McCarthy and Commissioner of Taxation
[2004] AATA 1206
•10 November 2004
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2004] AATA 1206
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT2002/177
TAXATION APPEALS DIVISION )
Re JULIE JEAN McCARTHY Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Senior Member KL Beddoe
Senior Member BJ McCabeDate10 November 2004
PlaceBrisbane
Decision The Tribunal decides:-
(a) the decision under review is set aside;
(b) the objection is allowed in full; and
(c) this proceeding has terminated in favour of the applicant........[Sgd].......
K L Beddoe
CATCHWORDS
TAXATION – appropriation of trust income – review of objection decision – purported appointment of income to beneficiary ineffective – consequences of ineffective appointment of income – decision to assess income of trustee set aside
Income Tax Assessment Act 1936 ss 97, 99A
McPhail v Doulton [1971] AC 424
East Finchley Pty Ltd v Federal Commissioner of Taxation (1989) 19 ALD 85
Ramsden v Federal Commissioner of Taxation [2004] FCA 632REASONS FOR DECISION
10 November 2004 Senior Member KL Beddoe
Senior Member BJ McCabe
1. Bamyili Pty Ltd as Trustee for the McCarthy Family Trust seeks review of objection decisions by the respondent in relation to the years of income ended 30 June 1996 to 30 June 1998. The individual applicant seeks review of an objection decision in relation to the year of income ended 30 June 1996.
2. The Trustee has been assessed in each year of income under section 99A of the Income Tax Assessment Act 1936 (“the Act”) and the individual applicant under section 97 of the Act in relation to the net income of the Trust.
3. Issues also arise as to whether the respondent was correct in assessing additional taxes in accordance with Part VII of the Act and, if so, whether those additional taxes should be remitted in full or in part. The individual taxpayer also objected on grounds that the amended assessment in issue was not authorised by section 170 of the Act.
4. These matters were heard jointly with other cases which have a common theme of appointment of net income of the relevant family trust to a company correctly described as No 2 Pitt Street Pty Ltd as Trustee of the Northbourne Holdings Unit Trust (“Northbourne”).
5. At the hearing Mr Russell QC appeared with Mr Bickford for all the applicants and Mr Hack SC appeared with Mr Robertson for the respondent.
6. The documents lodged in the Tribunal pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 were before the Tribunal. There is a generic set of documents marked T1 to T69 and also sets of documents specific to the applicants marked Exhibit Y.
7. Further documents were tendered and marked as exhibits and oral evidence was given by John Damian Andrews, Ian Roland Stevens, Ginette Danen Muller, Steven Irvine Hart, Julie Jean McCarthy and Peter Edmond McCarthy.
8. By a deed of trust dated 5 August 1977 Archibald Young Whyte settled the PE McCarthy Family Trust, the trustee being Bamyili Pty Ltd.
9. Clause 3 of the trust deed relevantly defines “beneficiaries” of the trust as follows:-
“(i) the said Peter Edmond McCarthy’
(ii) the said Julie Jean McCarthy;
(iii)any child, adopted child, grandchild or remainder issue of the said Peter Edmond McCarthy and Julie Jean McCarthy;
(iv)the trustees of any other trust (howsoever created the capital or income of which is or may be held in whole or in part and whether absolutely, contingently or otherwise) for any one or more of the said children adopted children or grandchildren of the said Peter Edmond McCarthy and Julie Jean McCarthy provided that no part thereof is or may be held for the settlor;
(v)any spouse of any child, adopted child or grandchild or remainder issue of the said Peter Edmond McCarthy and Julie Jean McCarthy;
….
(vii)any corporation at least one share in which is owned by any beneficiary hereinbefore referred to or by the trustee of an eligible trust;
(viii)the trustees (in their capacity as such) of any trust or settlement (whether now in existence or not) under which any of the beneficiaries hereinbefore referred to is a beneficiary whether present or contingent.”
