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Ruling

Subject: Income Tax: Trust income

Question 1

Did the payment of moneys to the Public Trustee by the appellants as a result of the order to pay moneys into court result in the creation of a trust estate of which the Public Trustee is trustee for the purposes of Division 6 of Part Ill of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

If no trust estate was created, is interest derived on the funds invested by the Public Trustee in its Common Account exempt from income tax under section 24AM of the ITAA 1936?

Answer

Not applicable.

Question 3

If a trust estate was created, is any beneficiary or are any beneficiaries presently entitled to interest derived on the funds invested by the Public Trustee within the meaning of the term in section 97 and/or section 95A of the ITAA 1936?

Answer

No

Question 4

If a trust estate was created and no beneficiary is presently entitled to interest derived on the funds invested by the Public Trustee, is the Public Trustee, as trustee of the trust estate:

(a) exempt from income tax under section 24AM of the ITAA 1936 on the interest derived on the funds invested?; or

(b) liable for income tax under section 99A of the ITAA 1936 on the interest derived on the funds invested?

Answer

(a) No

(b) Yes

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Court ordered that various defendants (appellants) pay certain amounts to various plaintiffs in the action (respondents). That judgment is currently subject to appeal.

In response to those orders the appellants made an interlocutory application to the Supreme Court seeking that payment of the judgment sum to the respondents be suspended until the appeal proceedings are finalised.

The Court suspended certain orders of the case until further order of the Court, provided that the appellants paid an amount ("Judgment Amount") either:

1. into an account (termed a 'suspension account); or

2. into Court.

In relation to paying an amount into Court, it was also ordered that the payment made into Court pursuant to these orders are to be invested by the Public Trustee in its Common Account.

The Judgment amount is now being held in several separate accounts which form part of the Public Trustee's Common Account pending the outcome of the appeal. The interest is being added to the balance in each account.

Relevant legislative provisions

Income Tax Assessment Act 1936, section 24 AM

Income Tax Assessment Act 1936, section 97

Income Tax Assessment Act 1936, section 98

Income Tax Assessment Act 1936, section 99

Income Tax Assessment Act 1936, section 99A

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

Reasons for decision

Question 1

Summary

It is considered that the payment of moneys to the Public Trustee by the appellant as a result of the Court order result in the creation of a "trust estate" for the purpose of Part III of the ITAA 1936.

Detail reasoning

A trust is the creature of equity rather than common law. There is no simple definition of equity. The word is used in many ways. Sometimes a court when speaking of the interpretation of statutes will refer to "the equity" of a statute, that is to say, a meaning based on liberal interpretation rather than close literal interpretation. On equitable construction of statutes which was possible in England in earlier times: Maxwell on the Interpretation of Statutes (12th ed, 1969), pp 236-238. The technique may not be entirely outmoded: Seaford Court Estates Ltd v Asher [1949] 2 KB 481 at 499; Beattie v Ministry of Transport [1973] 1 NZLR 20.

The nature of a trust is described in the following terms in Jacobs Law of Trusts in Australia, 6th Ed, as follows:

A trust is not a juristic person with a legal personality distinct from that of the trustee and the beneficiaries, whether they be individuals or corporations. A trust exists when the holder of a legal or equitable interest in certain property is bound by an obligation cognisable and enforceable in equity, to hold the interest not for its own exclusive benefit but for the benefit, as to the whole or part of such interest, of another person or persons, or of himself and such other persons, or for some object or purpose permitted by law.

Legally, trusts are classified as express, implied or constructive trusts. The first of these categories of trusts are created by express declaration or intention and the second and third by operation of law (see in Jacobs Law of Trusts in Australia, 6th Ed, p 62ff).

The concept of a "bare trust" was discussed by Gummow J in Herdegen & Anor v FC of T 88ATC 4995;(1988) 84 ALR 271. The concept encompasses a trustee who has no discretion, only nominal legal control of the property, and one duty, namely to convey it on demand. Such a case, cited by his Honour, was Re Docwra (1885) 29 ChD 693 where the trustees of certain real estate had but one obligation, being obedience to a court order to convey the land to a purchaser in accordance with the judgment of the Court.

