is a revenue item and not capital. Comr of Internal Revenue v P G Lake, Inc 356 US 260 (1958);

(d) Court rejected Myer's argument that it received no profit. The selling of the income stream was a profit received from making the loan immaterial that the profit is received immediately and not over the period of the loan.

The High Court in this case (Myer's case) added a new dimension to the traditional indicia of income by denying that such tests necessarily prevailed when the transaction occurred in the course of carrying on a business. Periodicity and other tests for income are diminished if the receipt is generated in the course of carrying on a business. Therefore, an amount that is received in, or as an incident to, or a product of, a business carried by that taxpayer, is included in the ordinary income.

In FCT v Cooling (1990) 21 ATR 13, Hill J (ATR 25-6) stated;

if the transaction can properly be said to have been entered into by the firm in the course of carrying on its business and if it can be said that the arrangement is a profit-making scheme in the sense that those words are used by the High Court in Myer then it will follow that the amount received by the parties will be income and it will matter not that viv-a-vis the firm, the transaction was extraordinary.

In Warner Music Australia Pty Ltd v FC of T (1996) 34 ATR 171, Hill J said that:

in seeking to determine whether an amount is received in the ordinary course of carrying on a business, it will be necessary to examine in detail both the scope and nature of a taxpayer's business". He referred to Gibbs J's analysis in London Australia Investment Company Limited v FC of T (1976-1977) 138 CLR 106 at 116 citing Western goldmines NL v Commissioner of Taxation (WA)(1937-1938) 59 CLR 729 at 740 and said, "this involves a wide survey and an exact scrutiny of the taxpayer's activities.

It is therefore necessary to establish the character of the investment made by the taxpayer in the retirement villages and the subsequent proceeds of settlement received as a result of the winding up of the retirement villages pursuant to the Federal Court Orders.

In 1999 and 2000, the taxpayer acquired partnership interest in two retirement village schemes. The consideration for the investment made by taxpayer in the two partnerships of the retirement villages was to acquire a partnership interest in the business. As a result of this investment, taxpayer was allowed a deduction for payments actually made by him i.e. they could only deduct that part of the investment which had actually been paid (Federal court case of FCT v Malouf (2009) FCAFC 44) for a share in the business that intended to purchase, construct, sell, manage and/or operate a retirement village.

In Taxation Ruling TR 94/24, the Commissioner expressed that any expenses incurred by the owner in acquiring or developing a retirement village is considered to be expenditure of a revenue nature. A deduction is allowed for that expenditure in the year in which it was incurred. The Commissioner also stated that the proceeds from the sale of such retirement village will compromise assessable income to the vendor.

The Commissioner subsequently withdrew Taxation Ruling TR 94/24 on 19 April 2000 but indicated that where a partnership commenced its investment prior to that date, the partners can rely on Taxation Ruling TR 94/24. As the taxpayer's investment in the said partnerships was acquired before that date, taxpayer continued to rely on Taxation Ruling TR 94/24. Subsequently, as a result of ASIC's proceedings, the retirement village schemes were wound up pursuant to Federal Court Orders in 2006 as it was illegally managed investment schemes.

The Federal Court Order stated that:

On completion … the Scheme will have no assets, other than the refund from the first defendant to investors in the Scheme ….

Subsequently, the Commissioner in a letter to the taxpayer stated that:

Where a deposit for retirement village is refunded, we consider the refund to be assessable income in the year of receipt.

In ATO ID 2009/119, the Commissioner expressed their view that:

The receipt of a refund of a deposit in the circumstances of this case can properly be regarded as an incident of the business to be stamped with the character of income and would be included in the assessable income of the business under section 6-5 of the ITAA 1997: Warner Music Australia Pty Ltd v Federal Commissioner of Taxation (1966) 70 FCR 197; 96 ATC 5046; (1996) 30 ATR 171.

To the extent that the refund of the deposit is not included in the taxpayer's assessable income under section 6-5 of the ITAA 1997, it would be included in assessable income under subsection 20-35(1) of the ITAA 1997 where it is an assessable recoupment.

The Commissioner in Draft Taxation Determination TD 2009/D11 (Income tax: is a payment received by an investor in a non-forestry managed investment scheme upon the winding-up of the scheme, that does not involve the disposal of your interest in the scheme to another person, necessarily ordinary or statutory income under the Income Tax Assessment Act 1997?) states at para 10:

Prima facie, receipts from the conduct of a business are assessable income. A payment that is the consideration received in respect of the disposal of the assets of a business may be an income or capital receipt depending on the circumstances. As mentioned above, a disposal of assets that are, or are deemed to be, trading stock may give rise to assessable income. It is unlikely that an individual who is carrying on a business of primary production in the context of a managed investment scheme will have any goodwill associated with that business. Accordingly, whilst a member's interest may be the subject of, for example, CGT Event C2, this does not necessarily mean that any money received will be the capital proceeds from the ending of the interest. Rather, it is more likely to be a distribution of the remaining scheme property to investors as a result of their business endeavours, albeit that these have been conducted under contractual arrangements with the Responsible Entity. As such any payment is also unlikely to be the capital proceeds from the ending of the taxpayer's business.