10. Clause 1 of the deed relevantly provides:
“Until the vesting day the Trustee shall stand possessed of the income of the trust fund derived by it in any financial year ending on the thirtieth day of June or such portion of such income as the Trustee may in its absolute discretion deem meet upon protective trust absolutely for the beneficiaries or any one or more of them exclusive of the other or others of them and in such shares and proportions as the Trustee shall in its absolute discretion determine prior to the 30th day of June in such year and in the event of the Trustee failing to make any such determination as aforesaid with respect to the income or any portion thereof then such income or such portion (as the case may be) shall be held upon protective trust absolutely for the children of PETER EDMOND MCCARTHY and JULIE JEAN MCCARTHY in equal shares as tenants in common. It is hereby expressly declared that any beneficiary in whose favour any such determination as to income as aforesaid is made or any beneficiary who becomes entitled to income in default of any such determination shall be absolutely and presently entitled to such income PROVIDED HOWEVER that notwithstanding the foregoing provisions of this Clause the Trustee may at any time upon expressly resolving so to do accumulate the whole or any portion of the income of the trust fund not previously paid or applied and hold any such accumulation as an accretion to the capital thereof.”
11. There has been a subsequent deed of variation which we are satisfied is not relevant for present purposes.
12. By an application dated 28 June 1996 the Trustee applied for 100 units in Northbourne (Exhibit E - IRS 25 Folio 61).
13. No 2 Pitt Street Pty Ltd, as Trustee of Northbourne, issued a certificate certifying that the Trustee was the holder of 100 units in Northbourne (T7).
14. The Trustee executed a document nominating “Pitt Street No 2 Pty Ltd as Trustee for The Northbourne Holdings Unit Trust” as a general beneficiary of “The McCarthy Family Trust” (T6). That document is dated 28 June 1996.
15. Also on 28 June 1996 the Trustee resolved to appoint the net income of the trust for the year of income ended 30 June 1996 as follows:-
“Pitt Street No 2 Pty Ltd as Trustee for the Northbourne Holdings Unit Trust – the first $100,000
Peter E McCarthy – 50% of the balance
Julie J McCarthy – 50% of the balance” (T5)
16. Also on 28 June 1996 the directors of the Trustee signed an acknowledgement of debt in favour of “Pitt Street No 2 Pty Ltd as Trustee for The Northbourne Holdings Unit Trust” (Exhibit E – IRS 25-65).
17. Minutes of Meeting of the directors of the Trustee dated 15 October 1996 record that a similar resolution appointing the net income for the year ended 30 June 1997 was made as follows:-
“It was resolved that the income for the Trust for the year ended 30th of June 1997 be appropriated, set aside and applied to the beneficiaries:-
No 2 Pitt Street Pty Ltd as Trustee for the Northbourne Holdings Unit Trust – the first $100,000
Peter E McCarthy – 50% of the balance
Julie J McCarthy – 50% of the balance” (T9)
18. The Trustee’s income tax return for the year of income ended 30 June 1997 shows that an amount of $32,734, being the net income of that year, was appointed to Northbourne.
19. On 30 June 1997 Northbourne issued a Unit Trust Certificate in favour of the Trustee for 100 units (Exhibit Z).
20. The Trustee’s income tax return for the year of income ended 30 June 1998 shows that the net income of $11,101 was appointed to Northbourne.
21. We have noted mis-descriptions of Northbourne and trust, but as in other related cases have decided that nothing turns on these mis-descriptions.
22. Both Mr and Mrs McCarthy gave oral evidence. There was some confusion in Mrs McCarthy’s evidence. It is apparent from her affidavit (Exhibit AA paragraphs 7 and 12) and her response to a question by Mr Bickford that she had a limited understanding of the arrangements purportedly entered into with Northbourne. Whatever understanding she may have had at the time she now has a limited recollection of the arrangements in relation to the Northbourne transactions. In particular she did appear to understand that the resolutions to appoint net income to Northbourne would not thereby deprive her children as beneficiaries in relation to the appointed net income.
23. In cross-examination Mrs McCarthy was, in our opinion, evasive because she consistently failed to respond to the questions put by Mr Robertson. If we are wrong about that then it must be the case that Mrs McCarthy had no effective understanding of the various transactions entered into by the Trustee including resolutions of the Trustee and transactions evidenced by documents signed by her as a director of the Trustee. She was aware, however, that the business superannuation fund had paid $12,000 as a fee to Harts.
24. In the result we are satisfied that Mrs McCarthy was an unreliable witness and we have given limited weight to that evidence.
