Bamford and P and D Bamford Enterprises Pty Ltd in Its Capacity as the Trustee of the Bamford Trust and Commissioner of Taxation
[2008] AATA 322
•18 April 2008
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2008] AATA 322
ADMINISTRATIVE APPEALS TRIBUNAL ) NT 2005/0488
) NT 2005/0490
TAXATION APPEALS DIVISION ) NT 2006/0114
ReDavina BAMFORD; Philip BAMFORD; and
P & D Bamford Enterprises Pty Ltd in its capacity as THE TRUSTEE OF THE BAMFORD TRUST
Applicants
And Commissioner of Taxation
Respondent
DECISION
TribunalMr J Block, Deputy President and Professor GD Walker, Deputy President
Date18 April 2008
PlaceSydney
DecisionIn respect of NT 2005/488 and NT 2005/490, the objection decisions are, save only that the penalty assessed is reduced to 20 per cent, affirmed and in respect of NT 2006/114 the objection decision is affirmed.
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Professor GD Walker
Deputy Presidentfor self and Mr J Block, Deputy President
CATCHWORDS
Distribution by a trust – income of the trust estate – tax income – binding nature of Zeta Force – where tax income exceeds trust income, excess is taxed to those beneficiaries presently entitled -– proportionate approach applies to all beneficiaries presently entitled - penalty – where reasonably arguable case – reduction in penalty warranted - whether capital gain distributed as income becomes income in the hands of the trustee for the purposes of s 97 – income defined in accordance with ordinary concepts – present entitlement to a share of the trust income is a present vested right to demand payment of what has been received, retaining the character of income when distributed - trust deed cannot alter the character of a receipt in the hands of a trustee - decisions under review are affirmed – 20 percent reduction in penalty for the 2000 assessment.
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RELEVANT ACT/S:
Income Tax Assessment Act 1936 (the Act): Part IVA, Division 6, ss 95, 97, 99A, 224, 226L, 226Y
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CITATIONS
Zeta Force Pty Ltd v Commissioner of Taxation (1998) 84 FCR 70
Richardson v Commissioner of Taxation (1997) 80 FCR 58
Re Wensemius & Anor and Federal Commissioner of Taxation [2007] AATA 1006
Cajkusic v Commissioner of Taxation (2006) 155 FCR 430
Richardson v Commissioner of Taxation 2001 ATC 4058
Commissioner of Taxation v Pilnara Pty Ltd (1999) 96 FCR 82
Richardson v Commissioner of Taxation 2001 ATC 4621
Federal Commissioner of Taxation v Prestige Motors Pty Limited as Trustee of the Prestige Toyota Trust (1998) 98 ATC 4241
Tracy v Repatriation Commission [2000] FCA 779
Federal Commissioner of Taxation v Totledge Pty Ltd (1982) 12 ATR 830
Commissioner v ANZ Savings Bank Ltd (1998) 194 CLR 328
FCT v Salanger (1988) 88 ATC 4449
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OTHER AUTHORITIES
PS LA 2005/1(GA)
TD 93/35
REASONS FOR DECISION
18 April 2008
Mr J Block Deputy President and Professor GD Walker, Deputy President
PART A - Preliminary and Introduction
1. The Applicants in NT 2005/488 and 490 are (respectively) Davina Bamford (“Mrs Bamford”) and Philip Bamford (“Mr Bamford”) and the relevant objection decisions are the disallowance by the Respondent of their objections against amended assessments dated 30 May 2005 referable to the year ending 30 June 2000 (“the 2000 year”). The Tribunal received into evidence T Documents lodged pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 in respect of each of Mr Bamford and Mrs Bamford.
2. The Applicant in NT 2005/114 is P & D Bamford Enterprises Pty Ltd (“the Trustee”) in its capacity as trustee of the Bamford Trust (“the Trust”) which was created by deed made in February 1995 (“the Trust Deed”); the relevant objection decision in respect of the Trustee is the disallowance of its objection against an original assessment issued on 27 February 2006 referable to the year ending 30 June 2002 (“the 2002 year”). The Tribunal received into evidence the T Documents lodged pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 in respect of the Trustee.
3. We use the term “2000 matter” to refer to the objection decisions referred to in paragraph 1 above, while correspondingly the term “2002 matter” refers to the objection decision referred to in paragraph 2 above. The terms “Applicant” or “Applicants” refers, as the context requires, to Mr Bamford and Mrs Bamford in respect of the 2000 matter and to the Trustee in respect of the 2002 matter.
4. The Applicants were represented by Mr Ian Young of counsel instructed by Mr Robert Richards of Robert Richards & Co, solicitors, while counsels Ms Jennifer Davies SC, Mr David Batt and Ms M Wall, instructed by Mr Michael Donohoe of the Australian Government Solicitor, represented the Respondent.
5. The Tribunal also received into evidence exhibits as follows:
Exhibit A1:Affidavit by Mrs Bamford dated 14 June 2007;
Exhibit A2:Affidavit by Mr Bamford dated 14 June 2007;
Exhibit A3:A further affidavit by Mr Bamford dated 14 March 2008; and
Exhibit A4:Affidavit by Mr GA Cammarata dated 14 March 2008.
6. There is virtually no dispute of fact between the parties; the witnesses referred to in paragraph 5 above were not required for cross-examination. It is for these reasons, in respect of the relevant facts, convenient to draw on the Statements of Facts, Issues and Contentions (SoFaC) submitted by the Applicants, in order to set out their content under the head of “Facts”. In this context:
7.In respect of the 2000 matter, the “Facts” are set out in clauses 1 to 30 of the Applicants’ SoFaC dated 14 June 2007 reading as follows:
Facts
1.At all material times Philip Bamford and Davina Bamford were the directors of P & D Bamford Enterprises Pty Ltd (the “Company”).
2.At all material times, and during the year of income ended 30 June 2000 (the “2000 tax year”) the Company acted as trustee of the Bamford Trust.
3.The Bamford Trust was a family discretionary trust and was settled on or about 9 February 1995.
4.At all material times, and during the 2000 tax year, Philip Bamford and Davina Bamford were within the class of discretionary beneficiaries of the Bamford Trust.
5.At all material times, and during the 2000 tax year, the Church of Scientology was also within the class of discretionary beneficiaries of the Bamford Trust.
6.On or about 20 May 2000, the Company as trustee for the Bamford Trust made a contribution of $175,000 to the Bamford International Super Fund in respect of Philip Bamford and Davina Bamford in their capacity as employees of the Company.
7.On or about 20 May 2000, in order to fund the contribution, the Company as trustee for the Bamford Trust borrowed an amount from the Equity Investment Bank.
8.In the 2000 tax year the Company as trustee for the Bamford Trust incurred an interest expense of $16,701.67 to the Equity Investment Bank in respect of its borrowing to make the contribution.
9.In the preparation of the financial accounts for the 2000 tax year the Company as trustee for the Bamford Trust recognized as expenses in the profit and loss statement of the Bamford Trust:
(a) the contribution amount of $175,000; and
(b) the interest expense of $16,701.67.
10.In the preparation of the income tax return for the Bamford Trust for the 2000 tax year and the calculation required by section 95 of the Income Tax Assessment Act 1936 (ITAA 1936”), the Company as trustee for the Bamford Trust recognized as deductions against the assessable income of the Bamford Trust trust estate, amounts in respect of:
(a)the contribution amount of $175,000 and
(b)the interest expense of $16,701.67.
11.In the preparation of the income tax return for the Bamford Trust for the 2000 tax year the contribution amount of $175,000 was claimed as a deduction under primarily section 82AAE of the ITAA 1936 and or section 8-1 of the Income Tax Assessment Act 1997, whilst the interest expense was claimed under section 8-1.
12.The net income of the Company as trustee for the Bamford Trust calculated under section 95 of the ITAA 1936 for the 2000 year was the amount of $187,530 and a trust estate income tax return was lodged and disclosed that amount as the net income.
13.Subsequently, in these Tribunal proceedings, the Company as trustee for the Bamford Trust now accepts that the contribution amount of $175,000 and the interest expense of $16,701.67 are not, and never have been, properly deductible in the calculation of the net income of the Bamford Trust pursuant to section 95 of the ITAA 1936.
14.On or about 30 June 2000 Philip Bamford and Davina Bamford as directors of the Company in its capacity as trustee for the Bamford Trust held a trustee meeting as to how the Company as trustee should exercise its discretion as to the distribution of the net income of the Bamford Trust amongst the class of eligible discretionary beneficiaries.
