Edited version of your private ruling

Authorisation Number: 1012461884822

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Ruling

Subject: Income Tax - Assessable income - trust income - other

ISSUE 1

Question 1

Is D as trustee for the XYZ Trust (the Trust), obliged to lodge trust tax returns under subsection 254(1) of the Income Assessment Act 1936(ITAA 1936) for the years ended 30 June 2008, 2009 and 2010 during which time XYZ Pty Ltd (XYZ) was trustee of the Trust?

Answer

No.

ISSUE 2

Question 2

Is any part of the distribution made by Farmco Pty Ltd (Farmco) included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2003?

Answer

Yes. The amount that represents the franked dividend out of the total distribution made by Farmco Pty Ltd is included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2003.

Question 3

Are any of the distributions made by PropertyCo Unit Trust on the proceeds of the sale of asset it held and Lots 1, 2 and 3 of a property development it undertook included in the net income of the Trust under section 95 of the ITAA 1936 in the any of the years ended 30 June 2008 to 30 June 2010?

Answer

Yes. All distributions relating to Lots 1, 2 and 3 of the development are included in the net income of the Trust under section 95 of the ITAA 1936 in the years ended 30 June 2008 to 30 June 2010.

However, none of the distributions made by PropertyCo Unit Trust on the proceeds of the sale of the asset are included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2008 to 30 June 2010.

Question 4

Is any part of the distribution made by PropertyCo Unit Trust on 1 June 2009 included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2009?

Answer

Yes. All of the distribution is included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2009.

Question 5

Is any part of the distribution made by PropertyCo Unit Trust in 2006 included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2006?

Answer

Yes. All of the distribution is included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2009.

Question 6

Are any of the payments made by the Asset Partnership included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2004 to 30 June 2007?

Answer

Yes. All payments made by the Asset Partnership are included in the net income of the Trust under section 95 of the ITAA 1936 for the financial years ended 30 June 2004 to 30 June 2007.

Question 7

Are any of the payments made by the Asset Partnership included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2008 to 30 June 2010?

Answer

Yes. All payments distributed by the Asset Partnership are included in the net income of the Trust under section 95 of the ITAA 1936 for the financial years ended 30 June 2008 to 30 June 2010.

Question 8

Is any part of the payment made on or before 20 September 1995 by ABC Pty Ltd to XYZ on the sale of XYZ's interest in a farm included in the net income of the Trust under section 95 of the ITAA 1936 in the year ended 30 June 1996?

Answer

No.

Question 9

If any of the amounts described in Question 2 to Question 8 above are to be included in the net income of the Trust for any of the years ended 30 June 1996, 30 June 2003, 30 June 2006 and 30 June 2008 to 30 June 2010:

(a) what amount, if any, is assessable to the current trustee under section 99A of the ITAA 1936; and

(b) does subsection 254(1) of the ITAA 1936 apply so that any assessment will not be issued to the current trustee of the Trust or any beneficiary of the Trust as at 30 June of each of those years?

Answer

(a) None.

(b) Yes. Subsection 254(1) of the ITAA 1936 will apply so that any assessment will not be issued to the current trustee of the Trust or any beneficiary of the Trust as at 30 June of each of those years.

ISSUE 3

Question 10

Are any of the portions of the Settlement Sum received by the Trust in relation to alleged amounts misappropriated from the Trust included in the net income of the Trust under section 95 of the ITAA 1936 in the year ending 30 June 2013?

Answer

No.

This ruling applies for the following periods:

§ Income year ended 30 June 1996.

§ Income year ended 30 June 2003.

§ Income year ended 30 June 2004.

§ Income year ended 30 June 2005.

§ Income year ended 30 June 2006.

§ Income year ended 30 June 2007.

§ Income year ended 30 June 2008.

§ Income year ended 30 June 2009.

§ Income year ended 30 June 2010.

The scheme commences on:

September 1995

Relevant facts and circumstances

Background to the Trust

1. XYZ Pty Ltd was the sole trustee of the Trust until its removal in 2010.

2. XYZ has two shareholders who were also its directors. They were A and C. The constitution of XYZ required two directors for a quorum.

3. The beneficiaries of the Trust are defined in its deed of settlement as:

(i) A and B's extended family together being the specified beneficiaries named in the schedule to the Trust Deed, who take in default of appointment as to capital on vesting;

(ii) various relatives and related entities of theirs (who are objects of the trustee's power of appointment as to income in each accounting period and the trust fund on vesting); and

(iii) A and B (who are additional beneficiaries and objects of the trustee's power of appointment as to income in each accounting period and to the trust fund on vesting).

4. The appointors and guardians under the Trust are A for A's life, and after A's death, B.

5. A died in 2008. No-one was appointed to succeed A as a director of XYZ. Because of A's death and the failure to appoint another director, XYZ was constitutionally unable to determine the net income of the Trust Fund in accordance with the Trust's deed of settlement after that date.

6. The Trust Deed states that the Trustees "may at any time before the expiration of any Accounting Period determine with respect to all or any parts of the net income of the Trust Fund for such Accounting Period - (a) to pay apply or set aside the same to or for the benefit of any one or more of the beneficiaries; (b) to pay apply or set aside the same to or for the benefit of any one or more of the beneficiaries; (c) to accumulate the same".

7. XYZ did not lodge income tax returns for the Trust for the financial years ended 30 June 2008, 30 June 2009 and 30 June 2010. No tax returns have been lodged for the Trust for those years.

8. In 2010, D was appointed as trustee of the Trust by order of the relevant authority in substitution for the then trustee, XYZ, pursuant to the relevant act. On the same day, B undertook to the Court that B would not exercise any appointment powers B possessed in relation to the Trust.

