If you have a family trust or discretionary trust you may need to consider the implications of the recent High Court case of Bamford v Federal Commissioner of Taxation (Bamford’s Case).
The wording of your trust deed may need amending as a result of the decision.
Broadly speaking the decision dealt with two issues:
(a) how should a beneficiary’s assessable ‘share’ of the income of the trust be determined?
(b) what is the meaning of ‘income of the trust estate’ as set out in the tax legislation and should the income of the trust available for distribution include ‘net capital gains’ derived by the trust where the deed allows capital gains to be treated as income of the trust?
The first issue arose because the ATO disallowed some deductions that the Bamford’s trust had claimed and as a result the assessable income increased from $187,530 to $379,231.
Given that
(a) the original distribution among the beneficiaries had only been of the $187, 530, and
(b) it was too late to change the basis of the distribution for the relevant tax year
the question was – how was the extra assessable income (i.e. the difference between the two amounts) to be distributed among the beneficiaries?
The Court approved what has been called ‘the proportionate approach’. This was the approach adopted by the ATO and means that you work out the proportion of the original amount ($187,530) that each beneficiary was given and then apply that proportion to the new amount ($379,231). Although this seems an uncontroversial approach the High Court’s decision has clarified an issue that has been unclear for some time.
The second issue is probably the more significant for most people. The trustee had distributed capital gain of the trust to the beneficiaries as income, as the trust deed allowed. The ATO disallowed this distribution and taxed the trustee instead at a much higher rate. The High Court had to look at the meaning in s.97(1) of the Tax Act of the phrase ‘income of the trust estate’. The ATO argued that the phrase had a meaning at law (namely - income according to ordinary concepts) so that the definition of that phrase in the trust deed was irrelevant. The trustee argued it was entitled to act as set out in the deed.
The High Court held that the phrase ‘income of the trust estate’ was not defined in the Tax Act and therefore took its meaning by application of general trust law principles. As such the trustee’s actions in relying on the trust deed were justified and the treatment of the trust’s capital gain as income by the trustee was acceptable.
In light of Bamford’s Case, trust deeds which have clauses which allow ‘income of the trust’ to equal ‘taxable income’ under s.95 of the Tax Act enable capital gain to be classified as income. However in considering whether to amend your deed to say this (if it doesn’t already) there may be other adjusting items in relation to trust income which make the position less clear and could lead to unforeseen results.
The ATO is intending to issue a Decision Impact Statement in respect of the decision which will allow tax advisers to better understand the ATO’s thinking on the decision in Bamford’s Case and its likely impacts in other areas.
We have taken the view that it might be appropriate to wait for the Decision Impact Statement before taking any steps to review the wording of particular trust deeds.
For further enquiries, contact Peter Townsend of TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.