15.On 30 June 2000 Philip Bamford and Davina Bamford as directors of the Company in its capacity as trustee for the Bamford Trust resolved as follows:
Distribution of
Income:It was resolved that the income for the year ended 30th June 2000 be allocated in the following proportions:-
J H Bamford (The first $643)
H J Bamford (The next $643)
Narconon Anzo Inc (the next $12,500)
Church of Scientology (the next $106,000)
P J & D L Bamford (the next $68,000
Shared equally)
Church of Scientology (The balance)
Redeposit of
Distribution: Representative of all Beneficiaries being present and agreeable it was resolved that the above allocation be credited to the Beneficiaries’ accounts with the Trust to remain on deposit subject to payment on demand by the Beneficiaries, by giving 14 days notice in writing.
16.By the tax return for the 2000 tax year the Company in its capacity as trustee for the Bamford Trust completed a statement of distribution in the following terms:
(a)Philip Bamford - $33,872;
(b)Davina Bamford - $33,872;
(c)Jarrod Bamford - $643;
(d)Narconon Anzo Inc - $12,500;
(e)Harrison Jack Bamford - $643;
(f)Church of Scientology Inc - $106,000.
17.Each of Philip Bamford and Davina Bamford lodged with the Commissioner a return of income for the 2000 tax year in accordance with the statement of distribution from the 2000 tax year return of the Bamford Trust.
18.On 17 May 2001 the Commissioner issued to Davina Bamford a notice of original assessment for the 2000 tax year in accordance with her tax return and the tax return of the Bamford Trust.
19.On 18 May 2001 the Commissioner issued to Philip Bamford a notice of original assessment for the 2000 tax year in accordance with his tax return and the tax return of the Bamford Trust.
20.Over four years later, by letters dated 19 May 2005 the Commissioner wrote separately to Philip Bamford and Davina Bamford and the Company as trustee of the Bamford Trust and collectively informed them that:
(a)in the calculation of the net income of the Bamford Trust under section 95 of the ITAA 1936, the aggregate amount of $191,701, comprising contribution amount ($175,000) and interest $16,701 would not be allowed as a deduction;
(b)in the case of each of Philip Bamford and Davina Bamford the additional aggregate amount of $34,624 would be included in their respective assessable income in the 2000 tax year.
21.On 19 May 2005 the Commissioner made the following Part IVA determinations against the Company as trustee of the Bamford Trust:
(a)that the deduction of $175,000, being the contribution amount, was not allowable to the Bamford Trust; and
(b)that the deduction of $16,701, being the interest amount, was not allowable to the Bamford Trust.
22.On 19 May 2005 the Commissioner made one only Part IVA determination against each of Philip Bamford and Davina Bamford individually that the amount of $3,016 was included in their respective assessable income in the 2000 tax year by virtue of section 97 of the ITAA 1936.
23.The amount of $3,016 is referable to the disallowed interest expense of $16,701.
24.The Commissioner did not make a Part IVA determination against either of Philip Bamford and Davina Bamford individually in respect of the disallowed contribution amount.
25.On 30 May 2005 the Commissioner issued an amended assessment to each of Philip Bamford and Davina Bamford for the 2000 tax year and included the additional aggregate amount of $34,624 in their respective assessable income. Each amended assessment contained the notation:
ADJUSTMENTS TO INCOME
Trust/Estate income
- Adjusted as a result of audit or investigation. + $31,608
Trust/Estate income
- Adjusted as a result of audit or investigation. + $3,016
26.Although not stated by the Commissioner, mathematically the percentage share, to each of Philip Bamford and Davina Bamford, of the net income of the Bamford Trust as per the 2000 trust return was 18.062%, being $33,872 divided by $187,530.
27.Additionally, although not stated by the Commissioner, mathematically 18.062% of the disallowed contribution amount of $175,000 is the amount of $31,608.
28.Further, mathematically, 18.062% of the disallowed interest expense of $16,701 is the amount of $3,016.
29.In each respective amended assessment to each of Philip Bamford and Davina Bamford, the Commissioner has imposed penalty of $6,717.05 being a Part IVA penalty amount of 40% of the tax increase.
30.Mathematically, the tax on the aggregate individual increase in assessable income amount of $34,624 at a 48.5% tax rate, is $16,972.64 and 40% of that amount is $6,717.05.
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8. In respect of the 2002 matter, the “Facts” are set out in clauses 1 to 19 of the Applicant’s SoFaC dated 14 June 2007 reading as follows:
Facts
1.At all material times Philip Bamford and Davina Bamford were the directors of P & D Bamford Enterprises Pty Ltd (the “Company”).
2.At all material times, and during the year of income ended 30 June 2002 (the “2002 tax year”) the Company acted as trustee of the Bamford Trust.
3.The Bamford Trust was a family discretionary trust and was settled on or about 9 February 1995.
4.At all material times, and during the 2002 tax year, Philip Bamford and Davina Bamford were within the class of discretionary beneficiaries of the Bamford Trust.
5.At all material times, and during the 2002 tax year, the Church of Scientology was also within the class of discretionary beneficiaries of the Bamford Trust.
6.On or about 20 May 2000, the Company as trustee for the Bamford Trust made a contribution of $175,000 to the Bamford International Super Fund in respect of Philip Bamford and Davina Bamford in their capacity as employees of the Company.
7.On or about 20 May 2000, in order to fund the contribution, the Company as trustee for the Bamford Trust borrowed an amount from the Equity Investment Bank.
8.In the 2002 tax year the Company as trustee for the Bamford Trust incurred an interest expense of $17,553.06 to the Equity Investment Bank in respect of its borrowing to make the contribution.
9.In the preparation of the financial accounts for the 2002 tax year the Company as trustee for the Bamford Trust recognized the interest expense of $17,553.06 in the profit and loss statement of the Bamford Trust.
10.The financial accounts for the 2002 tax year for the Bamford Trust showed a net profit of $55,675 after taking account of a profit on sale of assets of $58,454.
11.In the preparation and lodgment of the income tax return for the Bamford Trust for the 2002 tax year and the calculation required by section 95 of the Income Tax Assessment Act 1936 (ITAA 1936”), the Company as trustee for the Bamford Trust recognized:
(a)a net capital gain of $29,227 after taking account of the general CGT discount on capital gains; and
(b)carry forward losses of $26,448.
12.By letters dated 19 May 2005 and 5 December 2005, the Commissioner determined that carry forward losses from earlier years in the amount of $16,100 were not available to the Bamford Trust in the 2002 tax year.
13.On 5 December 2005 the Commissioner made a determination under Part IVA of the ITAA 1936 that the amount of $16,100 was not an allowable deduction to the Company as trustee for the Bamford Trust in the calculation of net income under section 95 of the ITAA 1936 for the 2002 tax year.
14.Subsequently, in these Tribunal proceedings, the Company as trustee for the Bamford Trust now accepts that the contribution amount of $175,000 and the concomitant interest expense are not, and never have been, properly deductible in the calculation of the net income of the Bamford Trust pursuant to section 95 of the ITAA 1936.
15.On or about 30 June 2002 Philip Bamford and Davina Bamford as directors of the Company in its capacity as trustee for the Bamford Trust held a trustee meeting as to how the Company as trustee should exercise its discretion as to the distribution of the net income of the Bamford Trust amongst the class of eligible discretionary beneficiaries.
16.On 30 June 2002 Philip Bamford and Davina Bamford as directors of the Company in its capacity as trustee for the Bamford Trust resolved as follows:
Distribution of
Income:It was resolved that the net income for the year ended 30 June 2002 be distributed as follows:
P J & D L Bamford the first $60,000 including capital gain, shared equally
Church of Scientology (The balance)
Redeposit of
Distribution: Representative of all Beneficiaries being present and agreeable it was resolved that the above allocations be credited to the Beneficiaries’ Accounts with the Trust to remain on deposit subject to payment on demand by the beneficiaries, by giving 14 days notice in writing.
17.By the tax return for the 2002 tax year the Company in its capacity as trustee for the Bamford Trust completed a statement of distribution and disclosed the net capital gain of $29,227 as being distributed to Philip Bamford and Davina Bamford.
18.Each of Philip Bamford and Davina Bamford lodged with the Commissioner a return of income for the 2002 tax year in accordance with the statement of distribution from the 2002 tax year return of the Bamford Trust.
19.On 27 February 2006 the Commissioner issued to the Company in its capacity as trustee for the Bamford Trust a notice of original assessment for the 2002 tax year under section 99A of the ITAA 1936. The taxable income was said to be $16,100 and the tax payable was $7,567 being 47% thereof.
