Special leave to appeal granted in Bamford

On 3 November 2009, the High Court of Australia granted both the taxpayer and the Commissioner leave to appeal from the decision of the Full Federal Court of Australia in Bamford v FCT [2009] FCAFC 66 (Federal Court, Full Court, Emmett, Stone & Perram JJ, 3 June 2009) (“Bamford”).

The case concerns:

1. the meaning of the words "that share" in the phrase "that share of the net income of the trust estate" in s 97(1)(a)(i) in Division 6 Part III of the Income Tax Assessment Act 1936 (“ITAA 1936”), and

2. the meaning of the words "the income of the trust estate" in s 97(1) of ITAA 1936.

The Implications for Trust Minutes

In the Full Federal Court, the court unanimously agreed with the Administrative Appeals Tribunal (“AAT”) that a beneficiary was to be taxed on its proportionate fractional entitlement to the income of the trust estate rather than on a specified or fixed amount.

The court unanimously held that the term “that share” in the phrase “that share of the net income of the trust estate” in Section 97)(1)(a)(i) of ITAA 1936 refers to a beneficiary's proportionate entitlement to the income of the trust estate, even where a beneficiary is only allocated a fixed dollar amount of income under the trust distribution minutes.

The Implications for Trust Deeds

However, the Full Federal Court, by majority with Stone and Perrett JJ, overturned the AAT's finding that “income of the trust estate” in Section 97 of ITAA 1936 meant ordinary income, instead holding that the expression should be interpreted as meaning the “income of the trust” as understood by trust law. This is consistent with and follows the Full Federal Court decision in Cajkusic v FCT (2006) 155 FCR 430 (Kiefel, Sundberg & Edmonds JJ, 24 November 2006).

Hence, if under the terms of a trust deed a capital receipt is deemed to be included in the income of the trust it will be so treated in determining the income of the trust. Therefore, where the trust deed provides the necessary powers, the trustee can re-characterise any capital gain as income of the trust estate, which can be appointed to a beneficiary to have a present entitlement to the net capital gain.

As a result, the capital gain can be assessed to the beneficiary. This should remove the risk that capital gains made by a trust are assessed at penal rates to the trustee, where the trust does not have any other income in that year.

Practice Statement Law Administration PSLA 2009/7

Under PSLA 2009/7 the Commissioner indicates that trustees and beneficiaries can adopt the Full Federal Court's views in Bamford provided they do not deliberately seek to create a mismatch between the economic and tax outcomes, or engage in aggressive tax planning or tax evasion.

Further, the Commissioner states that it will not impose penalties where trustees and beneficiaries have assessed their tax position based on the Full Federal Court's views in Bamford.

Action to take

In view of the decision of the Full Federal Court in Bamford, trust deeds (for all types of trusts) and distribution minutes (for discretionary and hybrid trusts) should be reviewed and/or drafted to ensure that beneficiaries are not taxed on more than they receive from their trusts. This may include:

1. reviewing trust deeds to ensure the deed provides the ability to re-define capital gains as “income of the trust estate”;

2. drafting a specific trustee determination that capital gains be treated as income of the trust;

3. drafting trust minutes by 30 June to ensure appropriate exercise of discretion by the trustee of a discretionary trust to allocate the percentages of income of the trust to beneficiaries [because minutes of a discretionary trust distributing dollar amounts of net income (calculated under s 95 ITAA 1936) to some beneficiaries and the balance to a stated beneficiary, will not be effective as in Bamford]; and

4. drafting written agreements by 31 August under PSLA 2005/1(GA) where all the capital beneficiaries and the trustee of the trust agree in writing to be taxed on their proportion of capital gains.

The above actions must be taken by 30 June when trust distributions must be made or by 31 August which is the ATO administrative deadline for trust minutes.

And, in view of the granting of the special leave to appeal to the High Court in Bamford the above actions may be taken as a back-up to ensure that beneficiaries are not taxed on more than they receive from their trusts.

If you have any queries in relation to Trust Distributions or Taxation of Trusts under Division 6 Part III of ITAA 1936 you may wish to contact Joseph Santhosh, Barry Stark or Steven Pynt of McDonald Pynt Lawyers.