9. XYZ and its director, C, were ordered to provide to the trustee all Trust documents in their possession or control. Documents were provided to the trustee in December 2010. The documents included Trust financial statements, tax returns, bank statements, cheque book butts and documents relating to the affairs of the Trust and other entities.

10. In each year of income ended 30 June 2003 to 30 June 2007 the net income of the Trust brought to account was distributed to A and C. There is no documentary evidence that the determinations were made prior to 30 June each year other than director's resolutions which had been prepared in early 2008 and backdated. Nevertheless, notices of assessment to A and C were issued in February 2008 on the basis of those reconstructed accounts and in March 2008 they paid income tax as assessed.

11. D, as the Trustee, lodged a Trust tax return for the year of income ended 30 June 2011 in June 2012. In July 2012 a notice of assessment was issued and in August 2012 the tax assessed thereupon was paid.

12. In December 2012 a Trust tax return for the year of income ended 30 June 2012 was lodged. No assessment for the 2012 financial year has issued.

Transactions

Farmco Pty Ltd.

13. Prior to 20 September 1985, XYZ as trustee for the Trust acquired one share in Farmco Pty Ltd representing 50% of that entity's share capital and became registered as the holder of that share in the subsequent year.

14. The principal asset of Farmco was a large tract of land on which a farming enterprise was conducted.

15. In 20xx, the land held by Farmco was sold, with settlement occurring in that year. Farmco received a bank cheque for the land sold.

16. In early 2003, it was resolved that Farmco would be wound up.

17. In the subsequent month 2003, XYZ received a letter from Farmco's liquidator informing it that he proposed to pay each shareholder half of the amounts available for distribution.

18. Immediately after, a letter was sent from A on behalf of XYZ (as trustee for the Trust) expressing agreement to the liquidator's proposal.

19. A bank cheque was then drawn in favour of XYZ as trustee for the Trust and handed to. A. This bank cheque was never presented to XYZ as trustee for the Trust's account. This distribution comprised net profit from the sale of the land and a franked dividend.

20. A dividend statement reflecting the franked dividend was sent by Farmco to XYZ as trustee for the Trust in 2003. The dividend was not disclosed in XYZ as trustee for the Trust's 2003 income tax return.

21. In July 2003, a further distribution was made by Farmco to XYZ by way of cheque. The distribution represented a return of capital and a franked dividend. A dividend statement was sent by Farmco to XYZ as trustee for the Trust in that same month.

22. The cheque was never presented to XYZ as trustee for the Trust's account. The dividend was not disclosed in XYZ as trustee for the Trust's 2004 income tax return.

23. The proceeds from both distributions were deposited into a bank account in the name of A and B.

24. A final meeting of Farmco was held and the company was deregistered in 2003.

25. There is no documentary evidence of a formal resolution or determination of a distribution of capital under the Trust's deed of settlement relating to the distribution of the land sale proceeds to. A and B.

Farm.

26. Some years ago, XYZ as trustee for the Trust became the registered owner of a half share as tenant in common with ABC in xx acres of land. A farm was conducted on the land in a partnership between these two entities.

27. C acquired all of the shares in ABC in the subsequent year. At the same time, C and A became directors of ABC.

28. In another year, XYZ as trustee for the Trust transferred its half interest in the land to ABC for a nominal amount.

29. Several years later, ABC sold the land to a third party for a substantially higher amount.

PropertyCo Unit Trust

30. PropertyCo Holdings Pty Ltd (PropertyCo Holdings) was incorporated by A and siblings.

31. PropertyCo Holdings was the sole trustee of the PropertyCo Unit Trust.

32. The PropertyCo Unit Trust was established by deed. XYZ was the holder of a certain share of the issued units of that Trust, from that date.

33. The PropertyCo Unit Trust's deed of settlement required the Trustee to pay the whole of the net income of the Trust Fund each year to unitholders in proportion to their unit holding. The deed entitled the Trustee, if directed by the unitholders, to make proportionate ayments of capital to the unitholders.

34. PropertyCo Holdings as trustee for the PropertyCo Unit Trust owned a certain number of assets. These assets were acquired by members of. A's family in the early twentieth century.

35. The assets were transferred to PropertyCo Holdings as trustee for the PropertyCo Unit Trust on or shortly following its establishment in 19xx.

36. The assets were sold in 20xx. A deposit was paid to PropertyCo Holdings as trustee for the PropertyCo Unit Trust and, a number of amounts, representing part shares of the deposit, were distributed for the benefit of the unitholders. A cheque was drawn in favour of A and was deposited into a bank account of A and B.

37. The net balance of the proceeds was received and distributed to the unitholders by PropertyCo Holdings as trustee for the PropertyCo Unit Trust in subsequent month in 2007.

38. In the subsequent month 2007, a cheque was drawn in favour of XYZ as trustee for the Trust and the cheque was deposited into a bank account of A and B.

39. Both the distributions noted above were made in the year of income ended 30 June 2008. Both distributions were of capital and were made for the benefit of XYZ as trustee for the Trust.

40. There is no documentary evidence that a formal resolution or minutes of a determination by XYZ under the Trust's deed of settlement relating to the distributions to A and B was made.

41. PropertyCo Holdings as trustee for the PropertyCo Unit Trust conducted a property development. Three allotments of a subdivision known as the PropertyCo Estate were sold in the income years ended 30 June 2008 to 30 June 2010.