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9. A consideration of the content of paragraphs 6, 7, and 8 above makes it clear that the 2000 matter and the 2002 matter (which by consent were heard together) are closely linked in that they both result from the fact that in May 2000 the Trustee as trustee of the Trust entered into an off-shore superannuation scheme (referred to in these reasons as “the Scheme”). In this context:
(a)In accordance with the Scheme the Trustee contributed $175,000.00 to the Bamford International Super Fund in respect of Mr Bamford and Mrs Bamford as employees of the Trustee; that contribution was funded by a loan from Equity Investment Bank (“the Bank”). In respect of the 2000 year the Trustee in its tax return claimed a deduction in respect of the contribution amount of $175,000.00, and also an amount described as “interest expense” and being an amount of $16,701.67 in respect of interest on the borrowing from the Bank. The Respondent disallowed the deductions claimed by the Trustee and in addition made determinations under Part IVA of the Income Tax Assessment Act 1936 (“the Act”). The Applicants, Mr Bamford and Mrs Bamford, in their SoFaC contended that Part IVA determinations were made against the Company and also against them personally, but confined in relation to them personally to the disallowed interest amount. The Respondent contends that Part IVA determinations were made against Mr and Mrs Bamford in respect of both the contribution amount and the interest expense; the Respondent referred in this context to Annexure J to Exhibit A2 contending that although it was a determination referable to the Trustee, its consequences flowed through to the beneficiaries through the operation of Division 6 of the Act. The Respondent referred also to document 8 in respect of the T-Documents referable to each of Mr and Mrs Bamford. We do not consider that anything material turns on the question of whether Part IVA determinations were made as contended by the Applicants or as contended by the Respondent.
(b)The 2000 matter arises from the fact that in consequence of the disallowance by the Respondent of the deductions claimed (amounting in aggregate to $191,701.67) the net income of the Trust calculated in accordance with s 95 of the Act (“the tax income”) exceeded its income as reflected in its accounts, and being the income of the Trust in accordance with s 97 of the Act (“the trust income”). In accordance with the amended assessments, the Respondent contends that Mr Bamford and Mrs Bamford are liable to tax on a proportionate share of the amount by which the tax income exceeded the trust income for the 2000 year.
(c)The 2002 matter is also (as set out previously) referable to the Scheme. In respect of the 2002 year, the Trustee claimed a deduction of $17,553.06 in respect of interest on the loan from the Bank; that deduction having been disallowed, the tax income in respect of the 2002 year exceeded the trust income by that amount.
10. In respect of the 2000 year and the 2000 matter:
(a)The Respondent contends that in accordance with the decision in Zeta Force Pty Ltd v Commissioner of Taxation (1998) 84 FCR 70 (“Zeta Force”) the excess of tax income over trust income must be taxed to the beneficiaries to whom the trust income was awarded in proportion to the amounts awarded to them. There is no dispute between the parties as to the actual amounts assessed (subject only to the fact that the Applicants contend that the penalties imposed should be reduced in whole or in part) and so that if the Respondent is successful on the law as to the 2000 matter, the amended assessments are (save in respect of penalties and which are dealt with as a separate issue later in these reasons) correct and should be affirmed.
(b)The Applicants contend that where, in respect of any given year, trust income is awarded to beneficiaries, there is a distinction to be drawn between an award of a specific amount and an award which is expressed as a proportion or percentage of the trust income.
(c)The Applicants contend that the decision of Merkel J in Richardson v Commissioner of Taxation (1997) 80 FCR 58 (“Richardson”) in which he favoured a different approach (referred to as “the Merkel alternative approach”) is both binding and to be preferred and do not accept that, as contended by the Respondent the decision of Merkel J in this particular context, was obiter.
(d)The Applicants contend that the decision of this Tribunal in Re Wensemius & Anor and Federal Commissioner of Taxation [2007] AATA 1006 (“Wensemius”) in which the taxpayer was taxed in the manner for which the Respondent contends, was incorrect.
(e)Accordingly, and in respect of the 2000 matter, the Tribunal must decide whether if it is bound by Zeta Force (as of course it is), it is also bound by the judgment of Merkel J in Richardson (on the basis that its content as to the Merkel alternative approach was not obiter) and if so which decision should be preferred.
(f)Furthermore, the Tribunal must decide whether, if it is of the view that it should follow Zeta Force and not the Merkel alternative approach set out in Richardson, whether a beneficiary to whom a specific amount is awarded should be taxed in the manner which applied to a beneficiary to whom a proportion or percentage of the trust income is awarded. The Applicants contend, in this context, that excepting only in respect of Wensemius there is no reported decision (and in particular a decision of the Federal Court) in which a beneficiary to whom a specific amount is awarded has been taxed in that manner.
11.In respect of the 2002 year and the 2002 matter, the question is again one of law; in this context:
(a)In the 2002 year the Trustee derived a capital gain of $58,454.00 arising from its sale of a half share in real property at Five Dock. That gain was reflected by the Trustee as a capital gain and in respect of that gain the capital gains tax discount was claimed; it was in other words accepted by the Trustee that that gain was not income according to ordinary concepts;
(b)The distribution resolution in respect of the 2002 year provided that the net income for the year be distributed as to Mr Bamford and Mrs Bamford as to “the first $60,000, including capital gain, shared equally”; and
(c)The question to be determined by the Tribunal is, as to whether the capital gain constituted trust income for the purposes of s 97 of the Act; if it did, there were, in respect of the 2002 year, beneficiaries presently entitled and so that an assessment against the Trustee under s 99A of the Act was not competent; if, by contrast, the capital gain did not constitute trust income for the purposes of s 97 of the Act, the Trustee did not have any trust income for the 2002 year, and in consequence of which there were no beneficiaries presently entitled, and so that the excess of tax income over trust income for that year was properly brought to tax in the hands of the Trustee under s 99A of the Act.
12. It was accepted by the Applicants, in respect of the Trust Deed constituting the Trust, that the term “income” is not a defined term; the Respondent contended, correctly in our view, that it must be construed so as to mean income in accordance with ordinary concepts.
13. Ms Davies on behalf of the Respondent drew the attention of the Applicants to the fact that the Trust Deed referred to contains a clause 7(n) which provided that the Trustees have the power:
… to determine in their absolute discretion whether any receipt, profit or gain or payment, loss or outgoing or any sum of money or investment is or is not to be treated as being on income or capital account PROVIDED THAT if they shall fail to make a determination or to the extent to which they fail to make a determination prior to the end of such year than the income of the Trust Fund for such year shall be calculated in the same manner as the net income of the trust estate is to be calculated under the provisions of the Income Tax Assessment Act, 1936 as amended.
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14. The affidavit evidence tendered on behalf of the Applicants does not contain any statement by the directors of the Trustee to the effect that pursuant to clause 7(n) of the Trust Deed they resolved that the capital gain be treated as trust income. The affidavit by Mr Cammarata (Exhibit A4), reads (exclusively of annexures) as follows:
On 14 March 2008, I Gaetano Antonio Cammarata, known as Tony Cammarata of …, chartered accountant make oath and say as follows:
1.I am a chartered accountant and was first admitted as a member of the Institute of Chartered Accountants in 1983. I was made a fellow of the Institute in 1995.
2.I am a graduate of Curtin University and graduated with a Bachelor of Business (Accounting) in 1981.
3.I have been a registered tax agent since 1981 and I am a registered company auditor since 1984.
4.I have worked continuously as a chartered accountant in public practice for some 28 years now, having spent the first four years an employee accountant and the last 24 years as self employed. I have had over 25 years experience in the preparation of Financial Statements.
5.I crave leave to refer to the earlier affidavit of Philip Bamford sworn in these proceedings on 14 June 2007. I refer specifically to the financial accounts for the Bamford trust for the year ended 30 June 2002 being annexure “D” to the Philip Bamford affidavit.
6.I prepared the Bamford Trust 2002 Financial statements being exhibit “D”. I recall my instructions that the Trust had disposed of its interest in a property at Queens Road, Five Dock NSW during the 2002 year. I recall calculating the profit on sale of that interest being the amount of $58,454 and entering that amount in the detailed profit and loss statement of the Trust for the 2002 year. It is that amount which appears in the 2002 financial accounts attached as annexure “D”.
7.Based on my 28 years experience as a chartered accountant, tax agent, and company auditor it is standard Australian accounting practice to show capital profits on the sale of non current assets as a revenue item on the profit and loss statement of an entity. In my experience I am not aware of ever not disclosing the profit on sale of a non current asset and bringing it to account as a revenue item on the profit and loss statement.
