Robert Richards looks at the tension between trust law and tax law; considers a busy period in the courts; and assesses GST cases.
Don't mention the tension
Trusts often cause accountants difficulties. This is because the tax law ignores basic trust concepts. As a consequence there is an inherent tension between trust law and tax law.
First, a trust is not an entity. Rather, it is a relationship and is not a legal entity as such. However, that is not the way tax law sees a trust; it sees a trust estate as a separately existing entity, independent of the trustee.
Second, the very basis of taxing the income of a trust estate depends upon who has present entitlement to that income (which is not a trust law concept). Several recent cases have involved the taxation of trust income.
The most important of these cases was the decision of the Administrative Appeals Tribunal in Bamford & Ors v FC of T (Administrative Appeals Tribunal, 11 April 2008). It is important because the tribunal decision is the starting point to an ATO-funded appeal to at least the Full Federal Court (the court having decided it should go directly to the Full Federal Court). It's hoped a decision will finally resolve the ongoing tension between the 'proportionate method' and the 'quantum method' of attribution of income to beneficiaries. These two methods represent the opposing theories as to how taxable income should be attributed to beneficiaries of a trust when the trust's taxable income exceeds its 'trust law income'.
This all sounds terribly technical, but the principles involved have application to trusts generally that should cause accountants concern when drafting resolutions that distribute trust income. For example, resolutions that purport to distribute specific amounts to beneficiaries, such as minor children, might not be as limited as planned.
The Bamford case concerned a trust that had made a non-deductible contribution to an offshore superannuation fund. The ATO disallowed the deductions claimed by the trust for that contribution and associated interest expense. It then assessed the husband and wife beneficiaries of the trust (Mr and Mrs Bamford) to tax on the amount of those deductions disallowed by it.
The ATO looked to the resolution of the trustee by which the trustee had distributed the income of the trust. Broadly speaking, that resolution distributed the income of the trust to the husband and wife and the balance to a tax-exempt entity.
Based on that resolution, the ATO applied the proportionate method to determine who should be assessed on the disallowed deductions.
The ATO did this by first determining Mr and Mrs Bamford's proportionate shares of the trust income of the trust. While not deductible for tax purposes, the superannuation contribution and associated interest were deductible for trust law purposes.
It then applied those proportions to the disallowed deductions so as to increase the Bamfords' assessable incomes by the result of those applications. This meant that they were each assessable on more than the specific amounts referred to in the trustee's resolution.
The Bamfords on the other hand argued that the 'quantum method' was the correct method for determining on how much they should assessed; they said they were only assessable on that amount (the quantum) referred to in the trustee's resolution.
The Administrative Appeals Tribunal, applying established cases, said that the proportionate method was the correct method to be applied in determining on how much Mr and Mrs Bamford should be assessed.
In May the tribunal had to consider similar issues to Bamford in Ryan v FC of T (Administrative Appeals Tribunal, 13 May 2008), although here the taxpayer relied upon a different argument. In this instance a trust had also made non-deductible contributions to an offshore superannuation fund.
The ATO increased Ryan's assessable income by the amount of the tax deductions disallowed to the trust.Here the trustee also had resolved to distribute a specific amount (first to Ryan) and the balance to some other beneficiary.
Again the ATO applied the proportionate method, causing Ryan to be assessed on 100 per cent of those disallowed deductions.
Ryan argued that the trust income and tax-law income of the trust were the same. This meant the trustee had distributed the entirety of the trust's tax income at the time of making the resolution, even though the trust's tax income had been adjusted by the ATO.
Ryan failed in his argument, not as a matter of law, but because the tribunal concluded that the deed establishing the relevant trust did not equate trust law income with tax- law income.
If for tax purposes trust-law income can be equated with tax-law income it would mean that by good drafting one could escape the horrors of the proportionate method. Why? Because if trust-law income and tax-law income can be made the same there might never be any difference between the two. As a consequence the whole debate regarding the application of the proportionate method versus the quantum method would be pointless. This is because the roportionate method only has relevance when there is a difference between trust-law income and tax-law income.
This will also be looked at in the Bamford appeal. The court will be asked to decide exactly what has to be included in 'income' when applying the tax trust law.
Busy busy times in tax law
I sometimes suspect that INTHEBLACK's editor finds me very frustrating. Sometimes I complain that there is little to write about, the courts and Administrative Appeals Tribunal seemingly unproductive. Then the next month I complain that there is too much to write about. So it has been in the past few months. But there are three decisions I particularly want to note.