42. Lot 3 was sold with settlement completed later in 2008. The net proceeds of the sale were paid into PropertyCo Holdings as trustee for the PropertyCo Unit Trust's cheque account and distributed for the benefit of the unitholders. Consequently, in late 2008, a cheque was drawn on PropertyCo Holdings as trustee for the PropertyCo Unit Trust's account payable to B. The cheque was presented for payment into a bank account in the name of B in the same month 2008.

43. Lot 1 was sold in 2009. The net proceeds were paid into PropertyCo Holdings as trustee for the PropertyCo Unit Trust's cheque account and distributed for the benefit of the unitholders. Consequently, in late 2009, a cheque was drawn on PropertyCo Holdings as trustee for the PropertyCo Unit Trust's account payable to B. The cheque was paid into a bank account in the name of B in late 2009.

44. Lot 2 was sold in early 2010 and the net proceeds of sale were subsequently received by PropertyCo Holdings as trustee for the PropertyCo Unit Trust. A cheque payable to XYZ as trustee for the Trust was drawn on PropertyCo Holdings as trustee for the PropertyCo Unit Trust's account. This cheque was paid into a bank account in the name of B in mid 2010.

45. The PropertyCo Unit Trust's cash payments book shows a cheque dated June 2006 payable to A. The amount was paid into a bank account in the name of A and B. in June 2006. There is no documentary evidence of any determination of the net income of the Trust Fund in accordance the Trust's deed of settlement in the 2006 income year.

46. The amount was brought to account as income of the Trust in its 2006 income tax return. The 2006 income tax return also shows the amount was distributed to A and B.

47. A distribution was made by the PropertyCo Holdings in its capacity as trustee for the PropertyCo Unit Trust for the benefit of XYZ as trustee for the Trust as a unitholder during June 2009. That amount was paid into a bank account in the name of B in the same month.

AssetLease Partnership

48. XYZ as trustee for the Trust held an interest in a partnership known as the 'AssetLease partnership'. The principal asset of the partnership was a large development.

49. The partnership received rental income from the assets in the income years ended 30 June 2004 to 30 June 2010 and paid it directly to A and B and on A's death to B alone. These amounts were referable to the income years ended 30 June 2004 to 30 June 2010.

50. XYZ did not determine the net income of the Trust Fund in accordance with the Trust deed of settlement.

51. The Trust's income tax returns for the income years ended 30 June 2004 to 30 June 2007 returned the amounts as income of the Trust and distributed to A and B.

Miscellaneous Payments

52. In early 2008, C drew a cheque from a Bank account held by XYZ as trustee for the Trust. The cheque was payable to A and B and was presented for payment into a joint account in their name.

53. There is no documentary evidence of any determination to make the payment as a distribution of capital or income by XYZ in its capacity as trustee for the Trust.

Proceedings and settlement

54. In a recent year, D in their capacity as Trustee for the Trust, commenced proceedings against C, D2 and ABC Pty Ltd concerning the alleged misappropriation of trust assets and breaches of equitable duties in relation to the transactions outlined above.

55. The Trustee sought to recover amounts relating to alleged misappropriations of Trust capital and Trust income from B.

56. A claim to recover from ABC Pty Ltd was advanced by the Trustee in relation to allegations that the sale of the farm land in 1995 was at below market value and a breach of fiduciary duty on the part of C.

57. The Trustee also sought to recover amounts for alleged misappropriations of Trust capital Trust income from C. A claim to recover an amount was also advanced in relation to allegations that the sale of the farm land in 1995 was at below market value and a breach of fiduciary duty on the part of C.

58. B brought a counterclaim against the Trustee to recover a sum paid to C under protest at the commencement of C's trusteeship.

59. In certain month in a recent year, an out-of-court settlement was reached by the parties. The Defendants jointly offered to pay the Trustee an amount less than the amount claimed in settlement of all his claims and in settlement of . B's counterclaim, which was accepted by the Trustee.

60. Of the $X received by the Trust from the Defendants, $Y, was paid by B and $Z was paid by C and ABC Pty Ltd.

Proposed Apportionment of Settlement Sum

61. B contributed XX% to the settlement sum and C and ABC Pty Ltd contributed YY% to the settlement sum.

62. In deriving the settlement sum, the Trustee incurred outgoings and expenses, resulting in a net settlement sum amount.

63. The Trustee therefore submits that the net settlement sum can be reasonably apportioned to each claim brought against B, C and ABC Pty Ltd.

Relevant legislative provisions

Income Assessment Act 1936 Subsection 6(1),

Income Assessment Act 1936 Section 44,

Income Assessment Act 1936 Section 47,

Income Assessment Act 1936 Section 92,

Income Assessment Act 1936 Section 95,

Income Assessment Act 1936 Subsection 161(1),

Income Assessment Act 1936 Subsection 254(1),

Income Assessment Act 1997 Section 6-5,

Income Assessment Act 1997 Section 104-10,

Income Assessment Act 1997 Section 104-20,

Income Assessment Act 1997 Subsection 104-25(1),

Income Assessment Act 1997 Subsection 104-70(7),

Income Assessment Act 1997 Subsection 104-135(5),

Income Assessment Act 1997 Section 108-5,

Income Assessment Act 1997 Section 108-7,

Income Assessment Act 1997 Section 109-10,

Income Assessment Act 1997 Section 116-20,

Income Assessment Act 1997 Section 110-25 and

Income Assessment Act 1997 Section 116-40.

Reasons for decision

ISSUE 1

Question 1

Summary

1. Subsection 254(1) of the ITAA 1936 does not impose any obligation on D as trustee for the Trust to lodge trust tax returns for the years ended 30 June 2008, 2009 and 2010 as D was not trustee for these periods.