8.I am aware that it is theoretically possible to carry the profit on sale of a non current asset direct to an account styled “capital profits reserve” or the like. In that manner the profit is not disclosed as a revenue receipt on the profit and loss statement of an entity. In my opinion that procedure of taking the profit direct to a capital profits reserve does not present a true and fair view of the entity’s financial position. For that reason I have always presented it as a revenue item and I am not aware of any actual example or case where such undisclosed “capital profits reserve” approach has been adopted.
9.In the preparation of the 2002 accounts for the Bamford Trust, and indeed for my preparation of any financial accounts, I am aware of, and took into account, the requirements of Australian Accounting Standard AAS 15 entitled “Revenue”. That is a basic standard. Attached and marked “A” is a copy of AAS 15.
10.In Note 1 to the 2002 Financial Statements reference is made to taking AAS 5 and AAS 8 into account, together with the annotation “No other Australian Accounting Standards, Urgent Issues Group Consensus Views or other authoritative pronouncements of the Australian Accounting Standards Board have been applied”. That statement is stock standard. I did not have specific regard to any particular Accounting Standards other than AAS 5 and AAS 8.
11.Reporting of profit on sale of non current assets as Revenue receipts under AAS 15 is in my view part of the basic framework of Australian reporting requirements. AAS 15 is just taken for granted, part of the accounting furniture, in a manner of speaking.
12.After recognizing on the profit and loss statement, after allowing for all expenses, a “net profit from ordinary activities before income tax” of $55,675 I carried that figure to the beneficiaries distribution statement and loan account. Annexed and marked “B” is a copy of the Bamford Trust 2002 beneficiary distribution summary and loan account.
15. It will be noted then that the evidence of Mr. Camarata was that the capital gain was correctly recorded as revenue; his evidence does not indicate that it was income or that it constituted trust income for the purposes of s 97 of the Act.
PART B - Relevant Legislation
16. It is convenient in this Part B to include those sections of the Act which are of particular relevance, and being ss 95 (confined to the definition “net income”), 97 (confined to subsection (1) of that section), 99A and (in relation to penalties) 226L and 226Y of the Act reading as follows:
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95. Interpretation
(1) In this Division:
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“net income”, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 16C or Schedule 2G and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.
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97. Beneficiary not under any legal disability
(1)Subject to Division 6D, where a beneficiary of a trust estate who is not under any legal disability 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; and
(ii)so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia; and
(b) the exempt income of the beneficiary shall include:
(i)so much of the individual interest of the beneficiary in the exempt income of the trust estate as is attributable to a period when the beneficiary was a resident; and
(ii)so much of the individual interest of the beneficiary in the exempt income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia;
except to the extent to which the exempt income to which that individual interest relates was taken into account in calculating the net income of the trust estate.
Note:If the trust estate’s net income includes a net capital gain, Subdivision 115‑C of the Income Tax Assessment Act 1997 also affects the assessment of the beneficiary.
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99A Certain trust income to be taxed at special rate
(2)This section does not apply in relation to a trust estate in relation to a year of income, being a trust estate:
(a) that resulted from:
(i)a will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil; or
(ii)an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of the estates of persons who die intestate;
(b)that consists of the property of a person who has become bankrupt, being property that has vested in The Official Receiver in Bankruptcy, or in a registered trustee, under the Bankruptcy Act 1966;
(c)that is administered under Part XI of the Bankruptcy Act 1966; or
(d) that consists of property of a kind referred to in paragraph 102AG(2)(c);
if the Commissioner is of the opinion that it would be unreasonable that this section should apply in relation to that trust estate in relation to that year of income.
(3) In forming an opinion for the purposes of subsection (2):
(a)the Commissioner shall have regard to the circumstances in which and the conditions, if any, upon which, at any time, property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to property of the trust estate, whether or not the rights or privileges have been exercised;
(b)if a person who has, at any time, directly or indirectly:
(i)transferred or lent any property (including money) to, or conferred any benefits on, the trust estate; or
(ii)conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate whether or not the right or privilege has been exercised;
has not, at any time, directly or indirectly:
(iii)transferred or lent any property (including money) to, or conferred any benefits on, another trust estate; or
(iv)conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of another trust estate, whether or not the right or privilege has been exercised;
the Commissioner shall have regard to that fact; and
(c)the Commissioner shall have regard to such other matters, if any, as he thinks fit.
(3A)For the purposes of the application of paragraph (3)(a) in relation to a trust estate of the kind referred to in paragraph (2)(a), a reference in that first‑mentioned paragraph to the trust estate shall be read as including a reference to the person as a result of whose death the trust estate arose.
(4) Where there is no part of the net income of a resident trust estate:
(a)that is included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;
(b)in respect of which the trustee of the trust estate is assessed and liable to pay tax in pursuance of section 98; or
(c)that represents income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia;
the trustee shall be assessed and is liable to pay tax on the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.
Note:If the trust estate’s net income includes a net capital gain, Subdivision 115‑C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.
(4A) Where there is a part of the net income of a resident trust estate:
(a)that is not included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;
(b)in respect of which the trustee is not assessed and is not liable to pay tax in pursuance of section 98; and
(c)that does not represent income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia;
the trustee shall be assessed and is liable to pay tax on that part of the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.
Note:If the trust estate’s net income includes a net capital gain, Subdivision 115‑C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.
(4B)Where there is no part of the net income of a trust estate that is not a resident trust estate:
(a)that is included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;
(b)in respect of which the trustee of the trust estate is assessed and liable to pay tax in pursuance of section 98; or
(c)that is attributable to sources out of Australia;
the trustee shall be assessed and is liable to pay tax on the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.
Note:If the trust estate’s net income includes a net capital gain, Subdivision 115‑C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.
(4C)Where there is a part of the net income of a trust estate that is not a resident trust estate:
(a)that is attributable to sources in Australia;
(b)that is not included in the assessable income of a beneficiary of the trust estate in pursuance of section 97; and
(c)in respect of which the trustee of the trust estate is not assessed and is not liable to pay tax in pursuance of section 98;
the trustee shall be assessed and is liable to pay tax on that part of the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.
Note:If the trust estate’s net income includes a net capital gain, Subdivision 115‑C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.
…
226L Penalty tax where unarguable position taken about scheme
Subject to this Part, if:
(a)a taxpayer has a tax shortfall for a year; and
(b)the shortfall or part of it was caused by the taxpayer in a taxation statement treating an income tax law as applying in relation to a scheme in a particular way; and
(c)the scheme was a tax avoidance scheme within the meaning of subsection 224(1); and
(d)none of the scheme sections applies in relation to the scheme;
the taxpayer is liable to pay, by way of penalty, additional tax equal to:
(e)if, when the statement was made, it was reasonably arguable that the way in which the application of the law was treated was correct—25% of the amount of the shortfall or part; or
(f)in any other case—50% of the amount of the shortfall or part.
…
226Y Reduction of penalty tax—disclosure after tax audit notified
If:
(a)under a shortfall section a taxpayer is liable to pay additional tax in respect of a year of income because of a tax shortfall or part of a tax shortfall; and
(b)after the Commissioner had informed the taxpayer that a tax audit relating to the taxpayer in respect of the year was to be carried out, the taxpayer voluntarily told the Commissioner, in writing, about the shortfall or part; and
(c)telling the Commissioner could reasonably be estimated to have saved the Commissioner a significant amount of time or significant resources in the audit;
the amount of the additional tax is reduced by 20%.
…
PART C - Zeta Force
17. The judgement of Sundberg J in Zeta Force is of such importance that we include its content under the following heads:
(a)The accounts and returns (pp72)
(b)The Tribunal’s corrections (p73)
(c)Division 6 (pp73-74)
(d)That share of the net income of the trust estate (pp74-75)
…
THE ACCOUNTS AND RETURNS
Until 17 November 1990 Lockwood Valley Pty Ltd as trustee of the Fenwick Family Trust ("the family trust") held 30 per cent of the units in the Independent Poultry Trust (No 2) ("the unit trust"). On that date its units were redeemed as part of a settlement among the unitholders. The initial profit and loss account of the unit trust for the period to 17 November 1990 showed a net profit of $965,545 and an interim distribution to the family trust of $289,663. A subsequent adjustment for a bad debt recovery increased the unit trust's net profit, and the interim distribution to the family trust was correspondingly increased to $291,484. The accounts of the unit trust for the year ended 30 June 1991 showed a net profit of $908,221, of which $291,484 had been distributed to the family trust. However the income tax return of the unit trust showed a net income of $1,335,554 and the family trust's share of the net income as $421,994. The difference between the unit trust's net income ($1,335,554) and its accounting income ($908,221) was principally attributable to an amount of $435,035 prepaid by the trustee in the 1990 year and deductible in that year for net income purposes but not until the 1991 year for trust accounting purposes. The distribution made by the unit trust to the family trust in respect of the 1990 year included an untaxed amount referable to the prepayment. Only the adjustment of $435,035 was attributed by the trustee of the unit trust to the period up to 17 November 1990. The family trust's share of that amount was $130,510.