In Harmer & Ors v FC of T 89 ATC 5180, where three solicitors were directed by the Court to hold moneys in an investment account with a named society "on trust" until certain legal proceedings were determined. French J said (at p 5189) that the control the solicitors exercised "may have been that of a bare trustee under a limited obligation" but it was a degree of control consistent with the existence of an equitable obligation and the ability to discharge it.

On appeal FC of T v Harmer & Ors 90 ATC 4672, the Full Federal Court upheld French J's finding that there was a trust. Wilcox and Lee JJ, in a joint judgment, said that legal title was given to the solicitors and the obligations placed upon them, namely to invest the moneys and earn income there from, were in the nature of trust obligations. The fact that the Court directed the manner in which the moneys were to be invested did not prevent trust obligations arising in respect of those moneys. Northrop J gave similar reasons for his decision that the solicitors were trustees of the disputed moneys. However, the Full Court disagreed with French J's decision that the parties to the dispute were beneficiaries presently entitled to trust income, ie the interest earned on the disputed moneys, within the meaning of section 97 of the ITAA 1936. The Full High Court confirmed the decision of the Full Federal Court on this issue: Harmer & Ors v FC of T 91 ATC 5000

When a court of equity decides to award a remedy against a defendant who in certain situations (including some cases of unjust enrichment) unconscionably seeks to retain property against another person it may consider that the most suitable remedy is a declaration that the defendant is a constructive trustee of the property for the plaintiff rather than a declaration that the plaintiff is to have a charge over the property or is to be awarded monetary equitable compensation.

An example of a constructive trust in a tax context is Zorbory v FC of T 95 ATC 4251 where the taxpayer argued successfully that moneys taken from his employer were held on constructive trust for that employer. The taxpayer was the Chief Accountant of Canon and withdrew moneys from a company account and invested those funds in bank accounts under his control. The Court concluded that the establishment of a constructive trust required no more than proof that the moneys invested belonged to the company. On that basis, it was held that the taxpayer was not liable to tax on the interest that was derived on those funds.

In this case the Court ordered that the Judgment amount to be held in the Common Account of the Public Trustee, which is the relevant "Fund". In The Registrar of the Accident Compensation Tribunal (Vic) v FC of T 93 AT 4835; it was held that the Registrar of the Victorian Accident Compensation Tribunal was a trustee of moneys he held in a fund on behalf of the dependants of deceased workers. The majority was of the view that the compensation moneys paid to the Registrar were trust moneys in the ordinary sense. They were held by the Registrar in trust for persons entitled to those moneys and, subject to the relevant provisions of the workers compensation legislation, should be administered by him in accordance with the general law of trusts. Further, as Kiefel J explained in Raftland Pty Ltd v FCT 2006 ATC 4189, at paragraph 65 (her comments not being overturned on appeal: see Raftland Pty Ltd v FCT 2008 ATC 20-029, per Gleeson CJ, Gummow and Crennan JJ, at paragraph 63):

A trust exists when the holder of a legal or equitable interest in property is bound by an obligation to hold that interest for the benefit of others or for some object permitted by law: RP Meagher & WMC Gummow, Jacobs' Law of Trusts in Australia 6^th Edition, Butterworths, Australia, 1997 at [101] ("Jacobs"). It is the essence of a trust that it is recognised by and enforceable in equity: Registrar of the Accident Compensation Tribunal v Federal Commissioner of Taxation (1993) 178 CLR 145 at 175 (emphasis added).

As determined in Harmer v FCT 91 ATC 5000; the court noted at 5006:

It is unnecessary to consider whether the contingent interests of the claimants in the moneys paid into court could be aggregated into a totality of beneficial ownership or whether the powers of the Supreme Court to make orders affecting the moneys, including orders as to costs, meant that one of the elements of an ordinary non-purpose trust was lacking. It suffices to say that the trust upon which the moneys were held was a trust for statutory purposes and that the legislative provisions, including Rules of Court, applicable to govern the payment of the moneys into court and their subsequent application effectively overrode any need of that element (emphasis added).