Detailed reasoning

2. Subsection 161(1) of the ITAA 1936 imposes the requirement to lodge a tax return.

3. This provision states:

Every person must, if required by the Commissioner by notice published in the Gazette, give to the Commissioner a return for a year of income within the period specified in the notice

4. Subsection 254(1) of the ITAA 1936 imputes the obligations of a taxpayer arising under the Act to the trustee in their representative capacity.

5. Relevantly, paragraph 254(1)(a) states:

He or she shall be answerable as taxpayer for the doing of all such things as are required to be done by virtue of this Act in respect of the income, or any profits or gains of a capital nature, derived by him or her in his or her representative capacity, or derived by the principal by virtue of his or her agency, and for the payment of tax thereon.

6. Paragraph 254(1)(b) provides further clarity as the ambit of this provision:

He or she shall in respect of that income, or those profits or gains, make the returns and be assessed thereon, but in his or her representative capacity only, and each return and assessment shall, except as otherwise provided by this Act, be separate and distinct from any other.

7. It follows that the requirement to lodge a tax return is specifically imposed on the individual or entity acting in the capacity of trustee at the time of the relevant Commissioner's notice published in the Gazette, as it is this instrument that gives rise to the requirement to lodge.

8. Support for this position is found in Practice Statement Law Administration PSLA 2012/2, which outlines the Commissioner's view that the tax liability for a particular income year is imposed on whichever individual or entity occupies the position of trustee at the end of the income year (i.e. 30 June). The liability is not imposed on any subsequent trustee in the event of any change in trustee following the conclusion of that income year.

9. While PS LA 2012/2 does not explicitly address the issue of whether a trustee will be required to lodge trust tax returns for an income year during which they were not trustee, it is consistent that the obligation to lodge remains with the trustee at the time that the tax liability arose.

10. As discussed above, the requirements of a trustee to lodge trust returns and discharge the consequent liabilities both arise from subsection 254(1) of the ITAA 1936. Given that the Commissioner has expressed his view that pecuniary liabilities arising from subsection 254(1) are imposed on whichever individual or entity occupies the position of trustee as at 30 June of the relevant income year and not any subsequent trustee, the lodgement requirements arising from the same provision are imposed on the same individual or entity acting in the capacity of trustee as at 30 June of the relevant income year.

ISSUE 2

Question 2

Summary

11. Only the amount that represents the franked dividend out of the total distribution made by Farmco in early 2003 is included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2003.

Detailed reasoning

12. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

13. Accordingly, to determine whether any part of the distribution made by Farmco to XYZ as trustee of the Trust in early 2003 is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and Income Tax Assessment Act 1997 (ITAA 1997) to the amount as though the trustee were a resident in respect of that distribution.

Facts relevant to the distribution

14. Prior to 20 September 1985, XYZ as trustee for the Trust entered into an agreement to purchase one share in Farmco. XYZ became registered as the holder of that share 1986. The single share represented 50% of the issued capital in Farmco.

15. Prior to August 1985, Farmco purchased a large tract of land, which was used to conduct a farming enterprise. This land represented Farmco's principal asset.

16. The land owned by Farmco was sold and later that year, Farmco received a bank cheque in settlement of the sale.

17. Farmco was subsequently wound up and a bank cheque, which represented half of the amount available for distribution to Farmco shareholders, was drawn in favour of XYZ as trustee for the Trust. This cheque was never presented to the account of the Trust.

18. Part of the total amount of the cheque drawn in favour of Farmco as trustee for the Trust was referable to the net profit from the sale of the Farmco land. The remaining amount related to a franked dividend paid by Farmco to XYZ as trustee for the Trust.

Consequences of the cheque never being presented to the account of the Trust

19. On the assumption the cheque drawn by Farmco in favour of XYZ as trustee for the Trust was misappropriated by XYZ or any other party, our view is that the principle in Zobory v FC of T [1995] FCA 1226 will apply so that XYZ, or any other party who misappropriated the funds, held those funds on constructive trust with the Trust as the beneficiary of that constructive trust.

20. In Zobory, it was held by Burchett J that misappropriated funds were held on constructive trust by the thief of those funds for the benefit of the true owner or the wronged party and that such a constructive trust would divert the liability to income tax to the true beneficiary of the interest earned on those amounts held on constructive trust.

21. Relying on the decision in MacFarlane v FC of T [1986] 86 ATC 4477 that such a constructive trust would divert the liability to income tax to the beneficiary, Burchett J stated at 4491 that:

'MacFarlane is perhaps particularly relevant to the present case because Beaumont J., with whom Fisher J. and I agreed on this point, made it clear (at 367) that a constructive trust, as well as an express trust or resulting trust, would be fully effective to divert the liability to income tax to the beneficiary.'

22. In MacFarlane, cash receipt for the sale of petroleum by a company that had been appropriated by the shareholder of a company for his own use, and originally not included by the company in its tax return, was nonetheless included in its assessable income after the true position was revealed. It was held by Beaumont J that:

'The income in question was the property of the company. That income was applied for the benefit of one of the company's shareholders with the acquiescence of the controllers of the company. The application of funds may well have constituted a breach of the directors' fiduciary duties at least so far as the company's creditors were concerned. … But whether the conduct of the company's directors was liable to be challenged as a misfeasance is a different question.' 86 ATC 4477 at 4491.

23. The Court therefore applied former section 108 of the ITAA 1936 to deem the amount appropriated by the shareholder a dividend paid out of profits of the company.

24. Therefore, based on the principle expressed in Zobory and MacFarlane, any amount misappropriated by XYZ or any other party is considered at law to be held on constructive trust by XYZ or the other party for the benefit of the Trust.