The return of income of the family trust for the year ended 30 June 1991 disclosed income of $289,633 from the unit trust and net income of $191,037. The trustee of the family trust appointed the distributable income as to $5,000 to a member of the Fenwick family and the balance to the applicant. The applicant's return of income disclosed income from the family trust of $186,037 and net income of $185,892. The Commissioner determined the net income of the family trust for the year ended 30 June 1991 to be $421,915, made up of $291,484 (the amount distributed by the unit trust) and $130,431 (the prepayment share). In consequence he increased the applicant's taxable income by $130,431.
THE TRIBUNAL'S CORRECTIONS
The Commissioner had increased the applicant's taxable income by $130,431, which was said to be the difference between the share of accounting profit and the amount returned by the family trust ($291,484) and its share of net income as shown in the unit trust's return of income ($421,915). The Tribunal pointed out that neither figure was correct. In fact the family trust's return showed income of $289,663 (rather than the amended figure of $291,484). The share of net income shown in the unit trust's return was in fact $421,994. The difference between the income returned by the family trust ($289,663) and its share of the net income disclosed in the unit trust's return ($421,994) was $132,331.
The Tribunal computed the family trust's share of the unit trust's net income as follows:
$291,484 X $1,335,554 = $428,632
$908,221
The net income of the family trust was thus increased by $138,969 ($428,632 less the amount returned of $289,663) to $330,006 ($191,037 as returned plus $138,969). The applicant's share of that amount was calculated as follows:
$223,053 X $330,006 = $322,771
$228,053
The $228,053 figure was the distributable income of the family trust for the year, and the $223,053 resulted from deducting from the distributable income the $5,000 distributed to the Fenwick beneficiary.
As a result of using some incorrect figures and relying on the allocation of net income in the unit trust's return of income, the Commissioner had included $316,468 in the applicant's amended assessment as the share of net income of the family trust. It was common ground before me that the Tribunal's figure ($322,771) is the correct one.
It will be apparent from the Tribunal's computation of the family trust's share of the net income of the unit trust that it allocated to the family trust that proportion of the net income as $291,484 is of $908,221. As I have said, the main question in the appeal is whether this "proportionate" calculation is the method contemplated by s 97.
DIVISION 6
Section 95(1) defines "net income" in relation to a trust estate as:
“the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions .... “
Except as provided in the Act, a trustee is not liable to pay income tax upon the income of the trust estate: s 96. Section 97(1) provides, so far as material, that:
“Where a beneficiary of a trust estate who is not under any disability is presently entitled to a share of the income of the trust estate:
(a) the assessable income of the beneficiary shall include:
(i)that share of the net income of the trust estate … “
Section 98(1) provides in part that:
“Where a beneficiary of a trust estate who is under a legal disability is presently entitled to a share of the income of the trust estate, the trustee of the trust estate shall be assessed and liable to pay tax in respect of:
(a) … that share of the net income of the trust estate …
…
as if it were the income of an individual and were not subject to any deduction.”
In the situations to which it applies s 99 subjects the trustee to tax on the net income of the trust estate, or part of that income, as if it were the income of an individual. It is sufficient to set out sub-s (3):
“Where there is a part of the net income of a resident trust estate:
(a)that is not included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;
(b)in respect of which the trustee is not assessed and is not liable to pay tax in pursuance of section 98; and
(c)that does not represent income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia,
the trustee shall be assessed and is liable to pay tax on that part of the net income of the trust estate as if it were the income of an individual who was a resident and were not subject to any deduction.”
Section 99 does not apply where s 99A applies. In the situations to which it applies s 99A subjects the trustee to tax on the net income of the trust estate at the rate declared by Parliament. It is sufficient to set out sub-s (4A):
“Where there is a part of the net income of a resident trust estate:
(a)that is not included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;
(b)in respect of which the trustee is not assessed and is not liable to pay tax in pursuance of section 98; and
(c)that does not represent income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia,
the trustee shall be assessed and is liable to pay tax on that part of the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.”
“THAT SHARE OF THE NET INCOME OF THE TRUST ESTATE”
In the ensuing discussion I put earlier authorities aside. I return to them later to determine whether they require me to depart from the conclusion I reach under this heading.
The words "income of the trust estate" in the opening part of s 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument. That the words have this meaning is confirmed by the use elsewhere in Div 6 of the contrasting expression "net income of the trust estate". The beneficiary's "share" is his share of the distributable income.
Having identified the share of the distributable income to which the beneficiary is presently entitled, s 97(1) requires one to ascertain "that share of the net income of the trust estate". That share is included in the beneficiary's assessable income. The expression "net income of the trust estate" in par (a)(i) has the meaning given it by s 95(1) - taxable income as opposed to distributable income. 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".
The contrast between the expressions "share of the income of the trust estate" and "that share of the net income of the trust estate" shows that the draftsman has sought to relate the concept of present entitlement to distributable income, and not to taxable income, which is, after all, an artificial tax amount. Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the notion of present entitlement has served its purpose, and the beneficiary is to be taxed on that share (or proportion) of the taxable income of the trust estate.
That construction of s 97(1)(a) seems reasonably clear to me, although it may, as I have indicated, result in unfairness to beneficiaries. Had the legislature intended a beneficiary to be assessed on no more than the amount of the distributable income to which he is presently entitled, it could easily have said so. Section 97(1)(a)(i) would have read along the lines:
"Where a beneficiary ... is presently entitled to an amount of the income of the trust estate, the assessable income of the beneficiary shall include so much of that amount as does not exceed the net income of the trust estate."
…
18. In Zeta Force the relevant resolution reflected a distribution of $5,000.00 to a member of the Fenwick family and the balance to the taxpayer in that case (Zeta Force). It will be noted then that there was an award of a specific amount and also an award of the residue. Sundberg J held that the additional income (being the excess of tax income over trust income) was to be taxed in the hands of the taxpayer (Zeta Force) on its proportion of the additional income. The judgment is silent as to what occurred in relation to the member of the Fenwick family to whom $5,000.00 was awarded, but the Tribunal considers it reasonable to accept having regard to the judgement that he or she too would have been liable for tax on his or her proportionate share of the additional income. This indeed was the basis on which tax was assessed to the taxpayer in Wensemius and the Tribunal does not believe that its decision in Wensemius was incorrect. Mr Young contended that in relation to a specific amount beneficiary an assessment of his or her proportion of the additional income should be made against the trustee under ss 99 or 99A of the Act; there does not appear to us to be any basis for that contention.
19. Put succinctly, the effect of the judgment in Zeta Force is that it is necessary in the first instance to ascertain in relation to the beneficiaries presently entitled, their shares of trust income and then to attribute any excess of tax income over trust income to them in accordance with the same proportion. There is nothing in those words which would suggest that the word “share” is confined to a share which is expressed as a fraction or percentage and it is our view that they are equally apposite to an award which is expressed as an amount. Zeta Force makes it clear that the fact that a beneficiary is presently entitled to a share of the trust income results in his or her being liable for tax on the same share of the tax income.
20. It is also relevant to note that Sundberg J in Zeta Force referred specifically to the judgment of Merkel J in Richardson’s case at pages 81 and 82 in the following terms:
…
Merkel J acknowledged that the problem with his solution is that it gives a different operation to the phrase "share of the net income of the trust estate" depending on whether the distributable income is less or more than the taxable income. He referred to s 15AAA of the Acts Interpretation Act 1901 and to the principles of construction considered in cases such as Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation [1981] HCA 26; (1981) 147 CLR 297 which, in his opinion, justified his differential approach. At 183-184 his Honour said:
“Notwithstanding the anomaly created by the legislative requirement, its purpose is clear. The relevant statutory provisions are not clear and unambiguous. In these circumstances the court will prefer a construction that gives effect to the statutory purpose rather than one which defeats it. However, to give effect to the statutory purpose, different approaches to the operation of s 97(1) and in particular to the meaning of a "share" for the purposes of s 97(1) need to be adopted depending on whether the trust income is less or greater than the trust's assessable income. I am satisfied that the authorities to which I have referred warrant that approach, particularly when it is necessary to avoid capricious, arbitrary and clearly unintended consequences.