The Public Trustee is still a trustee of the Common Account, which derived the interest, regardless of the lack of any fiduciary relationships.

Based on the above, it is considered that the payment of moneys to the Public Trustee by the appellant as a result of the Court order result in the creation of a "trust estate" for the purpose of Part III of the ITAA 1936.

Question 2

Not Applicable

Question 3

Summary

Under trust law, a beneficiary must have an indefeasible, absolutely vested and beneficial interest in the share of the net income of a trust estate before it is considered that present entitlement exists. The beneficiary must be able to demand immediate payment of the income in order to be presently entitled to the share of the income.

In this case the money held in the Common Account of Public Trustee is not owned by the State (as beneficial owner) but held in trust, where the beneficiaries only have a contingent interest, or a vested but defeasible interest, which means they are not 'presently entitled': Walsh Bay Developments Pty Ltd & Anor v FCT 95 ATC 4378, per Beaumont and Sackville JJ, at 4393. An 'estate is contingent if the title of the holder depends upon the occurrence of an event': Harmer, at 5004; Walsh Bay Developments, at 4388; and 'the entitlement of each of the appellants to interest earned at that time depended on uncertain future events' (which, in your case, is the outcome of the appeals): Walsh Bay Developments, at 4390. The trustee, being the Public Trustee is correctly assessed on the income derived to which no beneficiary is presently entitled.

Detailed reasoning

Under trust law, a beneficiary must have an indefeasible, absolutely vested and beneficial interest in the share of the net income of a trust estate before it is considered that present entitlement exists. The beneficiary must be able to demand immediate payment of the income in order to be presently entitled to the share of the income.

The phrase presently entitled is a central concept in those sections in Division 6 of Part III of the ITAA 1936 which impose a liability to tax. There is no definition of the term "presently entitled" in the ITAA 1936, in fact it is a term which is unique to the tax law. It is therefore necessary to fall back on judicial dicta to establish the meaning which has been given to the term by the Courts. The principles established by the courts apply to all trusts whether created inter vivos or will.

The meaning of the words 'presently entitled' has been considered in a number of High Court decisions. Those decisions have not attempted to give a comprehensive definition of what it means to be presently entitled. In these cases the court has preferred merely to ask itself whether the beneficiary was presently entitled in the particular circumstances in question, although the cases do contain some suggestions as to the broader meaning of the phrase. The conclusions be drawn from those cases that a beneficiary is presently entitled to a share of the net income of a trust estate when the beneficiary is able to demand payment of a distribution of that share or is able to direct the trustee to deal with it on behalf of the beneficiary, or would, but for the presence of a legal disability, be so able.

It would seem that for a beneficiary to be able to demand a distribution the beneficiary must, subject to the rule in Saunders v Vautier (1841) 4 Beav.115, have a vested interest in possession. The rule is particularly relevant where accumulation is directed to be made until the beneficiary reaches a greater age than 18 years. Its application is considered to confer present entitlement on a sole beneficiary who has attained his majority, and has an absolute indefeasible interest, even though the trust instrument may direct further accumulation.

In Dwight v FC of T 92 ATC 4192 (Dwight), Hill J held that the beneficiary was presently entitled to the interest income from a trust account which had been established to hold money deposited as security for costs. Hill J held that the interest earned from the trust account was income of the beneficiary notwithstanding that the trustee could deal with it in the event of a court order for costs being made against the beneficiary. Accordingly, the beneficiary had a vested and indefeasible interest in the income from the trust account and in view of this, it was deemed to be presently entitled to the interest income.

Hill J said at 4203,

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 at 63, and Re Kilpatrick's Policies Trusts [1966] 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 and 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.