As a result of the winding up of the said retirement village schemes where taxpayer made the investments, the retirement villages were unable to continue to meet its obligation and hence the purpose of the scheme cannot be accomplished. The issue of the monies invested and other property therefore remains to be paid to the investors and it is therefore important to determine the character of the monies refunded to the investors of the schemes. Generally, receipts from the conduct of a business are assessable income.

On the winding up of each of the unregistered retirement village schemes following the proceedings brought by ASIC, the Federal Court made Orders where the investors were refunded all monies initially invested. However, as taxpayer was made a bankrupt pursuant to a debtor's petition in 2005, the settlement proceeds were thus paid to the applicant trustee as trustee in bankruptcy as per the Deed of Settlements except for the last payment made in 2009 which was made to you in your capacity as composition trustee due to the annulment of the taxpayer's bankruptcy pursuant to section 74 of the Bankruptcy Act in 2008.

The nature of the investment made by the taxpayer into the retirement village schemes remains unaltered by the winding up of the retirement village schemes by ASIC. The payment was made by the taxpayer in their capacity as an investor to acquire a partnership interest in the business of retirement villages. The facts and the consideration for the investment made by the taxpayer to acquire a partnership interest in the business leads to the characterisation of the settlement proceeds received. In the circumstances, the investment made by the taxpayer in the retirement villages and the subsequent receipt of the settlement proceeds, retained the character of ordinary income. It does not have the characteristics of a capital nature. Further, taxpayer's interest in the two partnerships and the receipt of the settlement proceeds as a refund of the investments made in the retirement village is part of the business process and dealings which ought to be within the scope and nature of a business. The receipt of the refund of the settlement proceeds as a result of the winding up of the retirement village schemes or the prospect of such a receipt is within the scope and nature of the syndicate's business. Hence, the receipt of the refund of the settlement proceeds in the circumstances of this case is to be properly regarded as an incident of the business to be stamped with the character of income that would be included in the assessable income of taxpayer under section 6-5 of the ITAA 1997.

Question 2

Summary

The settlement proceeds are derived on the receipt of payment of such settlement proceeds.

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 states that assessable income includes ordinary income "derived" by the taxpayer during the income year. The issue of when income is "derived" is of considerable importance to ascertain the amount of tax payable.

In CT v Executor & Trustee Agency Co of South Australia (1938) 63 CLR 108 (Carden's case), Dixon J stated in the assessment of income:

the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.

There are basically two methods of tax accounting - the "receipts" or "cash" basis and the "accruals" basis. In the receipts basis, the income is not derived until it is received by the taxpayer. Under the accruals basis, an amount is derived once it becomes "due" to the taxpayer.

In this case, you as the applicant trustee, were paid the settlement proceeds in respect of the retirement village schemes based on the Deeds of settlement entered into and the Federal Court Orders made. Therefore, the right to the settlement proceeds arose at a time when the Court Orders were made and at a time when you were the trustee in bankruptcy for the taxpayer.

However, you received the majority of the settlement proceeds at a time when you were the trustee in bankruptcy except for one payment which you received in your capacity as the composition trustee for taxpayer's creditors after taxpayer's bankruptcy was annulled.

In the case of an agent or trustee, income may be derived by one person on behalf of another. Therefore, the agent or trustee is deemed to have derived the income in the year it is derived even if the beneficiary (or the trustee) does not receive or is not entitled to it in that year. Though the income is assessable to the person who is beneficially entitled to it, that does not mean that the person who derived the income for another, for which they are accountable to, did not derive the income in the first instance.

Gibbs J in Brent v FC of T 71 ATC 4195 at p 4200, where his Honour upheld an appeal against the assessment of an amount payable to the taxpayer, but not yet received by the taxpayer. His Honour said:

The Act does not define the word 'derived' and does not establish a method to be adopted as a general rule to determine the amount of income derived by a taxpayer, although particular situations not relevant to the present case are dealt with. The word 'derived' is not necessarily equivalent in meaning to 'earned'. 'Derive' in its ordinary sense, according to the Oxford English Dictionary, means 'to draw, fetch, get, gain, obtain (a thing from a source)'. It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which 'is calculated to give a substantially correct reflex of the taxpayer's true income' (The Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Carden's case) (1938) 63 CLR 108 at pp 152-154).

Although income can often be derived before it is received, it sometimes does not become income derived until after its receipt. In Jay's The Jewellers Pty Ltd v IR Commrs (1947) 29 TC 274, it was held that the amounts received do not represent income derived by the recipient until the recipient's title to it becomes absolute.

