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28 Nov 06 Section 97 trust law "income" determined by trust deed -Cajkusic

In a very important decision, the Full Federal Court (Kiefel, Sundberg and Edmonds JJ) has confirmed that when s 97 ITAA 1936 refers to "income" in the phrase "where a presently entitled to a share of the income of the trust estate", it is referring to the trust law/accounting income as modified by any provision in the relevant trust deed. The argument of the Commissioner that "what [is] income for trust law purposes, s 97 purposes, cannot be governed by what is said in the trust deed" was expressly rejected by the Court.

The Court said, at para 22 as follows:

" 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 ss 99 or 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 FCT (1998) 84 FCR 70 and the cases there referred to."

In support of his argument, the Commissioner had relied on a statement made by Gleeson CJ in FCT v ANZ Savings Bank Ltd [1998] HCA 53 (2 September 1998) at para [15], in which his Honour said: "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 unitholders, treated the deductible amount as capital, did not alter what was described in Charles v Federal Commissioner of Taxation [(1954) 90 CLR 598 at 608] as 'the character of those moneys in the hands of the trustees'." It has been suggested from time to time that this statement rendered ineffective clauses in trust deeds which attempt to equate trust law distributable income with s 95 net income (tax law income).

The Court said, at para 29 as follows:

"At [13], his Honour had observed that the trust deed defined income - net distributable income - to mean the net income of the fund as defined in accordance with s 95 of the 1936 Act. Thus, the deductible amount (that part which was exempt income by virtue of the provisions of s 27H(1)(a) of the 1936 Act) was treated under the deed as capital and dealt with by a different clause of the trust deed than that which dealt with income as defined. So understood, the passage from the Chief Justice’s judgment at [15] was dealing with what was income in the hands of the trustee in the calculation of the ‘net income’ of the trust estate for the purposes of s 95 of the 1936 Act. The point the Chief Justice was making was that it was not possible by the terms of the trust deed to bifurcate a receipt in the hands of the trustee which was income according to ordinary principles, and therefore income for the purposes of calculating the s 95 ‘net income’, so that some part of that receipt was not income in calculating the s 95 ‘net income’. The Chief Justice was not, as the [Commissioner's] submission would have it, saying that a provision of the trust deed could not prescribe what was a receipt on revenue account and what was an outgoing on revenue account for the purpose of determining the s 97 income, that is, the distributable net income."

In the event, the Full Federal Court upheld the taxpayers' appeals on the objections issued by the Commissioner. The 3 taxpayers were beneficiaries in a trust, the trustee of which had claimed deductions for contributions made to an employee benefit scheme in the 1997 and 1998 income years. These deductions were denied by the Commissioner and the denial was upheld by the AAT. As a result, the Commissioner sought to include the total amounts so disallowed in the assessable income of each of the beneficiaries for both years.

However, as a result of the contribution in 1997, the accounts of the trust had recorded a loss and no distributions had been made to any beneficiaries during that year. The trustee had not exercised the discretion conferred upon it by the trust deed to determine that the distributable income of the fund was the same as the s 95 net income. The Commissioner seems to have assumed, wrongly, that if the amounts were not deductible for tax purposes, they were not deductible for trust law purposes. This was implicitly rejected by the Court in its reasons (see paras 18 and  31). In any event, the Commissioner had already conceded before the AAT that the taxpayers' objections in relation to the 1997 year should be wholly allowed (see para 7). Strictly speaking, therefore, the 1997 assessments were no longer in issue before the Court.

In relation to the 1998 assessments, the Court held that although the accounts recorded a distributable income of $28,697 (taking into account the employee benefit contribution but before taking into account the carry forward of losses from previous years), the loss of $54,838 incurred in the 1997 income year was to be made up of profits of the 1998 income year, such that there was no distributable income in the 1998 year also. Thus, the liability for tax on the s 95 ‘net income’ fell wholly on the trustee under s 99A of the 1936 Act. Once again, therefore, the objections were allowed, and the assessments set aside.

In view of the findings on this issue, the Court merely noted the Commissioner's alternative argument that the trustee's right of indemnity precluded any beneficiary having any entitlement to any income of the trust in the 1998 income year. The Court said:

"However, in passing we would merely observe that this submission, which appears to have its origin in what fell from the High Court in CPT Custodians Pty Ltd (previously t/as Sandhurst Nominees (Vic) Ltd (2005) 221 ALR 196 at [49] - [51], conflates two totally different concepts - present entitlement to an amount equal to the income of the fund (not to any particular asset vested in the trustee) on the one hand and the trustee’s right to resort to such assets to meet liabilities on the other. This latter right of the trustee would not seem to impact on the beneficiary’s present entitlement."

Cajkusic v Commissioner of Taxation [2006] FCAFC 164 (Full Federal Court; Kiefel, Sundberg and Edmonds JJ; 24 November 2006).

For a copy of the decision, go here

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