...
The approach I have adopted to the operation of s 97(1) ensures that those entitled to the trust income, including the trustee in respect of "income" to which no beneficiary is presently entitled, bear their commensurate "share" of the tax liability in respect of the trust's income.”
His Honour then acknowledged that his conclusion differed from that adopted by Hill J, but noted that in Davis no submission had been made against the proportionate view. Nor had the differential approach been put to or considered by Hill J. Merkel J did not refer to Richard Walter.
Merkel J's remarks were obiter, since he held the Administrative Appeals Tribunal had erred in law in failing to give real and genuine consideration to the effect of s 97, in that it had arrived at its conclusion that the distributable income and the taxable income were the same without any evidence to support it: at 177 and 180. His Honour remitted the matter to the Tribunal for it to determine the distributable income. The observations his Honour made about the proportionate and quantum approaches to s 97 were made since, in his view, it would almost certainly be necessary for the Tribunal to consider the application of s 97, and it might be assisted in that task if his Honour set out his views on the operation of the section.
…
21. In Cajkusic v Commissioner of Taxation (2006) 155 FCR 430 (“Cajkusic”), the Full Court referred with approval to the judgment of Zeta Force; see paragraph 22 at page 436 reading as follows:
…
[22]First, it does not follow that, because the instrument pursuant to which a trust estate is constituted spells out that the trustee has an absolute discretion as to what receipts are treated as income and what outgoings are treated as outgoings against that income for the purposes of determining the income for s 97 purposes – the distributable net income – you can define your way out of the application of the 1936 Act. Liability for tax on the s 95 “net income” will fall where the 1936 Act intends it to fall. In other words, if there is no s 97 income – no distributable net income – to which any beneficiary is presently entitled, then liability for the tax on any s 95 “net income” will fall on the trustee under s 99 or s 99A of the 1936 Act. On the other hand, if there is any s 97 income to which beneficiaries are presently entitled, then any s 95 “net income”, whether it is greater or smaller than the distributable net income, will fall to be taxed in the hands of those beneficiaries in proportion to their respective shares of the s 97 income: see Zeta Force Pty Ltd v Commissioner of Taxation (1998) 84 FCR 70 and the cases there referred to.
…
22. Zeta Force was also referred to with approval by Finkelstein J in Richardson v Commissioner of Taxation 2001 ATC 4058 (“Richardson 4058”); see para 9 of that judgment. Zeta Force was furthermore referred to in Commissioner of Taxation v Pilnara Pty Ltd (1999) 96 FCR 82 (“Pilnara”); we refer in this context to page 102, para 70 reading as follows:-
…
[70]Should the result of an inquiry reveal that there is attributable income which is to be included in the computation of “net income” under s 95 of the Act in a year of income, there would arise a discrepancy between the result of the computation of “net income” and the calculation of the income to which a beneficiary could be presently entitled pursuant to the provisions of the trust deed. That problem has been the subject of a number of decisions in this Court, the most recent of which is the decision of Sundberg J in Zeta Force Pty Ltd v Commissioner of Taxation (Cth) (1988) 84 FCR 70.
…
PART D - Richardson
23. There are a number of reported judgements in respect of Richardson. Richardson was first decided by Merkel J in 1997; that decision was (as set out previously) reported as (1997) 80 FCR 58. Merkel J remitted the matter back to the Tribunal and thereafter appeals to the Federal Court (Finkelstein J) reported (again as set out previously) at 2001 ATC 4058, and to the Full Federal Court, reported at 2001 ATC 4621. This Tribunal is in this case concerned with the judgment by Merkel J only in relation to the Merkel alternative approach, and pursuant to which the treatment for tax purposes of an income differential would differ depending on whether trust income exceeded tax income or tax income exceeded trust income. We refer in this context to pp75-76 of the decision of Merkel J in Richardson as follows:
…
In giving effect to these principles it has been long accepted that the legal meaning of an enactment includes what is necessarily or properly implied so as to give effect to the legislative intention gleaned from the language used: see Chorlton v Lings (1868) 4 CP 374 at 387 per Willes J and Statutory Interpretation at pp 361-368.
The cause of the s 97(1) problem is easy to identify. The statutory requirement that a share of a trust's assessable income be determined by reference to a share of trust income assumes that two fundamentally different concepts can be treated as the same for the purpose of determining the tax consequences of a present entitlement to trust income.
Notwithstanding the anomaly created by the legislative requirement, its purpose is clear. The relevant statutory provisions are not clear and unambiguous. In these circumstances the Court will prefer a construction that gives effect to the statutory purpose rather than one which defeats it. However, to give effect to the statutory purpose, different approaches to the operation of s 97(1) and in particular to the meaning of a "share" for the purposes of s 97(1) need to be adopted depending on whether the trust income is less or greater than the trust's assessable income. I am satisfied that the authorities to which I have referred warrant that approach, particularly when it is necessary to avoid capricious, arbitrary and clearly unintended consequences. As was said by McHugh J in Saraswati at 22 the Court is entitled to give effect to the statutory purpose "by addition to, omission from or clarification of, the particular provision".
In my view s 97(1) and the difficulties to which I have referred require that that principle of construction be employed to ensure that when trust income exceeds the trust's taxable income a proportionate approach is adopted to determine the distribution of assessable income to beneficiaries presently entitled under s 97(1). But, when the trust's taxable income exceeds the trust income a quantum approach is to be adopted to determine the distribution of assessable income in relation to the beneficiary presently entitled to the trust income under s 97(1). In the latter case the deficiency will be undistributed "income" to which no beneficiary is presently entitled and will be taxable income of the trustee under s 99 or 99A of the Act.
The approach I have adopted to the operation of s 97(1) ensures that those entitled to the trust income, including the trustee in respect of "income" to which no beneficiary is presently entitled, bear their commensurate "share" of the tax liability in respect of the trust's income. I would add that where the trustee is assessed under s 99 or 99A no capricious, unfair or anomalous result arises. The situation is usually one which is avoidable by the trustee, if it so desires, by exercising its power under the deed to ensure that there has been a distribution of all of the assessable income. In any event it is difficult to perceive any unfairness in the trustee's tax liability being borne by the trust estate, rather than the beneficiaries who did not become entitled to the "income" giving rise to the liability.
I appreciate that the conclusion at which I have arrived is different from that expressed by Hill J in Davis. However in Davis no submission was made or argument put to Hill J against the conclusion at which his Honour arrived. That is not so in the present case. Further, the approach to construction which I have adopted was not put to or considered by his Honour.
…
24. As set out previously, Merkel J then referred the matter back to the Tribunal for reconsideration and although his judgment contains statements as to how in his view, the income differential should be dealt with, those statements were plainly obiter. Certainly the judgment has, in this particular context, been treated as obiter in Zeta Force itself and in FC of T v Prestige Motors Pty Limited as Trustee of the Prestige Toyota Trust (1998) 98 ATC 4241 (“Prestige Motors“) and in particular the passage at page 4257 reading as follows:
… The reference to the word “income” is to the trust law income of the relevant trust estate: Taylor & Anor v DFC of T 69 ATC 4072; (1969) 123 CLR 206; Davis & Anor v FC of T 89 ATC 4377; (1989) 86 ALR 195 (FCA/ Hill J), at ATC 4403; ALR 229-230. It is not necessary to consider the difficulties which arise where the tax law income and the trust law income do not coincide, since no such discrepancy has been suggested in the present case. (This question was recently considered by Merkel J in Richardson v FC of T 97 ATC 5098 at 5111-5113, where his Honour, obiter, declined to follow part of the reasoning in Davis, notwithstanding that Davis had been followed in Richard Walter Pty Ltd v FC of T 95 ATC 4440 (FCA/Tamberlin J) at 4445, in a passage not affected by the subsequent appeal: Richard Walter Pty Limited v FC of T 96 ATC 4550; (1996) 67 FCR 243 (FCA/FC). The usual position is that where a beneficiary of a trust estate is presently entitled to a percentage of the trust law income, there is to be included in his or her assessable income the same percentage of the tax law income, pursuant to s 97 of the ITAA.)