Based on the facts of this case and the previous advice to the taxpayer in a letter in 2007, the right to receive the settlement proceeds arose at the time of the making of the court orders but the point of derivation of the income is at the time of receipt of the income by you.

Question 3

Summary

The Commissioner determined that the settlement proceeds are ordinary income pursuant to section 6-5 of the ITAA 1997 and the applicant trustee is considered to have derived and be liable to pay tax on the settlement proceeds under Division 6 of the ITAA 1936.

Detailed reasoning

As discussed in Question 2 above, the trustee is considered to have derived the settlement proceeds upon receipt of the settlement proceeds by the applicant trustee.

The term "trustee" is defined in section 6(1) of the ITAA 1936 to include:

an executor or administrator, guardian, committee, receiver or liquidator and every person having the administration or control of income affected by any express or implied trust, or acting in a fiduciary capacity or having the possession, control or management of the income of a person under any legal or other disability.

The term "trust" is not defined for the purposes of the income tax legislation so the trust law definition is relevant. The following definition is often referred to by courts:

A trust is an equitable obligation, binding a person (who is called a trustee) to deal with property over which he has control (which is called the trust property), for the benefit of persons (who are called the beneficiaries or cestuis que trust), of whom he may himself be one, and any one of whom may enforce the obligation: see Re Marshall's Wills Trusts (1945) 1 Ch. 217 at 219; Green v Russell (1959) 2 Q.B. 226 at 241.

In Harmer v FCT 89 ATC 5180, French J referred to criticisms of the above definition for its emphasis on obligations rather than relationships. He then quoted the following definition, which has been relied upon by some Australian academics:

[A trust is] the relationship which arises wherever a person called the trustee is compelled in equity to hold property, whether real or personal, and whether by legal or equitable title, for the benefit of some persons ... or for some object permitted by law, in such a way that the real benefit of the property accrues, not to the trustee, but to the beneficiary or other object of the trust. [emphasis added]

The assessment of incomes of trust estates are dealt with by Division 6 of the ITAA 1936. The relation between the provisions of Division 6 and those of section 254 of the ITAA 1936 is explained by Rich and Dixon JJ in Howey v FCT (1930) 44 CLR 289 at 294 as:

Section 89 (now section 254) enables the Commissioner to assess a trustee but it is not easy to say precisely in respect to what income. It is perhaps doubtful whether it operates to impose upon a trustee any liability for tax which is not provided for by section 31 (now sections 95-102AA), and it is by no means clear what is the relation between section 89 (now section 254) and section 31 (now sections 95-102AA). Possibly, so far as it affects trustees, section 89 (now section 254) should be regarded as a "collecting section and not a taxing section", to borrow the language used by Lord Parker in Drummond v Collins (1915) AC 1011 at 1019. If so, it does no more in respect of trustees than provide machinery for carrying out the provisions of section 31 (now sections 95-102AA).

Section 254 of the ITAA 1936 applies to an entity that is an agent or trustee for the purposes of the ITAA 1936. Paragraph 254(1)(a) of the ITAA 1936 makes a trustee answerable as taxpayer for the doing of all such things as are required to be done by virtue of this Act and for the payment of tax on any income, profit or gain derived by the trustee in their representative capacity.

Paragraph 254(1)(d)of the ITAA 1936 states that an agent or trustee is obliged to retain from time to time out of any money which comes to him in their representative capacity so much as is sufficient to pay tax which is or will become due in respect of the income, profits or gains, and paragraph 254(1)(e) states that they are personally liable for the tax payable but only to the extent of any money that they are obliged to retain.

As stated earlier section 254 does not take precedence over the trust assessing provisions in Division 6 of Pt III of the ITAA 1936 and therefore a trustee's liability to pay tax as assessed under Division 6 of Pt III of the ITAA 1936 is not affected by section 254. Therefore, the trustee is liable to pay tax on the settlement proceeds under Division 6 Part III of the ITAA 1936.

Question 4

Question 5

Question 6

Summary for Questions 4, 5 and 6

As the Commissioner has determined that the settlement proceeds constitute ordinary income under section 6-5 of the ITAA 1997, these questions (question 4, 5 and 6) are not applicable.

Question 7

Summary

The Commissioner has determined that the settlement proceeds are assessable to the applicant trustee under Division 6 of the ITAA 1936 and the Commissioner will exercise their discretion in section 99A(2) of the ITAA 1936 not to apply section 99A of the ITAA 1936 to the taxation of the applicant trustee on the settlement proceeds for the period the applicant trustee was the trustee in bankruptcy for the taxpayer.