25. Mr McCarthy also had an unreliable recollection of events relevant to the Northbourne transactions. He agreed it was his understanding that distributions made by the Trustee were not to be paid in full to Northbourne but were to be retained as working capital of the Trustee and used in the business operated by the Trust(ee) (Exhibit AB).
26. He also agreed that his statement in Exhibit AC contradicting the above statement “really was not correct” and it was correct that the pharmacy profits were retained by the Trustee.
27. We are satisfied that Mr McCarthy believed, on the advice of Mr Hart, that the Northbourne transactions were a method of deferring taxation liability and were also a sound investment in the long term.
28. Mr McCarthy said he paid the $12,000 fee to Harts from the superannuation fund because someone at Harts said he could do so. He also said that the pharmacy business operates through a bank account in his name and not in the Trustee’s name. We are unable to determine how it comes about that the business income is said to be derived by the Trustee but is paid to Mr McCarthy’s bank account. We have, with some hesitation, proceeded on the basis that the income of the business is derived by the Trustee because the respondent has proceeded on that basis and in its submissions has not sought to contend that the Trustee did not derive the income of the business.
Re Northbourne
29. The Northbourne Holdings Unit Trust (“Northbourne”) was established by deed in 1989 (Exhibit F) for the purpose of acquiring and redeveloping real property known as No 22 Pitt Street, Sydney.
30. For reasons not apparent to us and not relevant to these proceedings, the investment was unsuccessful and Northbourne incurred substantial losses. The 20 issued units were held for the benefit of Northbourne Rural Property Trust.
31. At all relevant times No 2 Pitt Street Pty Ltd was the Trustee (initially the company was known as Northbourne Holdings Pty Ltd but nothing turns on the change of name).
32. In or about 1995 (probably March 1995), Harts Consulting Pty Ltd (“Harts”), a company controlled by Steven Irvine Hart, acquired the units in Northbourne and the two shares issued in No 2 Pitt Street Pty Ltd. It is reasonable to infer, and we do, that the purchase of Northbourne was for the purpose of getting access to approximately $13.5 million in accumulated losses resulting from the unsuccessful Pitt Street development. Northbourne does not appear to have had any commercial value at March 1995 or at any time immediately thereafter except for any value of tax losses.
33. While the evidence of Mr Stevens made it apparent to us that proper process was not a strong point of Harts so that it could be said that the share transfer was not properly executed, we accept that the company controlled No 2 Pitt Street Pty Ltd effectively from probably March 1995.
34. In the years of income ended 30 June 1995 through to 30 June 1999, Harts promoted a scheme whereby Trustees of family trusts were invited to acquire units in Northbourne on the basis of one unit for each $1,000 of net income of the family trust appointed to Northbourne. Essential to this arrangement was the need for the Trustees of the family trusts to add Northbourne as a general beneficiary of the family trust. Fees at 12% were payable to Harts.
35. As already noted, the Trustee appointed income to Northbourne in each of the years of income on the basis, we assume, that it was thought Northbourne had been properly nominated as a beneficiary.
36. On the basis of the evidence of Mr Stevens, Ms Campbell and Exhibit G, we are satisfied that there was no intention that the family trusts would be required to repay the acknowledged debts, being the unpaid distributions in favour of Northbourne. Northbourne had limited recourse only for unpaid amounts, being the right to redeem the units issued to the family trusts by Northbourne.
37. Northbourne, guided by Harts, purported to enter into contracts for the purchase of the Birralee Shopping Centre. The respondent initially contested that the shopping centre was never purchased. Certainly Harts represented that the purchase had taken place in stages with completion by December 1997 (Exhibit F). The documents before the Tribunal are not complete as to purchase of the shopping centre and shops, but we are satisfied that it is more likely than not that Northbourne had contracted to purchase the centre. We are uncertain as to actual dates of purchase but note that the report in Exhibit H by Ms Muller indicates date of purchase as 5 July 1996 for $2.8 million. We are satisfied that is in relation to the Centre but does not include the purchase of some strata title shops. It is apparent, however, that final settlement in the purchase of the shopping centre and shops did not occur until February 1998 with a payment of $4.2 million funded by borrowing from Metway Bank.