25. Accordingly, the cheque drawn by Farmco in favour of XYZ as trustee for the Trust that was misappropriated by XYZ (or any other party) will nonetheless be assessed to the Trust as the beneficiary of the constructive trust created by the misappropriation.

26. It is therefore necessary to consider how the amount is assessed under the provisions of the ITAA 1936 and the ITAA 1997 as applied to the Trust for the distribution made by Farmco.

Application of the CGT provisions to the share in Farmco

27. As the share in Farmco is a CGT asset as defined in section 108-5 of the ITAA 1997, it is necessary to consider whether the amount is included in the assessable income of the trust as a capital gain under the CGT provisions of Part 3 of the ITAA 1997. The cancelation of shares in a company upon the liquidation of the company is a CGT Event C2: subsection 104-25(1) of the ITAA 1997.

28. However, a capital gain is disregarded if the taxpayer acquired the CGT asset that is a share before 20 September 1985: subsection 104-135(5) of the ITAA 1997. The table contained in section 109-10 of the ITAA 1997 provides acquisition rules for CGT assets acquired without a CGT event. According to Item 2 of the table in section 109-10 of the ITAA 1997, in the circumstances where a company issues or allots equity interests in the company to a taxpayer, the taxpayer acquires the asset when the contract is entered into.

29. XYZ as trustee for the Trust entered into the relevant contract for its share in Farmco prior to September 1985, which pre-dates the application of the CGT regime from 20 September 1985. That XYZ did not become the registered holder of the share until 1986 is not relevant because the contract for its share in Farmco was entered into prior to 20 September 1985.

30. Therefore, the amount of the cheque relating to the sale of the land is not included in the assessable income of the Trust under the CGT provisions.

Application of section 47 of the ITAA 1936: distributions by a liquidator

31. As the cheque constituted a liquidator's distribution, section 47 of the ITAA 1936 is relevant. Subsection 47(1) of the ITAA 1936 states:

'Distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.'

32. Subsection 47(1A) of the ITAA 1936 limits the ambit of the concept of 'income' for the purposes of subsection 47(1):

A reference in subsection (1) to income derived by a company includes a reference to:

(a) an amount (except a net capital gain) included in the company's assessable income for a year of income; or

(b) a net capital gain that would be included in the company's assessable income for a year of income if the Income Tax Assessment Act 1997 required a net capital gain to be worked out as follows: … [Method statement omitted].

33. The land held by Farmco was purchased prior to XYZ acquiring its interest in Farmco prior to 20 September 1985 and is therefore a pre-CGT asset. Accordingly, the proceeds from the sale of the land were not included in the Farmco's assessable income.

34. The amount distributed to XYZ as trustee for the Trust therefore does not satisfy the definition of income for the purposes of subsection 47, contained in subsection 47(1), as the amount does not represent income from either the company's assessable income or a net capital gain for a year of income.

35. Similarly, CGT event G1, which generally applies to bring otherwise non-assessable capital distributions by companies within the purview of the CGT regime, will not apply, as XYZ Pty Ltd as trustee for the Trust's share in Farmco was acquired before 20 September 1985 as per subsection 104-135(5) of the ITAA 1997.

Application of section 44 of the ITAA 1936 to the franked dividend

36. As previously stated, part of the cheque drawn in favour of XYZ as trustee for the Trust in early 2003, comprised a franked dividend.

37. In determining the assessability of this amount, regard must be had to the operation of section 44 of the ITAA 1936.

38. Subsection 44(1) of the ITAA 1936 relevantly provides:

'The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes:

(a) if the shareholder is a resident:

(i) dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and

(ii) all non-share dividends paid to the shareholder by the company; …'

39. Subsection 6(1) of the ITAA 1936 defines 'paid' for the purposes of section 44:

paid in relation to dividends or non-share dividends includes credited or distributed.

40. The franked dividend was both credited and distributed to XYZ as trustee for the Trust by Farmco.

41. The fact that the cheque referable to the franked dividend was never presented to the account of XYZ as trustee for the Trust does not render the amount as not being 'paid' for the purposes of section 44 of the ITAA 1936.

42. The franked dividend component of the cheque is therefore included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2003 as a dividend under section 44 of the ITAA 1936.

Question 3

Summary

43. None of the distributions made by PropertyCo Unit Trust on the proceeds of the sale of the Assets it held are included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2008 to 30 June 2010.

44. Distributions relating to Lots 1, 2 and 3 of its property development are included in the net income of the Trust under section 95 of the ITAA 1936 in the years ended 30 June 2008 to 30 June 2010.

Detailed reasoning

45. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

46. Accordingly, to determine whether any part of the distributions made by the PropertyCo Unit Trust to XYZ as trustee of the Trust is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of that distribution.

47. The PropertyCo Unit Trust was established with XYZ as trustee for the Trust as the holder of certain share of its issued units. The trustee was PropertyCo Holdings Pty Ltd (PropertyCo Pty Ltd), which was a company incorporated by A and A's siblings.

Sale of certain Assets

48. A number of certain assets were held by A's family for several decades and were transferred to the PropertyCo Unit Trust on or shortly following its establishment in some time ago.

49. These assets were sold in 2007. Prior to their sale, the assets had been used as capital assets from which assessable income was derived. Accordingly, the proceeds of sale are considered to be on capital account.

50. During the 2008 income year, cheques in relation to the sale proceeds were drawn in favour of XYZ as trustee for the Trust. The cheques represented distributions referable to XYZ as trustee for the Trust's one-fifth interest in the issued units of the PropertyCo Unit Trust.

51. As the assets were acquired by the PropertyCo Unit Trust prior to 20 September 1985, any capital gain arising from their disposal will be disregarded: paragraph 104-10(5)(a) of the ITAA 1997.

