Edited version of private advice

Authorisation Number: 1012624317566

Ruling

Subject: Present entitlement

Question 1

For the income year ending 30 June 2013, is the part of the net income of Trust 1 that has been paid out to beneficiaries, assessable to the Trustee under Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

For the income year ending 30 June 2013, is the part of the net income of Trust 1 that is retained in the trust assessable to the Trustee under Division 6 of Part III of the ITAA 1936?

Answer

Yes

Question 3

Is the Trustee liable to pay tax under Division 6 of Part III of the ITAA 1936 on the net income of Trust 1 in the income years ending 30 June 2010, 30 June 2011, and 30 June 2012?

Answer

Yes

Question 4

Does the Agreement affect the Trustee's liability to pay tax under Division 6 of Part III of the ITAA 1936 on part or all of the net income of Trust 1 in the income years ending 30 June 2010, 30 June 2011, 30 June 2012, and 30 June 2013?

Answer

No

Question 5

Is the Trustee liable to pay tax under Division 6 of Part III of the ITAA 1936 on the net income of Trust 2 in the income year ending 30 June 2013?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2010

Income year ending 30 June 2011

Income year ending 30 June 2012

Income year ending 30 June 2013

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

The Trustee is the trustee of Trust 1 and Trust 2.

Trust 1 and Trust 2 were created by payment of moneys into court.

The moneys paid into court resulted from separate Orders of the Court.

The Court orders required the Trustee to invest the moneys paid into court.

The moneys invested by the Trustee derived income.

The Court made further Orders setting out entitlement to the money in Trust 1. The order only required part of the money in Trust 1 to be released to beneficiaries.

The money was released to the beneficiaries in accordance with the Orders. The money released included income.

The beneficiaries of Trust 1 and Trust 2 entered an agreement on the entitlement to the money in Trust 1 and Trust 2

The Commissioner of Taxation previously determined that the payment of money into court (Trust 1) created a trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95A

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 98 and

Income Tax Assessment Act 1936 Section 99A

Reasons for decision

Question 1

Division 6 of Part III of the Income Tax Assessment Act 1936 (section 95AAA to section 102) sets out the basic income tax treatment of the net income of a trust estate.

Sub-section 97(1) of the ITAA 1936 provides that where a beneficiary of a trust estate that is not under a legal disability is presently entitled to a share of the income of the trust estate, the beneficiary will be assessed on the share of the net income that they are entitled to.

Sub-section 98(1) of the ITAA 1936 provides that where a beneficiary of a trust estate that is under a legal disability is presently entitled to a share of income of the trust estate, the trustee of the trust estate will be assessed and liable to pay tax in respect of the share of the net income that the beneficiary is entitled to.

Sub-section 95A (1) provides that 'where a beneficiary of a trust estate is presently entitled to any income of the trust estate, the beneficiary shall be taken to continue to be presently entitled to that income notwithstanding that the income is paid to, or applied for the benefit of, the beneficiary'.

Section 99A of the ITAA 1936 provides that the trustee of a resident trust estate will be assessed and liable to pay tax on all or part of the net income of the trust estate where all or part of the net income of the resident trust estate is not assessed under section 97 and section 98 of the ITAA 1936, or there is no beneficiary of the trust estate that is presently entitled to part or all of the relevant income. If Section 99A applies the trustee is assessed on the net income at a rate declared by Parliament.

In determining which of the above provisions applies it is necessary to consider whether there is a beneficiary presently entitled to income of the trust estate and whether the beneficiary is under a legal disability.

Legal disability

The expression 'legal disability' is not defined in the ITAA 1936. In Taylor & Anor v Federal Commissioner of Taxation 70 ATC 4026 the High Court had to consider whether a trustee of a trust estate should be assessed under section 99A of the ITAA 1936 or section 98 of the ITAA 1936. In determining section 98 should apply, Kitto J considered that a person is under a legal disability if they are unable to give a valid discharge for payment of money; they are not legally competent to break the trust and demand payment (at 4028).

Presently entitled

The expression 'presently entitled' is not defined in the ITAA 1936. In Harmer & Ors v Federal Commissioner of Taxation 91 ATC 5000 the High Court stated the following on the meaning of 'presently entitled' (at 5004):

The parties are agreed that the cases establish 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.

Similarly, in Federal Commissioner of Taxation v Totledge Pty Ltd 82 ATC 4168, the Full Federal Court determined that the requirement in sub-section 97(1) of the ITAA 1936 of 'present entitlement to a share of the income of the trust estate' refers to (at 4175):

…a present vested right to demand and receive payment of the whole or part of what has been received by the trustee as income, and retaining that character in his hands, is legally available to be distributed to those entitled to it as beneficiaries under the trusts of the relevant trust estate. Such a right to demand and receive payment represents a present entitlement to receive a share of what retains its character as income of the trust estate…

In Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16, Stone J held that, for the purpose of section 97 of the ITAA 1936, present entitlement must arise within the relevant tax year (at paragraph 32):

… Harmer makes it clear that for s 97(1) purposes, the applicant needs to be presently entitled "at the time when the interest was derived that is to say, during the tax years"… It is clear from Harmer that it is "during the tax years" that the entitlement must arise.