In FC of T v Harmer & Ors 90 ATC, parties to a dispute concerning money held under a court order by solicitors acting as trustees were not presently entitled beneficiaries as they did not have a present vested right to demand payment of trust income (the interest earned on the disputed moneys), affirmed by the Full High Court (Harmer & Ors v FC of T 91 ATC 5000). A trust arrangement, established from the depositing of moneys in joint names, resulted in no beneficiaries being presently entitled, as the interest of the parties in the income derived from the deposit pursuant to the Deed of Agreement was contingent and not vested (Walsh Bay Developments Pty Ltd v FC of T 95 ATC 4378).

Further, paragraph 23 of the Taxation Ruling IT 2680 states that:

23. The conclusion 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

was agreed to by the parties before the Full High Court in Harmer v. FC of T 91 ATC 5000 at 5004; (1991) 22 ATR 726 at 729, 730.

The Full High Court, per Mason CJ, Deane, Dawson, Toohey and McHugh JJ found in Harmer at 5006 that:

As had been the case when the moneys were held by the Court, however, any beneficial interest of an individual claimant was contingent upon an order being made in his or its favour. Unless and until such an order was made, no claimant had any vested interest in the moneys lodged with the Building Society, in the interest earned thereon or in the rights of the appellants as legal creditors of the Building Society.

Further, the money held in the Common Account of Public Trustees not owned by the State (as beneficial owner) but held in trust, where the beneficiaries only have a contingent interest, or a vested but defeasible interest, which means they are not 'presently entitled': Walsh Bay Developments Pty Ltd & Anor v FCT 95 ATC 4378, per Beaumont and Sackville JJ, at 4393. An 'estate is contingent if the title of the holder depends upon the occurrence of an event': Harmer, at 5004; Walsh Bay Developments, at 4388; and 'the entitlement of each of the appellants to interest earned at that time depended on uncertain future events' (which, in your case, is the outcome of the appeals): Walsh Bay Developments, at 4390. The trustee, being the Public Trustee, is correctly assessed on the income derived to which no beneficiary is presently entitled.

Accordingly, no beneficiary is presently entitled for the income derived from the money paid to the Common account of the Public Trustee.

Question 4

a) Exemption under section 24AM of the ITAA 1936

The money held in suspense is not owned by the State (as beneficial owner) but held by the Public Trustee of the State in trust for the contingent beneficiaries; and, therefore, any income on such is not income derived by the Public Trustee as a State Government instrumentality. Rather the income is derived by the Public Trustee as trustee for the various owners of proportionate beneficial interests. In these circumstances, no exemption from tax is available for the Public Trustee.

Further, the Public Trustee can be considered as a State or Territory Body under section 24AQ of the ITAA 1936. However, as explained above the Public Trustee is considered as trustee for the money paid to the Common Account of the Public Trustee as per the Court order. Therefore, the interest income earned from those account is not considered as Public Trustee's income. Accordingly, the interest income earned from those account is not exempt under section 24 AM of the ITAA 1936.

b) Liability to pay tax under section 99A of the ITAA 1936

Sections 99 and 99A of the ITAA 1936 apply to impose a liability to tax on the trustee of a trust estate in respect of income of the trust estate to which no beneficiary is presently entitled; that is, income which is neither assessable to a beneficiary under section 97 of the ITAA 1936 or to the trustee under section 98 of the ITAA 1936.

However, section 99A of the ITAA 1936 will not apply to a trust estate to which no beneficiary is presently entitled if the trust estate under subsection 99A(2) of the ITAA 1936:

1. resulted from a will or intestacy;

2. resulted from a bankruptcy; or

3. consists of property of a kind referred to in sec 102 AG(2)(c);and

4. the Commissioner forms the opinion that it would be unreasonable that section 99A of the ITAA 1936 should apply; .

In this case the trust that holds the moneys under Court order in the Common Account of Public Trustee does not fall into any of the categories above.

Therefore, the Public Trustee is liable to pay tax under section 99A of the ITAA 1936 for the income earned from the moneys deposited in the Common Account of Public Trustee of WA as per the Court order.