52. It is well-established that an amount will retain its character as it flows through a trust to a beneficiary. This is known as the "conduit theory", the origins of which are found in the case of Syme v FCT (1914) 18 CLR 519, wherein it was stated at 512:

'In the ordinary course of business the trustee may mix all the sums that come to their hands from all sources, and with them discharge indiscriminately all or any of the obligations which fall upon them whether at law or equity … What was the produce of personal exertion in the trustees' hands till they part with it does not, in the instant of transfer, suffer change, and become the produce of property and not of personal exertion, as it passes to the hands of the cestui que trust'.

53. This principle was affirmed in Charles v FCT (1954) 90 CLR 598 at 601:

'On the proper construction of the Act … there could not be any change in the character of these moneys between the time they were held by the trustees and the time they were held by the beneficiaries.'

54. Therefore, the distributions will retain their pre-CGT status in the hands of XYZ as trustee for the Trust. Similarly, CGT event E4 will not apply because the Trust acquired its units in the PropertyCo Unit Trust prior to 20 September 1985: subsection 104-70(7) of the ITAA 1997.

55. Consequently, the distributions relating the proceeds of the sale of assets are excluded from the net income of the Trust under section 95 of the ITAA 1936 in the 2008 income year, as the distributions are capital in nature and any associated CGT event will be disregarded due to the retention of the underlying asset's pre-CGT status.

Sale of Lots 1, 2 and 3 of the property development

56. PropertyCo Holdings also conducted a subdivision as part of a property development business it operated. As the subdivision relates to a property development business, any proceeds are of an income character: FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; and Taxation Ruling TR 92/3.

57. Lot 3 was sold in 2008 income year. Subsequently a cheque was drawn on PropertyCo Holdings' cheque account in favour of XYZ as trustee for the Trust as payee in relation to the net proceeds of the sale.The cheque was paid into a bank account in the name of B.

58. Lot 2 was sold in 2010 income year. A cheque in favour of XYZ as trustee for the Trust as payee, was drawn on PropertyCo Holdings' cheque. The cheque was paid into a bank account in the name of. B.

59. Lot 1 was sold in mid 2009.and a cheque payable to B was drawn on PropertyCo Holdings' cheque account in late 2009. That cheque was paid into a bank account in the name of B in late 2009.

60. All three distributions represented income to which XYZ as trustee for the Trust was entitled as unit holder of the PropertyCo Unit Trust. Therefore, on the assumption that these amounts have been misappropriated by B, these amounts are considered at law to be held on constructive trust by B the benefit of the Trust: see discussion of Zobory under Question 2 above.

61. As the distributions from the sale of Lots 1, 2 and 3 stem from revenue derived in the carrying on of a property development business, they will constitute assessable income according to ordinary concepts under section 6-5 of the ITAA 1997. Therefore, consistent with principle enunciated in Syme and Charles, these distributions are included in the net income of the Trust under section 95 of the ITAA 1936 in the years ended 30 June 2009 and 30 June 2010.

Question 4

Summary

62. The distribution made by the PropertyCo Unit Trust in June 2009 is included in the net income of the XYZ Trust under section 95 of the ITAA 1936 for the year ended 30 June 2009.

Detailed reasoning

63. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

64. Accordingly, to determine whether the distribution made by the PropertyCo Unit Trust to XYZ as trustee of the Trust in June 2009 is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of that distribution.

65. A distribution was made by the PropertyCo Unit Trust for the benefit of XYZ as trustee for the Trust as its unitholder in June 2009. A cheque was made payable to B in the same month. This cheque was paid into a bank account in the name of B in mid June 2009.

66. The cheque represented an amount to which XYZ as trustee for the Trust was entitled as unit holder of the PropertyCo Unit Trust. Therefore, on the assumption that these amounts have been misappropriated by B, these amounts are considered at law to be held on constructive trust by B for the benefit of the Trust: see discussion of Zobory under Question 2 above.

67. Accordingly, this amount is included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2009 and 30 June 2010.

Question 5

Summary

68. The distribution made by PropertyCo Unit Trust in June 2006 is included in the net income of the Trust under section 95 of the ITAA 1936 for the year ended 30 June 2006.

Detailed reasoning

69. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

70. Accordingly, to determine whether the distribution made by the PropertyCo Unit Trust to XYZ as trustee of the Trust in June 2006 is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of that distribution.

71. The distribution was made by the PropertyCo Unit Trust for the benefit of XYZ as trustee for the Trust as its unitholder. A $xx, cheque representing this distribution was made payable to B in June 2006. This cheque was paid into a bank account in the name of. A and B in June 2006.

72. There is no documentary evidence of any determination of the net income of the trust in accordance with cl. 4(1) of the Trust Deed in the 2006 financial year.

73. The $xx,000 cheque represented an amount to which XYZ as trustee for the Trust was entitled as unit holder of the PropertyCo Unit Trust. Therefore, on the assumption that these amounts have been misappropriated by B, these amounts are considered at law to be held on constructive trust by B for the benefit of the Trust: see discussion of Zobory under Question 2 above.

74. Accordingly, this amount is included in the net income of the Trust under section 95 of the ITAA 1936 in any of the years ended 30 June 2006.

Question 6

Summary

81. All payments made by the AssetLease Partnership are included in the net income of the Trust under section 95 of the ITAA 1936 for the financial years ended 30 June 2004 to 30 June 2007.

Detailed reasoning

82. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

83. Accordingly, to determine whether the payments made by the AssetLease Partnership to XYZ as trustee of the Trust is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of those payments.