…
25. Mr Young referred the Tribunal to Tracy v Repatriation Commission [2000] FCA 779 (“Tracy”) in support of his contention that the Merkel alternative approach by Merkel J in Richardson to which we have referred was not obiter. We do not need to refer to that judgment because we are satisfied that the relevant statement by Merkel J in Richardson was in fact obiter; so much is clear from the judgment of Sundberg J in Zeta Force and the Full Federal Court in Prestige Motors. Even if it could be said that it was not obiter (and we do not consider this is so) and so that we must choose between the competing Federal Court judgments Zeta Force, approved by the Full Federal Court in Cajkusic and by Finkelstein J in Richardson 4058 must be preferred.
26. Other cases were cited before the Tribunal but it is not necessary for us to refer specifically to them. Zeta Force is binding on us and it establishes that where tax income exceeds trust income the excess is taxed in the hands of those beneficiaries presently entitled in proportion to their awards of trust income. The fact that an award may be of an amount rather than of a percentage does not in our view have any different consequence.
PART E - Penalty
27. Mr and Mrs Bamford were assessed for penalty tax in relation to the 2000 matter pursuant to the then s 226L, as quoted at paragraph 16 above.
28. The Respondent submitted that the penalty met the requirements of the various paragraphs of s 226L, as follows:
(a)There was a tax shortfall for the year because a claim for a deduction had been disallowed.
(b)Although the deduction was claimed by the Trust, the Bamfords were beneficiaries of the Trust; they were also directors and shareholders of the Trustee and effectively controlled it. That deduction was disallowed (correctly as the Applicants conceded) and accordingly the trust income was correspondingly increased. In accordance with Zeta Force a proportion of the increase was taxable to the Applicants. There was thus a tax shortfall in respect of the Applicants.
(c)The Applicants had not disputed that the arrangement was a scheme, nor had they adduced evidence to show that it was not. The tax was imposed under s 224(1), and the Applicants had the onus of showing that it was not a scheme. Although the Part IVA determination related to the Trust rather than to the Applicants, its effect flowed through to the beneficiaries. The Applicants had not disputed that there was a scheme, although they could have done so.
(d)The requirement in relation the scheme sections was satisfied by the Applicants’ concession that the payment was not deductible.
(e)The Applicants did not qualify for a 25 percent penalty pursuant to this paragraph because, for the reasons set out above, it was not reasonably arguable that the payment was deductible. The law as explained in Zeta Force was clear and there had been no other case analogous to that of the Applicants.
29. The Applicants conceded that s 226L captured the Trustee, but pointed out that the taxpayers for the purposes of that section were the Bamfords as individuals. They contended that the phrase “caused by” implied that the shortfall was the direct or immediate result of an avoidance scheme, but in that sense the scheme in the present case had caused a deduction at the Trust level, not at the level of the Bamfords as individuals. They contended in other words that the causation was not of a direct or proximate nature.
30. As far as the Bamfords were concerned, the cause of the shortfall was (so they contended) the proportional application of the additional trust income in their individual returns. They therefore contended, that this was a cause which was (relevantly) subsequent to the scheme.
31. The Applicants also contended that they had a reasonably arguable position as to the application of the law, and that consequently, if a penalty were to be imposed at all, it should have been at the rate of 25 percent pursuant to paragraph (e). That it was arguable (so they contended) was shown by:
§The observation of Mr AH Slater QC in his paper “The Intersection of Tax, Legal and Accounting Concepts” presented at the Federal Court Judges Taxation Conference in 2007 [referred to also in para 36 below];
§The decision of Merkel J in Richardson;
§The Commissioner’s own policy statement in PS LA 2005/1(GA);
§The unprecedented application apart from the Tribunal’s decision in Wensemius of the proportionate view to the present facts,;
§The inapplicability of Zeta Force; and
§The undesirable consequences from a tax policy viewpoint.
32. Penalty was assessed in relation to Mr and Mrs Bamford at 50 percent on the basis that there was no arguable case. It was then reduced to 40 percent through the operation of s 226Y of the Act.
33. Section 226L applies where inter alia there was a scheme which was a tax avoidance scheme. The Applicants did not contend that there was not a tax avoidance scheme. It is relevant in this context that in 2007 the Applicants, through their solicitor, conceded that the deductions sought were not allowable and had never been allowable; once that concession was made Part IVA of the Act became irrelevant. If the Applicants wished to contend that the Scheme was not a tax avoidance scheme, the onus was on them to establish that this was so. They made no attempt to do so.
34. Mr Young argued that the Scheme was entered into by the Trustee and not by the Applicants, being Mr Bamford and Mrs Bamford. He contended, in other words, that there was no sufficient connection. We do not consider that that contention was well founded. Mr and Mrs Bamford, the Applicants in the 2000 matter, were also the directors of and shareholders in the Trust and were moreover beneficiaries under the Trust Deed. The borrowing from the Bank was made in order to fund an alleged contribution to an offshore fund for them as employees of the Trustee. They were directly and intimately concerned in the whole process and so that a sufficient consideration was, on any basis, established.
35. Penalty was assessed in respect of each of Mr and Mrs Bamford at a time when each of them claimed that the relevant deductions were allowable and that Part IVA did not apply. It was only at a much later stage that they conceded that the deductions claimed were not allowable and so that and in consequence Part IVA became irrelevant. It is our view that in all the circumstances the Respondent properly imposed a penalty but it remains for us to consider whether it should be reduced.
36. We have taken account of the fact that the law involved in this matter is complex. Even apart from the conflict between Zeta Force and Merkel J in Richardson (and we do not think that it can reasonably be argued that Richardson as decided by Merkel J can, as regards the Merkel alternative approach, be preferred to Zeta Force), we accept that there is an argument as to whether or not a specific beneficiary is to be treated for these purposes in the manner applicable to a proportionate award beneficiary. Even if the first aspect was of limited relevance for these purposes the second was not. Some conception of the difficulties involved can be obtained from a consideration of the paper entitled “The Intersection of Tax Legal and Accounting Concepts” presented at the Federal Court Judges’ Taxation Conference in 2007 by Mr AH Slater QC, although it is unnecessary for us to specify the areas of complexity involved.
37. Although in respect of the 2000 matter we have found against the Applicants, we are inclined to the view that they did have a case which was arguable. That being so, we think it proper to reduce the penalty awarded against Mr Bamford and Mrs Bamford to 25 percent, and then to allow the disclosure discount provided in s 226Y reducing the penalty overall in the case of each of them to 20 percent.
PART F - 2002 Matter
38. Clause 7(n) of the Trust Deed furnishes the Trustee with discretion to determine whether a given receipt should be treated as income or as capital. Clause 7(n) has been set out in full at paragraph 13 above.
39. As set out previously in these reasons, the evidence before the Tribunal does not indicate that the Trustee did in concrete terms make a determination to that effect. Mr Cammarata referred at some length to AAS 15 and said that in accordance with accounting standards, the capital gain was treated as revenue and for these reasons was not credited to a capital reserve. Mr Cammarata did not in his affidavit indicate whether or not he acted on his instructions from the Trustee and he did not state that he treated the capital gain as income. Income and revenue are different concepts.
40. The relevant resolution referred to a distribution of “income including capital gain”. That statement is prima facie ambiguous. It could be read as indicating a recognition of the fact that the capital gain constituted a separate and distinct item or, in the alternative, it could be construed as indicative of the fact that in accordance with clause 7(n) of the Trust Deed it has been categorised as trust income. Mr Young contended that at least implicitly the Trustee had categorised it as income in accordance with clause 7(n) of the Trust Deed. The wording involved is not clear but on balance we are inclined to the view that the contention by Mr Young should be accepted; the use of the word “including” in this context favours this interpretation, although one might in that event have expected some reference to that determination in the affidavit by Mr Cammarata. His evidence was that the capital gain was revenue, which, as we said previously, is not the same as income.
41. It is important to remember that the term “income” as set out in the Trust Deed is not defined and so it must be construed so as to refer to income according to ordinary concepts. Tax law has for centuries recognised the distinction between a capital gain and income, most often in the context of the respective rights of the life tenant and remainderman in relation to an estate.
42. It is conceivable that if a Trust Deed had contained a definition of “income” which had the effect that trust income and tax income were the same, the term “income” might without reference to clause 7(n) of the Trust Deed include gains of a capital nature. There are comments in the Full Federal Court decision in Cajkusic (obiter), which suggest that this may be so. Clause 7(n) of the Trust Deed provided for just such treatment but only in default of a determination and as set out previously we have accepted that the resolution should implicitly be construed as a determination in accordance with that clause. But the fact that pursuant to a deed something which is not income is re-determined as such does not have the effect that it is income (and more particularly trust income) within s 97 of the Act.