Detailed reasoning

Division 6 of the ITAA 1936 provides for the assessment of income tax on the income of a trust estate and the amounts distributed by the trust estate. The trustee of a resident trust estate will be assessed and liable to pay tax either under section 99 or 99A of the ITAA 1936 on the net income of the trust estate if there is no beneficiary presently entitled to whole or part of the income of the trust estate. All such income will initially fall under section 99A of the ITAA 1936 which applies automatically to any income of a trust estate where there is no beneficiary presently entitled to whole or part of the income of the trust estate unless the Commissioner is of the opinion that it is unreasonable to apply section 99A (section 99 of the ITAA 1936 will apply only if section 99A does not apply as provided for by section 99(1) of the ITAA 1936). Section 99A attracts a penal rate of tax whereas section 99 applies the individual rates of tax. The Commissioner has a discretion to apply section 99 rather than section 99A in the following situations (section 99A(2)):

· deceased estates

· bankrupt estates administered by Official Receiver or a registered trustee

· trusts that consist of the following types of property as specified in section 102AG(2)(c)

For the Commissioner to form an opinion pursuant to section 99A(2), section 99A(3) lists the matters to be considered by the Commissioner which states:

In forming an opinion for the purposes of subsection (2):

(a) the Commissioner shall have regard to the circumstances in which and the conditions, if any, upon which, at any time, property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to property of the trust estate, whether or not the rights or privileges have been exercised;

(b) if a person who has, at any time, directly or indirectly:

(i) transferred or lent any property (including money) to, or conferred any benefits on, the trust estate; or

(ii) conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate whether or not the right or privilege has been exercised;

has not, at any time, directly or indirectly:

(iii) transferred or lent any property (including money) to, or conferred any benefits on, another trust estate; or

(iv) conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of another trust estate, whether or not the right or privilege has been exercised;

the Commissioner shall have regard to that fact; and

(c) the Commissioner shall have regard to such other matters, if any, as he thinks fit: Perron v FCT (1972) 128 CLR 595.

In determining the weight given to the matters described in subsection 99A(3) of the ITAA 1936, Windeyer J has stated in Giris Pty Ltd v FC of T (1969) 119 CLR 365; 69 ATC 4015; (1969) 1 ATR 3 that:

The Commissioner is to ask himself whether it would be unreasonable that section 99A of the ITAA should apply to any particular trust estate. But the idea of reasonableness seems to be here amorphous....It does not clearly emerge from the Act in respect of what matter - or whose interest...he is to consider whether it would be reasonable or unreasonable to apply section 99A in the case of any particular trust estate. He is to have regard to certain stated matters; but what weight or influence each is to have is not made clear.....That [the Commissioner] has formulated certain considerations by which he is guided, and made them publicly known, may be important as showing that in the exercise of their statutory discretion he acts honestly, consistently and, as he thinks, in accordance with the legislative purpose. That purpose I take it is to enable the Commissioner to keep sec 99A as an instrument to prevent avoidance of taxation by the medium of trusts, but not to use it when to do so would seem to him not in accordance with that purpose.

In Official Receiver in Bankruptcy as Trustee of Estate of William Fox (otherwise Rankin) v FC of T (1956) 11 ATD 119, the Official Receiver was liable to be assessed under the provisions of section 99 of the ITAA 1936.

In the circumstances and in accordance with the abovementioned court decisions, the Commissioner is of the opinion that it would be unreasonable to apply the special rate of tax under section 99A of the ITAA 1936 to the settlement proceeds. Accordingly, the Commissioner will exercise their discretion under section 99A(2) of the ITAA 1936 and assess you (the applicant trustee) on the settlement proceeds for the period you (the applicant trustee) was the trustee in bankruptcy for the taxpayer.

The last payment was received by you in 2009 in your capacity as a composition trustee for the taxpayer's creditors. As stated in Question 2, the right to receive the settlement proceeds arose at the time of the making of the court orders but the point of derivation of the income is at the time of receipt of the income by you. As stated by you (Clause 7.1 (c)), the right to receive the settlement proceeds was assigned by the taxpayer to you as composition trustee for the taxpayer's creditors as part of their composition arrangement prior to the receipt of this last payment of the settlement proceeds. By virtue of section 254 of the ITAA 1936, every trustee and agent is answerable as a taxpayer for the doing of all such things as are required by virtue of the Act for any income, profits or gains derived by him in their representative capacity and for the payment of tax thereon. Paragraph 254(1)(d) of the ITAA 1936 states that the trustee is authorised and required to retain out of any money which comes to him in their representative capacity so much as is sufficient to pay tax which is or will become due in respect of income, profits or gains.

Therefore, in the circumstances you are required to pay any tax due and payable in respect of any income, profits or gains derived by you in your representative capacity despite the annulment of the bankruptcy of the taxpayer. The annulment of the taxpayer's bankruptcy does not provide an avenue for the avoidance of the tax obligations.