84. In the years of income ended 30 June 2004 to 30 June 2010, the AssetLease Partnership, to which XYZ as trustee for the Trust was a partner, received rental income in relation to a particular development it owned.

85. Between the 2004 to 2007 income years, rental distributions totalling $yy,000 were made to XYZ as trustee for the Trust and paid directly to A and B.

86. The amount received by A and B represented amounts to which XYZ as trustee for the Trust was entitled to in relation to its interest in the AssetLease Partnership. Therefore, on the assumption that these amounts have been misappropriated by A and B, these amounts are considered at law to be held on constructive trust by A and B for the benefit of the Trust: see discussion of Zobory under Question 2 above.

87. The distributions received relate to rental income of the partnership, which is assessable income under section 6-5 of the ITAA 1997. Therefore, in accordance with section 92 of the ITAA 1936, the rental distributions are included in the net income of the Trust under section 95 of the ITAA 1936 with respect to the relevant income years.

88. We note that this income has already been properly included as net income of the Trust for the 2004 to 2007 income years.

Question 7

Summary

89. All payments distributed by AssetLease partnership are included in the net income of the Trust under section 95 of the ITAA 1936 for the financial years ended 30 June 2008 to 30 June 2010.

Detailed reasoning

90. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

91. Accordingly, to determine whether the payments made by the AssetLease partnership to XYZ as trustee of the Trust is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of those payments.

92. Rental distributions were made to XYZ as trustee for the Trust in relation to its interest in the AssetLease partnership in the 2008 to 2010 income years. The relevant amounts were paid directly to B.

93. The amount received by B represented amounts to which XYZ as trustee for the Trust was entitled to in relation to its interest in the AssetLease partnership. Therefore, on the assumption that these amounts have been misappropriated by B, these amounts are considered at law to be held on constructive trust by B for the benefit of the Trust: see discussion of Zobory under Question 2 above.

94. The distributions received relate to rental income of the partnership, which is assessable income under section 6-5 of the ITAA 1997. Therefore, in accordance with section 92 of the ITAA 1936, the rental distributions are included in the net income of the Trust under section 95 of the ITAA 1936 with respect to the relevant income years.

Question 8

Summary

95. The payment made by ABC Pty Ltd is not included in the net income of the XYZ Trust under section 95 of the ITAA 1936 in the year ended 30 June 1996.

Detailed reasoning

96. Section 95 of the ITAA 1936 relevantly provides that the net income of a trust estate includes the total assessable income of the trust estate as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

97. Accordingly, to determine whether the payment made by ABC Pty Ltd to XYZ as trustee of the Trust is included in the net income of the Trust, it is necessary to apply the provisions of the ITAA 1936 and ITAA 1997 to the amount as though the trustee were a resident in respect of those payments.

98. Some years prior to 20 September 1985, XYZ as trustee for the Trust became the registered proprietor of a half share as tenant-in-common, with an entity called ABC Pty Ltd of a large tract of land. XYZ as trustee for the Trust and ABC Pty Ltd conducted a farm on the land in partnership.

99. In the subsequent year, .A and . C acquired all of the shares in ABC Pty Ltd and became directors of that entity.

100. In 1995, XYZ as trustee for the Trust transferred its half interest in the farm to ABC Pty Ltd for a certain amount.

101. The half share of the land held by XYZ as trustee for the Trust constituted a CGT asset in its hands due to the conjunctive operation of sections 108-5 and 108-7 of the ITAA 1997.

102. Subsection 108-5(1) provides the general definition of a CGT asset as:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

103. Section 104-10 is therefore relevant to the land's disposal. Subsection 104-10(1) provides:

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

104. It is therefore clear that, in accordance with this provision, the disposal of the land would ostensibly give rise to a CGT event A1. However, it is noted that XYZ as trustee for the Trust acquired its half share in the land prior to 20 September 1985. Consequently, any capital gain that would arise is disregarded by virtue of paragraph 104-10(5)(a), which states that a capital gain is disregarded if the asset is acquired before 20 September 1985.

105. Therefore, the proceeds do not constitute assessable income as they are of a capital nature and any relevant capital gain will be disregarded due to the land's pre-CGT status. The proceeds are not included in the net income of the XYZ Trust under section 95 of the ITAA 1936 in the year ended 30 June 1996.

Question 9

Summary

106. No amount described in Question 1 to Question 8 above are included in the net income of the Trust will be assessable to the current trustee under section 99A of the ITAA 1936. This is because subsection 254(1) of the ITAA 1936 will apply so that any assessment will not be issued to the current trustee for income years prior to being appointed as trustee of the Trust.

Detailed reasoning

107. Subsection 254(1) of the ITAA 1936 imputes the obligations of a taxpayer arising under the ITAA 1936 or ITAA 1997 to the trustee in their representative capacity.

108. Relevantly, paragraph 254(1)(a) of the ITAA 1936 states:

He or she shall be answerable as taxpayer for the doing of all such things as are required to be done by virtue of this Act in respect of the income, or any profits or gains of a capital nature, derived by him or her in his or her representative capacity, or derived by the principal by virtue of his or her agency, and for the payment of tax thereon.

109. Paragraph 254(1)(b) explicitly provides for trustees to be assessed in relation to the trust's net income in their representative capacity:

He or she shall in respect of that income, or those profits or gains, make the returns and be assessed thereon, but in his or her representative capacity only, and each return and assessment shall, except as otherwise provided by this Act, be separate and distinct from any other.

110. D was appointed as trustee of the Trust by order of the the relevant authority in late 2010 and was therefore not acting in the capacity of trustee of the Trust during or at the end of any the relevant income years, being the years ended 30 June 1996, 30 June 2003, 30 June 2006 and 30 June 2008 to 30 June 2010.