38. The borrowing by Northbourne from Metway Bank was secured by bank guarantees to be provided by the unit holders in Northbourne, that is the respective Trustees of the family trusts including the present applicant Trustee. The Trustee provided a guarantee on or about 11 July 1997 for an amount of $100,000.
39. Northbourne instituted proceedings in the Supreme Court of Victoria regarding matters arising out of the Birralee project. Copies of two judgments by Balmford J are part of Exhibit B. We have read the judgments but nothing arises from them in the context of this matter other than to explain one of the factors delaying the Birralee development.
40. The investment scheme for the Birralee Shopping Centre did not promise any profit to the unit holders in Northbourne until the tenth year of the scheme. It is apparent to us from the material before us that any ultimate return to unit holders depended on a successful sale of the shopping centre after, it may be assumed, ten years.
41. We are satisfied that the applicant Trustee was motivated by two factors when entering into the arrangements proposed by Harts, namely:-
(a) the projected ultimate return; and
(b)the understanding that income tax payments would be deferred for up to ten years.
42. In the ultimate, the development of the shopping centre failed and the company is in liquidation. Northbourne’s investment in the development appears to be worthless. That is not to say that the shopping centre was other than a reality – it was probably overly ambitious in its concept but we accept that the proposal put to the Trustee was such that it could not be foretold to be a failure. In deciding to go into the scheme the applicant Trustee made decisions which included the investment in the shopping centre. We accept that the investment decision followed the decision to appoint the net income to Northbourne and, we infer, it is unlikely the investment decision was made independently from the decision to appoint the net income to Northbourne. We have come to that conclusion after taking into account the documents and the evidence of Mr McCarthy.
43. In his oral evidence Mr McCarthy gave his understanding of the Northbourne transactions as follows:-
“Q: This Northbourne Investment though, what did you understand that to be? A: Well, as I explained before it was a matter of you put the money in – a certain amount of money in up front like an entrance fee sort of thing. I think for us I think it was about 24,000 and then you had some tax breaks for a few years. And then as I said, the rents and things like that as the development came on line and you got those and you get those back so pay tax on that. And then at the end of the 10 year period, you would sell the whole thing and then consequently well, you’d hope that you’d have good capital gains on that and consequently you’d pay tax on that.”
44. We are satisfied that Mr McCarthy, as one of the directors of the Trustee, had an understanding along these lines at the time of the initial Northbourne transactions. That understanding was however on the basis of his primary understanding of taxation not being payable on the net income said to have been appointed to Northbourne.
45. We are also satisfied that the Trustee, acting through its directors, was content to rely on the advice of Harts.
46. The arrangements entered into by the Trustee have their genesis in advice to the directors of the Trustee by Steven Irvine Hart. Mr Hart was called to give evidence. He answered formal questions but refused to answer questions relevant to the arrangements in question on the grounds that he claimed the privilege against self-incrimination. The basis for this claim is set out in Exhibit 2. The Tribunal accepted that he was not required to answer questions where the privilege was claimed. The Tribunal does not draw any inferences from the fact that Mr Hart claimed the privilege.
Consideration
47. Detailed written submissions were made on behalf of the applicants and the respondent. These were explained and supplemented by oral submissions.
48. By clause 2 of the Trust Deed the Trustee stood possessed of the Trust Fund as defined and income thereof upon the trusts and subject to the powers and provisions expressed in the Trust Deed.
49. Clause 1 of the Trust Deed provides for the Trustee to stand possessed of the net income of the Trust Fund for each accounting period and may, in its complete discretion, at any time prior to the 30th June in each year determine the net income held on protective trust for all or any of the beneficiaries and in default the net income to be held on trust for the children of Mr and Mrs McCarthy absolutely.
50. We understand, as a question of law, that where a Trustee exercising its discretion decides to distribute the net income of the trust, the Trustee must ensure that a proposed appointee is within the range of beneficiaries as defined, that the quantum of the distribution is appropriate and takes into account the interests, including needs, of all beneficiaries.
51. In McPhail v Doulton [1971] AC 424 at 449 Lord Wilberforce expressed the law as follows:-
“Any Trustee would surely make it his duty to know what is the permissible area of selection and then consider responsibly, in individual cases, whether a contemplated beneficiary was within the power and whether, in relation to other possible claimants, the particular grant was appropriate.”