43. In Federal Commissioner of Taxation v Totledge Pty Ltd (1982) 12 ATR 830 (“Totledge”) at page 838 the judges held:
... the preferable construction of s 97(1) is to treat the requirement of present entitlement to a share of the income of the trust estate as not being concerned with distinctions between gross income as derived and `surplus income' after payment of costs, expenses and outgoings but as referring to 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 (emphasis added).
…
44. We agree with the Respondent’s contention that a present entitlement to a share of the trust income is a present vested right to demand payment of what has been received by the Trustee with the character of income and, retaining that character, is distributed as such. It is not a present vested right to demand and receive payment of a capital receipt redefined by the terms of the Trust Deed as income of the Trust Deed and distributed as such.
45. The Respondent’s contention, as set out in the preceding paragraph, is supported by the decision in Commissioner v ANZ Savings Bank Ltd (1998) 194 CLR 328 (“ANZ”); we refer to (and approve) paragraph 21 of the Respondent’s written submissions reading as follows:
…
21.This is supported by the reasoning of the High Court in Commissioner of Taxation v ANZ (1998) 194 CLR 328. In that case, a partnership borrowed money to invest in units in a unit trust which used the funds to purchase an annuity. Under s 27H of the Act, the amount of an annuity payment included in assessable income is the total amount of the annuity less the ‘deductible amount' (ie the purchase price of the annuity) allocated to each annuity payment on a pro‑rata basis. The deductible amount is exempt income for the purposes of the Act. The Commissioner disallowed part of the deduction claim on the ground that some of the interest had been incurred for the purpose of gaining or producing exempt income. The taxpayer argued that the terms of the trust deed treated the deductible amount of the annuity as capital held on trust for the unit holders. The High Court expressly adopted what had been held by the Full Federal Court on this issue. The High Court and the Full Federal Court both held that the annuity instalments paid to the trust contained no element of capital although the instalments could be treated as such by the terms of the trust. The income character was retained for the purposes of s 97 – that is, the whole of the annuity amount was income of the trust estate within the meaning of s 97 notwithstanding that part of the amount was treated as capital under the deed. Hence there was a present entitlement to the whole of the annuity amount. Gleeson CJ (with whom all the other members of the Full Court of the High Court agreed) at p 337 line 15 stated that what the trust deed provided for did not alter the law’s characterisation of the whole of an annuity payment as constituting income (citing Charles v Federal Commissioner of Taxation (1954) 90 CLR 598 at 608):
… For the reasons earlier given, the whole of the annuity amounts received by the trustee constituted income of the trust. The circumstance that the trust instrument, for the purpose of dealing with the entitlements of unit holders, treated the deductible amount as capital, did not alter what was described in Charles v FCT [(1954) 90 CLR 598 at 608] as "the character of those moneys in the hands of the trustees".
…
46. We also accept the Respondent’s contention that the terms of a trust deed cannot alter the character of a receipt in the hands of a trustee. Put in other words, the fact that a trustee (having the power to do so) elects to treat a capital gain as income in order to distribute it to a beneficiary will not alter its character as capital in the hands of the trustee. It will be a capital receipt in the hands of the trustee even though the trustee may be entitled to treat it as income for the purposes of distribution. The fact that beneficiaries may have rights against the trustee based on his decision to distribute a capital gain in a particular manner will not have the effect that the provisions of the Act are to be interpreted differently. As set out previously in these reasons, the position might (and see in particular paragraph 47 below) be different if the Trust Deed defined trust income as equivalent to tax income, but it is not necessary for us to decide whether that is so.
47. There was during the hearing considerable discussion of the decision of the Full Federal Court in Cajkusic, which suggests, but obiter, that in the determination of income for the purposes of s 97 of the Act the terms of the Trust Deed might take precedence; (see clause 22 at page 437). In Cajkusic the Full Federal Court was not concerned with the issues which here concern the Tribunal. In Cajkusic deductions were claimed but were not allowed for tax purposes. The effect of that decision was that the deductions claimed were nevertheless deductible in the computation of the trust income. In the result, and because there was no trust income, there were no beneficiaries presently entitled, so that an assessment against default beneficiaries could not be sustained. It does not seem that the Full Federal Court in Cajkusic either considered or needed to consider Totledge and ANZ. The Respondent contends (correctly in our view) that in the factual circumstances of Cajkusic, the conclusion reached is consistent with the principles applied in Totledge.
48. Mr Young referred at some length to a Practice Statement, PS LA 2005/1(GA), which, so he contended, is inconsistent with the assessment under s 99A in respect of the 2002 matter. He referred in particular, but not only, to clauses 12, 13 and 26 and the flow chart contained at page 10 of the Practice Statement. Clauses 13 and 26 are included in these reasons as follows:
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Capital beneficiary approach
13.If there is a beneficiary who would satisfy the terms outlined in paragraph 8 in relation to the amount of capital gain, the Commissioner will accept, instead of the trustee approach, assessing the capital gain to a trustee on behalf of that beneficiary or treating that capital beneficiary as having capital gains for the purposes of subsection 115-215(3) of the ITAA 1997. If the capital beneficiary approach is not chosen, the approach in paragraph 12 will apply.
…
Explanation
…
26.The courts have determined that the ‘share’ of net income that must be included in the assessable income of a beneficiary is based on the proportion of the trust income to which the beneficiary is presently entitled: Zeta Force Pty Ltd v Federal Commissioner of Taxation [98 ATC 4681 at 4693; (1998) 39 ATR 277]. See also Davis v FC of T [89 ATC 4377; 20 ATR 548; (1989) 86 ALR 195], DCT v Richard Walter Pty Ltd [(1995) 29 ATR 644; (1995) 183 ALR 168; (1995) 69 ALJR 223; 95 ATC 4067] and FCT v Prestige Motors Pty Ltd [(1994) 27 ATR 160; (1993) 118 ALR 497; (1993) 47 FCR 138; 93 ATC 5021] (contrast Merkel J in Richardson v FC of T [97 ATC 5098; (1997) 150 ALR 167; 37 ATR 452; (1997) 80 FCR 58]).
…
It will be noted that the Practice Statement in its terms seeks to deal with the approach to be adopted when a capital gain is distributed. The flow chart suggests that a number of alternatives are acceptable, and in particular three approaches are suggested. As to whether the Practice Statement is correct may be debatable but it is not a binding ruling and in any event does not appear to us to be apposite in this particular case. Mr Young also referred the Tribunal to a taxation determination which is a binding determination; he was referring in this context to TD 93/35; the Tribunal has considered that determination, but does not think that it is of assistance in the decision in this matter.
PART G - Summary and Conclusion
49. In respect of the 2000 matter we consider that Zeta Force is binding and that the judgment of Merkel J in Richardson as to the Merkel alternative approach is not. We consider also that the proportionate approach, as the law stands, applies to all beneficiaries presently entitled and regardless of whether they receive awards expressed as amounts or as proportions of trust income. Mr Young referred the Tribunal in this context to FCT v Salanger (1988) 88 ATC 4449 (“Salanger”); that decision of French J deals with the situation where there are two conflicting binding decisions of the Federal Court both binding on the Tribunal. The Tribunal does not consider that Salanger is relevant in the context of this decision simply because as set out previously in these reasons, the judgment of Merkel J as to the Merkel alternative approach was obiter.
50. We consider as regards penalty that the Applicants in respect of the 2000 matter did have an arguable case and so that the rate of penalty should be reduced in respect of each of Mr Bamford and Mrs Bamford, and taking into account the applicable discount, to 20 percent.
51. Save only for the reduction in penalties set out in the preceding clause, the objection decision in respect of the 2000 matter in relation to each of Mr Bamford and Mrs Bamford must be affirmed.
52. In respect of the 2002 matter and in relation to the Trustee the preferable view is that the relevant resolution should be construed as a determination that the capital gain be distributed as trust income but the fact that this is so does not have the effect that it is trust income within s 97 of the Act; accordingly the objection decision in respect of the 2002 matter must be affirmed.
I certify that the 52 preceding paragraphs are a true copy of the reasons for the decision herein of Professor GD Walker, Deputy President
Signed: ...........................[sgd]...................................................
Renee Wallace, AssociateDate/s of Hearing: 17, 18 March 2008
Date of Decision: 18 April 2008
Solicitor for the Applicant: Robert Richards
Counsel for the Applicant: Michael Donohoe, AGS
Solicitor for the Respondent: Mr I Young
Counsel for the Respondent: Ms J Davies, Mr D Batt, Ms M Wall
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