First is the decision in Fowler v FC of T (Federal Court 21 April 2008). This was a case that superficially involved the alienation of personal service income provisions. But more importantly it was a case designed to give a judge the opportunity of deciding on the structure of the Income Tax Assessment Act 1997. That is, whether the various provisions, such as the alienation of personal services provisions and the controlled foreign companies provisions, operate in isolation or whether all income has to be bought to account though Division 6 of that Act and thus be subject the requirements of the division.
If this was the case it would have been arguable that the alienation of personal services income provisions, and all other provisions deeming an amount to be assessable income, such as the controlled foreign companies provisions and even Part IVA, are of no effect. However, the court simply decided the Fowler case by reference to the intention of the alienation of personal service provisions, as a consequence a judicial analysis of the structure of the tax law will have to wait to another day. One can understand why a judge would not want to decide that question. However, tax payers who want to argue whether or not they should be assessed on some deemed income should consider making an argument such as was made by Fowler.
The second case should be of interest to readers because it involved a former partner of an accounting practice. The decision (Mews v FC of T, Administrative Appeals Tribunal, 30 April 2008) concerned a former partner in what was Price Waterhouse & Co. Subsequently Price Waterhouse & Co merged with Coopers & Lybrand. The international Price Waterhouse firm had established a captive insurance company that was not required after the merger.
That captive insurance company was wound up; it had surplus funds and part of those surplus funds were indirectly returned to Mews.
Mews argued that he should not be assessed to tax on that part of the surplus paid to him. The tribunal disagreed. It said that Mews was assessable on that income because he had derived it as consequence of previously having been a partner of Price Waterhouse.
The third decision, Murdoch v FC of T (Full Federal Court, 30 April 2008), is one of interest not just because of the people involved (Dame Elisabeth Murdoch and her son Rupert Murdoch). But I would not be surprised if the ATO attempts to appeal the Federal Court decision to the High Court.
The facts involved what could cheekily be described as a wayward son whom the mother claimed had mismanaged a family trust. More specifically, Rupert Murdoch was a trustee of a trust under which his mother could benefit. The mother argued that the trustees had, by reason of their trust investment policy, breached their trustee duties to her. This was denied. However, the trustees said, to avoid any unnecessary litigation, that they would pay $85 million to the mother if she released them from any claims she might have against them.
This she did. The ATO then assessed the mother on that $85m. The Full Federal Court, however, said that she should not have been so assessed. It said, 'The [mother's] claim was to an accounting for a capital profit or gain made by Mr Murdoch ... she was paid the lump sum in satisfaction of those claims. The lump sum was not income.'
This might be correct. However, I find it somewhat strange that no attention was given to the capital gains tax implications of the arrangement, Dame Elisabeth giving up her right to sue in return for a capital payment.
GST: the simple and the substantial
There have been two recent goods and services tax cases. The first is a simple one, illustrating the old principle that ignorance of the law is not an excuse. The Administrative Appeals Tribunal heard the case in which the taxpayer (a trust) argued that it should not be penalised for underpaying GST. The case, [2008] AATA 415, 21 May 2008, was one of those relatively rare cases where the tribunal suppressed the name of the taxpayer.
The taxpayer claimed that it was not aware that GST was payable on its sale of industrial real estate. Consequently, it underpaid GST when lodging a business activity statement (BAS). The ATO levied a 25 per cent shortfall penalty on that underpayment. The taxpayer was unsuccessful before the Tribunal when it sought to have that penalty remitted, arguing that it should not be penalised for misunderstanding GST. But the tribunal disagreed, saying that the taxpayer should have checked whether GST was payable on the sale of the land before it lodged its BAS return.
The second case was more substantial. It also was something of a rarity in that it was a High Court tax case (the High Court hears only a few tax cases each year). This case, FC of T v Reliance Carpet Co Pty Limited (High Court, 22 May 2008), involved an appeal by the ATO from a decision of the Full Federal Court (5 July 2007), where the court held that GST was not payable on a forfeited deposit.
Reliance had entered into a contract to sell real estate. The purchaser defaulted. Reliance rescinded the contract of sale and kept the deposit. Reliance argued that no GST was payable on the retention of the deposit. It argued that in retaining the deposit it had not made a 'taxable supply' (GST is only payable on a 'taxable supply' as defined by the A New Tax System (Goods and Services Tax) Act 1999.
The High Court disagreed with Reliance. It said that when someone contracts to sell land it makes two supplies. The first is the making of the contract. The second in the conveyance it makes in fulfilling the contract. However, because of sections 99-5 and 99-10 of Act often GST is not payable until settlement of the contract. The position might be different when someone receives a pure compensation payment.
Robert Richards CPA is a solicitor specialising in tax matters.
