Summary
Majority: Unanimous (French CJ, Gummow, Hayne, Heydon and Crennan JJ).
Decision: Appeals dismissed.
In order to determine what is ‘Income of the trust estate’, as it appears in s 97 of the Income Tax Assessment Act 1936 (Cth), consideration is to be had to the general law of trusts, which includes reference to the Trust Deed and any exercise of discretion by the trustee.
The phrase ‘that share of the net income of the trust estate’, as it appears in s 97, means the proportion of the net income to which the beneficiary becomes entitled rather than the dollar amount which the beneficiary is able to demand from the trustee.
The Issues in the Case
The respondents were the beneficiaries of a discretionary trust (“the Trust”).
The respondents disputed two assessments made by the Commissioner in financial years 2000 and 2002 under s 97 of the Income Tax Assessment Act 1936 (Cth), which states:
(1) Where “a beneficiary of a trust estate ... is presently entitled to a share of the income of the trust estate”:
(a) the assessable income of the beneficiary shall include:
(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident
This appeal raised the issue of the meanings of “income of the trust estate” and “that share” for the purposes of that section.
Income of the Trust Estate
Issue
The trust deed of the Trust entitled the trustee to treat any receipt as being “on income or capital account”. In 2002 the trust made a capital gain on a property sale. Pursuant to the deed, the trustee declared that the gain was income and distributed it equally to the beneficiaries.
The issue for the Court was whether this amount was “income of the trust estate”. The Court had to determine whether to apply the ‘tax law’ definition of income or the ‘trust law’ definition. Put simply, if the tax law approach were taken, the determination by the trustee that the gain was income would not be relevant, and the gain would not be considered in the calculation of the income. Whereas under trust law, the trust deed and, accordingly, the determination by the trustee would be relevant to determining whether the receipt was income.
Finding
The Court found that, as a matter of statutory construction, the general law of Trusts applies to determining what is ‘income of the trust estate’. Accordingly the capital gain became income of the trust estate upon the trustee declaring it income.
The Court said that s 97 employs terminology which “bespeaks” the general law of trusts. That is, the first sentence of sub-s (1) refers to “income” rather than “net income”, the latter being defined in the legislation, the former being a matter for general law (at [37]). Also, the section refers to “a trust estate” and “a beneficiary”, both of which are not defined in the legislation (at [38]). Finally, the use of the phrase “presently entitled to a share of the income” refers the reader to trust law concepts of beneficiary entitlement (at [39]). Accordingly, the Court considered that the Parliament intended the general law of trusts to apply to the definition.
That Share
Issue
In 2000 the trustee declared that the net income of the Trust would be distributed to the beneficiaries in particular amounts with the balance paid to the Church of Scientology. As it turned out, the trust did not have sufficient net income, so that the beneficiaries did not receive their total amount and there was no balance for the Church. Subsequently, certain deductions made by the trustee in calculating the net income were disallowed and so the trust found itself with more net income, which was not distributed to beneficiaries.
The Commissioner argued that, pursuant to s 97, the beneficiaries should be taxed on the increase in the net income which arose from the disallowance of the deductions, in the same proportion in which they received the income that was actually distributed. The respondents argued that they should only be taxed on the amount to which they are presently entitled to receive from the trust.
The question for the Court was whether the phrase “that share” attracted the so called ‘proportionate approach’ or the ‘quantum approach’. The former approach calculates the relevant amount by virtue of the proportion to which the beneficiary is entitled, and the latter takes the relevant amount to be the amount, or quantum, of money to which the beneficiary is actually entitled.
Finding
The Court adopted, without addition, the reasoning of Sundberg J in Zeta Force Pty Ltd v Comm of Tax (1998) 84 FCR 70, that the phrase “that share” related to a proportion rather than a specific amount (at [46]).
In that case Sundberg J identified that ‘that share’ relates not to the phrase “income” but to the phrase “net income” which is defined in the Act to mean taxable income rather than distributable income. His Honour said:
The words 'that share' in par (a)(i) refer back to the word 'share' in the expression 'a share of the income of the trust estate', and indicate that the same share is to be applied to an income amount calculated according to a different formula (taxable income as opposed to distributable income). Since the income amount may differ according to which formula is applied, the natural meaning to give to 'share' where it appears for the second time is 'proportion' rather than 'part' or 'portion'. When Parliament wanted to convey the latter meaning, as it did in ss 99 and 99A, it used the word 'part'.
Comment
The issues in this case have been plaguing Tax lawyers for some time and it is relieving to have them determined by the High Court. The view held by the Commissioner, that s 97 did not relate to the trust law definition of income was contrary to the view of many practitioners in this area (and intermediate courts) and so the Commissioner pursued this case as a test case.
However, the outcome doesn’t display a clear win to the tax payer or the tax collector except insofar as clever lawyers and accountants are able to structure trusts to best minimise tax liability. On this, the Court said:
both sides in argument on the present appeals accepted that whichever of the competing constructions of Div 6 were accepted examples could readily be given of apparent unfairness in the resulting administration of the legislation…
What is interesting is that the Commissioner withdrew an argument during the hearing of the appeal that the income be interpreted as including “statutory income”. Their Honour’s weren’t pleased ([2010] HCATrans 38):
MR GLEESON: Your Honours, we have provided the Court with two documents which seek to clarify the matter I put yesterday.
HEYDON J: But they are a complete retraction of what you said in the last 15 minutes yesterday.
MR GLEESON: Your Honour, to the extent what I said in that period overstated the Commissioner’s position, I seek to withdraw it. I apologise. The fault is mine, not the Commissioner’s.
HEYDON J: Mr Gleeson, if the Court had known on 2 November 2009, I think it was, that those things were going to be said, there would have been a very strong argument against granting special leave to appeal. Why should not special leave be revoked now?
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