In the present case, the moneys in Trust 1 were paid into court in accordance with Orders of the Court. The orders required the money to be paid directly to the Trustee, who was required to hold the money until further order of the Court. The order required the money to be invested by the Trustee. The invested money derived income. The Commissioner of Taxation has previously determined that the payment of money into court created a trust estate for the purposes of Division 6 of Part III of the ITAA 1936.

In Harmer & Ors v Federal Commissioner of Taxation (supra), the High Court had to determine whether claimants to a case in the Supreme Court of Western Australia were presently entitled to the interest income of money paid into court under order of that Court (a subsequent court order required the money to be held by the claimants' solicitors on trust and invested in a building society). In finding that the claimants were not presently entitled to the interest income of money paid into court (or held on trust by their solicitors) the High Court stated (at 5005):

The respective interests of the individual claimants were, at best, contingent. None had an entitlement to the capital or the income of the fund which was vested either in interest or in possession. A fortiori, none had a present legal right to demand or receive payment of either capital or income… As had been the case when the moneys were held by the Court… 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.

As was the case in Harmer & Ors v Federal Commissioner of Taxation (supra), the respective interests of the parties to the Court case were contingent on the Court making orders in their favour. Until such an order was made no party had a vested interest in the income or corpus of the money paid into court. As such, no party to the Court case could be presently entitled to the income of the money paid into court until the Appeal Court made orders setting out entitlement to the money.

The Court made orders requiring moneys to be released to specified beneficiaries. The money was released to the beneficiaries in accordance with the Orders. The money released to the beneficiaries included income.

The beneficiaries are presently entitled beneficiaries, have had income of trust 1 paid to them in the income year ending 30 June 2013, and therefore would be assessable under section 97 of the ITAA 1936.

As such, the Trustee will not be assessable on the part of the net income of Trust 1 that was paid to the beneficiaries in the income year ending 30 June 2013.

Question 2

As discussed in question 1, section 99A of the ITAA 1936 provides that a trustee will be assessed and liable to pay tax on all or part of the net income of a resident trust estate where sections 97 and 98 do not apply to tax the net income, or there is no beneficiary of the trust estate that is presently entitled to part or all of the net income of the trust estate.

The money in Trust 1 was paid into court pending further orders of the court. The respective interests of the parties to the Court case were contingent on the Court making orders in their favour. The Court gave Orders regarding the money paid into court. The Orders provided for the release of part of the money paid into court to beneficiaries, with the remainder to continue to be held by the Trustee subject to further Orders of the Court. As the Order does not cause any beneficiary to be presently entitled to all of the income of Trust 1, section 99A of the ITAA 1936 will apply, and cause the Trustee to be assessed and liable to pay tax on the part of the net income of Trust 1 that continues to be held by the Trustee.

Question 3

As discussed in question 1, the money in Trust 1 was paid into court pending further orders of the court. No party to the Court case could be presently entitled to the income of the money paid into court until the Court made orders setting out entitlement to the money. The orders were made in 20XX.

As held by Stone J in Colonial First State Investments Limited v Commissioner of Taxation (supra), section 97 of the ITAA 1936 will only apply in an income year if the present entitlement arises in that year. As the Court had not made any orders prior to 20XX, no party to the Court case could have a present entitlement to the income of Trust 1 prior to that time. As such, no party to the Court case was presently entitled to the income of Trust 1 in the years ending 30 June 2010, 30 June 2011, and 30 June 2012. Sections 97 and 98 of the ITAA 1936 could not apply to those years of income.

The Trustee will be assessed and liable to pay tax, under sub-section 99A(4) of the ITAA 1936, on all of the net income of Trust 1 in the years ending 30 June 2010, 30 June 2011, and 30 June 2012.

Question 4

As discussed in question 3, for section 97 of the ITAA 1936 to apply in a year of income, present entitlement must arise in that income year. Prior to 20XX no party to the Court case was presently entitled to the income derived from Trust 1. The Agreement between the parties in a subsequent income year does not change the fact that there was no party to the Court case presently entitled to income from Trust 1 in the relevant income years.

The Agreement does not affect the Trustee's liability to pay tax on the income of Trust 1 in the relevant income years.

The Trustee will be assessed and liable to pay tax, under sub-section 99A(4) of the ITAA 1936, on all of the net income of Trust 1 in the relevant income years.

Question 5

In 20XX there is no party to the Court case that is presently entitled to the income of Trust 2. The respective interests of the parties were contingent on the court making orders in their favour. As no such order was made, no party had a vested interest in the income of Trust 2. As such, no party was presently entitled to the income of Trust 2 in 20XX.

As no party is presently entitled to any of the income of Trust 2, in 20XX, sub-section 99A(4) of the ITAA 1936 will apply so that the Trustee will be assessed and liable to pay tax on all of the net income of Trust 2 in that year.