52. In this case the Trustee clearly failed Lord Wilberforce’s test. Northbourne was clearly not a beneficiary and therefore it was not within the Trustee’s power to appoint income to it. We have come to that conclusion because we are satisfied that Northbourne was not an entity contemplated by the definition of beneficiary. Insofar as it may be said that the Trustee was a beneficiary of Northbourne, we are satisfied that the Trustee itself is not within the defined meaning of beneficiary. The fact the Trustee is being a beneficiary in Northbourne does not thereby make the Trustee a General Beneficiary as defined. Whatever doubts may exist as to the certainty of the definition should be resolved on the basis that there is a clear intention that the Trustee would not be a beneficiary as defined. That intention is evident from construction of the definition itself.
53. We are satisfied, as submitted for the applicants, that the purported nomination of Northbourne as a beneficiary was ineffective. It follows that there was no effective appointment of net income to Northbourne in the years of income before the Tribunal.
54. We also agree that it does not follow from the resolutions of the Trustee that the net income said to have been appointed to Northbourne is thereby net income appointed to Mr and Mrs McCarthy. We agree with the applicant’s submission to the effect that the default provision in clause 1 of the Trust Deed means that the income not effectively distributed is held on trust absolutely for the children of Mr and Mrs McCarthy in equal shares.
55. Accepting, as we do, that the purported nomination of Northbourne as a beneficiary was ineffective, and accepting that the Trustee did not determine to accumulate any of the net income in each relevant year of income, there was default by the Trustee in respect of the net income said to have been appointed to Northbourne during each year of income.
56. It follows, in our view, that the Trustee holds so much of the net income, in respect of which no effective determination was made, for the default beneficiaries described in clause 1 in equal shares as tenants-in-common.
57. In coming to that view we have accepted the submission for the applicant to the effect that the residual income provisions of the distribution minutes do not apply to amounts purported to have been appointed to Northbourne. The Trustee intended that the distribution of net income to Northbourne have effect and the whole of the arrangements entered into by the Trustee with Northbourne can only be explained by the Trustee having that intention. Clearly, there was no basis for the Trustee to acknowledge debts owing to Northbourne except for the unpaid purported appointments of net income in favour of Northbourne.
58. In East Finchley Pty Ltd v Federal Commissioner of Taxation (1989) 19 LAD 85, the issue was whether the taxpayer company had been correctly assessed in accordance with section 99A of the Act. The company was Trustee of a discretionary trust. The company, as Trustee, purported to determine a distribution of net income to non-resident beneficiaries. The Commissioner assessed the company on the basis that the purported distributions were made in connection with a reimbursement agreement.
59. The case proceeded on the assumption that the non-resident persons, the object of the Trustee’s determination, were, in fact, beneficiaries of the Trust. In that sense it is different to the present case because the applicants have not sought to argue that the appointment of income to Northbourne was effective.
60. In the course of his judgment, Hill J made it clear (ALD 87) that where there is no present entitlement to net income vesting in the relevant persons then section 100A of the Act has no operation.
61. So instructed, we are satisfied section 100A has no effect on the facts of this case given that we are satisfied that it is the default beneficiaries, and not Northbourne, who were presently entitled to the net income sought to be appointed to Northbourne. We are further satisfied, for the reasons given by Spender J in Ramsden v Federal Commissioner of Taxation [2004] FCA 632, that the default beneficiaries were so presently entitled in the respective years of income, the Trustee having made no decision to accumulate the net income of each year of income.
62. It follows, in our view, that the present applicants are not the persons who in fact derived the net income said to have been appointed to Northbourne. It is, of course, not for this Tribunal to decide whether income should be assessed to the takers in default who are not before the Tribunal.
63. For these reasons the decisions under review will be set aside and the objections allowed.
64. We certify that these proceedings have terminated in favour of the applicants.
I certify that the 64 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member KL Beddoe and Senior Member BJ McCabe
Signed: S Appleton
Associate
Date/s of Hearing 18 - 26 September 2004
Date of Decision 10 November 2004
Counsel for the Applicant Mr Russell QC with Mr Bickford
Solicitor for the Applicant Abbott Tout
Counsel for the Respondent Mr Hack SC with Mr Robertson
Solicitor for the Respondent ATO Legal Practice
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