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08 Feb 10 Taxpayer succeeds on interest deduction and penalty - Forrest

The Full Federal Court (Spender, Sundberg and McKerracher JJ) has partially upheld the taxpayer's appeal from the decision of the AAT (Nicholson DP) and held that:

  • interest incurred on moneys borrowed to acquire units in a trust was deductible under s 8-1 ITAA 1997; and
  • a 50% penalty (based on gross carelessness) imposed by the Commissioner in respect of a separate issue, on which the taxpayer was unsuccessful, should be reduced to nil.

In relation to the deductibility of the interest, the Commissioner submitted, and the AAT held, that the trust was a discretionary trust in relation to the income of the trust (it was accepted that it was discretionary in relation to capital of the trust). This finding was based on a clause in the trust deed (clause 12) which conferred on the trustee a power to determine whether amounts received or disbursed were on income account or capital account. In contrast, the taxpayer submitted that the trust was a fixed trust in relation to the income of the trust and, in particular, the relevant clause in the trust deed was a power to classify receipts, and could not be used to vary the trusts created by the trust deed.

The Full Federal Court agreed with the taxpayer. It said, at paras 27-28:

"In our opinion, the power conferred by cl 12 cannot be exercised by the trustee wrongly to classify a receipt as a capital gain, when the receipt is, in truth, income, and thus deprive the [taxpayer] of his interest in the unit component of the trust. Clause 12 is not an unlimited power to be exercised in the trustee’s unconfined discretion...The words used in cl 12 do not have the literal and broad meaning which the Tribunal gave to them. The [Commissioner] accepts that no effect can be given to cl 12.1 to the extent that it purports to make the trustee’s determination "conclusive and binding" to the exclusion of the courts. Clause 12.1 is a power to make an honest administrative determination whether receipts are on capital account or income account. It is not a power to determine, in the trustee’s unconfined discretion, whether a receipt "represents realised or unrealised capital gains". It is that fact which determines whether components of the trust fund are held on trust for the discretionary beneficiaries or the Unit Holders."

The Full Court held that the settlor’s and trustee’s objective intention was that income other than capital gains was to be held on a fixed trust for the Unit Holders, and that capital gains were to be held on a discretionary trust. It followed that the interest payments were deductible.

The Full Court rejected the Commissioner's attempt to raise a belated argument based on apportionment as it had not been raised either in the Commissioner's statement of facts, issues and contentions or before in argument before the AAT.

In relation to the second issue, the Commissioner had imposed a penalty on the taxpayer based on gross carelessness, in relation to the omission from the taxpayer's assessable income of an amount which the Commissioner submitted, and the AAT held, was an eligible termination payment (ETP). The Full Federal Court also held that there were grounds to hold that the payment was an ETP. However, the Full Federal Court found that the taxpayer's advisers had considered whether the payment was an ETP and had concluded, erroneously, that it was not. On this basis, it could not be said that the taxpayer was guilty of gross carelessness. In all the circumstances, the Full Federal Court held that the penalty should be reduced to nil.

Forrest v FCT [2010] FCAFC 6 (Full Federal Court; Spender, Sundberg and McKerracher JJ; 5 February 2010).


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