111. Therefore, no amount described in Question 1 to Question 8 to be included in the net income of the Trust will be assessable to D. This is consistent with the Commissioner's practice as outlined in Practice Statement PS LA 2012/2, as explained under Question 1 above.

ISSUE 3

Question 10

Summary

112. None of the Settlement Sum is included in the net income of the Trust under section 95 of the ITAA 1936 in the income year ended 30 June 2013.

Detailed reasoning

Undissected lump sum

113. An undissected settlement amount received by a taxpayer without differentiation as to any of its constituent parts will not constitute income in the hands of the taxpayer. This long-standing principle was established in the case of McLaurin v Federal Commissioner of Taxation (1961) 104 CLR 381 and is reflected in the following quote from Dixon CJ, Fullagar and Kitto JJ at 392:

'But the whole of the damage which it did, whether covered by the appellant's list of particulars or not, was compensated for by the one entire sum; and it is simply not true that that sum took the place in the appellant's hands of assessable income.'

114. The provisions of the CGT regime within Part 3 of the ITAA 1997 are therefore relevant to determining whether any amount of the Settlement Sum is included in the net income of the trust under section 95 of the ITAA 1936 in the income year ended 30 June 2013.

The relevant asset

115. To determine the particular CGT asset in respect of which a compensation receipt has been received, Taxation Ruling TR 95/35 advocates a 'look-through' approach as the most appropriate basis on which to determine whether any capital gain arises on the disposal of any asset of the taxpayer. The 'look-through' approach requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related.

116. The settlement sum received by the Trust was in settlement of all claims and demands made by the Trustee against the defendants to the proceedings and in settlement of B's counterclaim against the Trustee.

117. Each right to compensation was in respect of a misappropriated amount or in respect of an alleged breach of fiduciary duty resulting in a loss to the trust. Therefore, each underlying asset in respect of the right to compensation was in relation to a particular amount that was misappropriated from or incurred as a loss by the Trust.

118. Both the right to compensation and the right to receive the individual misappropriated amounts are considered to be CGT assets under section 108-5 of the ITAA 1997.

119. It is therefore considered that there are two distinct CGT assets potentially relevant to the Settlement Sum - the right to compensation and the right to receive the individual misappropriated amounts.

120. Paragraph 82 of TR 95/35 states:

'In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, the taxpayer must be able to show that the compensation receipt has a direct and substantial link with the underlying asset. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening or event which generated the amount of compensation, the taxpayer is not able to demonstrate that link. It follows that the compensation cannot be directly related to that asset. In those cases, the most relevant asset may be the right to seek compensation, or the notional asset.'

121. No portion of the settlement sum received by the Trust was in respect to any disposal of any underlying asset, or any permanent damage or reduced value by the happening of an event to that underlying asset. Each portion was in relation to alleged amounts that were misappropriated from the Trust. The individual misappropriated amounts (the underlying asset), therefore, do not have a direct and substantial link to the receipt of compensation and the most relevant asset is the right to compensation.

122. Accordingly, it is appropriate to apply the CGT provisions to the settlement sum on the basis that the compensation is received for the Trust's surrender of its right to compensation.

Apportionment of the Settlement Sum

123. The Settlement Sum received by the Trust relates to more than one CGT event - it relates to the surrender of several rights to compensation, with each discrete right being a CGT asset.

124. Relevantly, subsection 116-40(1) of the ITAA 1997 provides:

If you receive a payment in connection with a transaction that relates to more than one CGT event, the capital proceeds from each event are so much of the payment as is reasonably attributable to that event.

125. Similarly, subsection 116-40(2) of the ITAA 1997 provides:

If you receive a payment in connection with a transaction that relates to one CGT event and something else, the capital proceeds from the event are so much of the payment as is reasonably attributable to the event.

126. It follows from the above that where an amount can be reasonably apportioned between CGT events, it should be so apportioned.

127. The Commissioner accepts the Trustee's apportionment of the Settlement Sum to the various heads of claims. It is noted that this approach to apportionment applies the net proceeds after deducting outgoings and expenses that were incurred in deriving the settlement sum, which the Commissioner also accepts.

CGT Event C2

128. The Trust's surrender of each right to compensation will constitute a CGT Event C2, per subsection 104-25(1) of the ITAA 1997.

129. As to the timing of each event, subsection 104-25(2) of the ITAA 1997 provides that the time of the event is either:

a. when you enter into the contract that results in the asset ending; or

b. if there is no contract - when the asset ends.

130. The Trust's receipt of the Settlement Sum in the recent year is therefore the time of each CGT event C2 being triggered.

131. The capital proceeds for each CGT event will be the compensation amount received, in accordance with the general rules contained in section 116-20 of the ITAA 1997.

132. As the right to seek compensation arises in respect of a monetary loss of the taxpayer, the cost base for each CGT event will include the amount of that loss. This position is explained by the Commissioner at paragraph 104 of TR 95/35:

'If the right to seek compensation arises in respect of a monetary loss of the taxpayer (e.g., in respect of a claim for breach of contract, as a result of which the taxpayer must incur additional expenditure) the amount of that loss is included in the cost base of the right to seek compensation for that loss. It is an amount which the taxpayer has paid or is required to pay in respect of the acquisition of the right to seek compensation for having to incur the expenditure.'

133. Therefore, applying the above approach to each amount to each apportioned amount of the net settlement sum gives rise to a capital loss calculated in accordance with subsection 104-20(3) of the ITAA 1997. This is because the Trust surrendered its rights to compensation for an amount less than the amount claimed. The amount under each head of claim forms part of that portion's cost base.