Commissioner of Taxation v Bamford; Bamford v
Commissioner of Taxation [2010] HCA 10 30 March 2010
(Bamford)
Introduction
The High Court's unanimous decision confirming the Full Federal
Court's decision in Bamford is welcomed, especially by
trustees whose earnings largely consist of capital receipts. Had
the Commissioner's submissions been successful (that 'income' of a
trust estate cannot for tax purposes include capital receipts)
then, in certain circumstances, capital receipts would have been
taxed in the hands of the trustee at penalty rates in accordance
with s99A of the Income Tax Assessment Act 1936
(Act). This would occur wherever a trust estate's
income only comprised capital receipts to which beneficiaries were
presently entitled. (In situations where revenue and capital
receipts comprised the income of the trust estate, any capital gain
would be included in a beneficiary's assessable income.)
The High Court also confirmed that a beneficiary's share of the
net income of a trust estate is determined using the proportion
applicable to their entitlement to distributable income of the
trust estate. Trustees and beneficiaries will regard this aspect of
the decision as less helpful.
Background
Bamford involved a corporate trustee of a discretionary
trust which had made distributions of trust income to eligible
beneficiaries. The Commissioner disallowed various deductions
claimed against the trust's assessable income in the financial
years ended 30 June 2000 and 30 June 2002. This gave rise to two
questions concerning how the additional net income of the trust
should be treated for tax purposes.
Does 'Share' Mean Proportion or a Numerical Amount?
The High Court examined the interpretation of the word 'share'
in ss97(1) and 97(1)(a) of the Act. These sections specify that a
beneficiary presently entitled to a 'share' of a trust estate's
income (ignoring for present purposes what concepts are applied to
determine such income) is to include in their assessable income
'that share' of the 'net income' (as defined by s95 of the Act; ie
a trust's taxable income) of the trust estate.
The court had to decide whether 'that share' meant a
'proportional' or 'fractional' part of the income of a beneficiary.
If proportional was the accepted meaning, then that proportion was
to be applied to the trust's net income (taxable income) to
determine the quantum of net income the beneficiary included in its
assessable income.
The alternate interpretation of 'share' involved a trustee
distributing the trust's income by specifying a numerical or fixed
amount as the 'share' of the income to which a beneficiary becomes
presently entitled. This amount is also taken as 'that share' of
the trust's net income (taxable income) to be included in the
assessable income of a beneficiary, provided it does not exceed the
total net income of the trust. For the financial year ended 30 June
2000, the trustee of the Bamford trust had used the numerical
method when it determined the income to which the respective
beneficiaries were to become presently entitled.
The Commissioner argued 'that share' meant 'proportion' and not
a numerical amount, which was consistent with the amended
assessments he had issued to the beneficiaries of the Bamford
trust.
In the Full Federal Court proceedings Emmett J had concluded:
'[t]he term "that share" in s97(1) refers to a beneficiary's
proportionate or fractional entitlement to the income of the trust
estate and, given that trust income and taxable income are
different concepts, the only ordinary or natural meaning that could
be given to "share" must be "proportion"'.[1] The High Court
affirmed the decision of Sundberg J (on whom Emmett J relied) in
Zeta Force Pty Ltd v FCT (1998) 84 FCR 70
(Zeta Force). In Zeta Force
Sundberg J made it clear that the proportionate method was the
correct method to use in determining the quantum of a beneficiary's
share of a trust's taxable income. The High Court accepted Sundberg
J's and, by implication, Emmett J's approach and approved Sunberg
J's statement: '[t]he natural meaning to give to "share" where it
appears for the second time [in s97(1)] is "proportion" rather than
"part" or "portion". When parliament wanted to convey that latter
meaning, as it did in ss99 and 99A it used the word "part"'.
Can Trustees Recognise Income According to the Terms Contained
in the Trust Instrument?
The second, and arguably the most critical question dealt with,
was whether a discretion granted in the trust instrument to the
trustee (and exercised by it) to include a capital receipt as trust
income was consistent with the concept of 'income' referred to in
s97(1). In respect of the financial year ended 30 June 2002, the
trustee of the Bamford trust had included a capital profit earned
by the trust on a property transaction as income of the trust
estate.
The Commissioner argued the words 'share of income
of a trust estate' contained in s97(1) required the exclusion of
capital receipts, because income should be determined according to
ordinary income tax concepts (as specified in s6-5 of the
Income Tax Assessment Act 1997). The High Court
confirmed the Full Federal Court's decision holding that 'income of
the trust estate' for the purpose of s97(1) means income as
understood under the general law of trusts and not taxation
law.
The Commissioner had stated publicly over a number of years
that, in his view, 'income of the trust estate' in s97(1) means
income determined according to ordinary concepts. Had the court
accepted the Commissioner's interpretation, no income
would have arisen out of which the trustee could set aside a
present entitlement share for a beneficiary. This followed from the
fact that all receipts on revenue account of the Bamford trust were
absorbed by operating expenses incurred in the financial year and
by carried forward losses. Only a capital surplus was distributed
by the trustee. The Commissioner argued that, as there was no
beneficiary presently entitled to income (as
income under ordinary concepts means capital receipts must be
excluded), for s97(1) purposes, 'that share'
(proportion) of a beneficiary's entitlement to income equated to
zero. Therefore, no share of the trust's net income could
become attributable to a beneficiary's assessable income as
required by s97(1). Consequently, the capital receipt must be taxed
in the trustee's hands, at penalty rates under s99A of the Act.
In essence the purpose of the concept of 'income of a trust
estate' in s97(1) is to determine the extent of the apportionment
as between the beneficiaries and the trustee. The Commissioner's
approach sought to circumvent this process by making, in certain
circumstances, capital gains always taxable in the hands of the
trustee of a trust.
The court accepted that, for s97(1) purposes, 'income' is to be
determined pursuant to the general law of trusts, which includes
the terms of the instrument governing the relevant trust estate
(although no explicit statement dealing with trust instruments was
made). The court stated: '[t]he very juxtaposition within s97(1) of
the defined expression "net income of a trust estate" and the
undefined expression "the income of the trust estate" suggests that
the latter has a content found in the general law of trusts, upon
which Div 6 then operates…further the phrase "presently entitled to
a share of the income" directs attention to the process in trust
administration by which the share is identified and entitlement
established'.
This approach is consistent with the general observations made
by the Justices regarding developments in the general law of trusts
which affect a trustee's treatment of capital and revenue. The
Justices concluded that, having regard to these developments, '[i]t
was to be expected that the treatment of receipts and outgoings by
a trustee would not necessarily correspond with that in the taxing
statute'.
The judgement was brief, suggesting the Justices were less than
impressed with the Commissioner's submissions on this matter. The
court noted '[t]he Commissioner only partially invoked the
operation of the 1936 Act to give content to the expression "income
of the trust estate", and would exclude "statutory income", which
is not income according to ordinary concepts. The lack of
consistency which this involves tells against the submission'.
Comment
The High Court referred to the comment of Hill J, who observed
in Davis v Federal Commissioner of Taxation (1989) 86 ALR
195 that 'the scheme of Div 6 calls out for legislative
clarification, especially since the insertion into [the 1936 Act]
of provisions taxing capital gains as assessable income'. The
reference suggests the court would prefer the legislature to remedy
the anomalies inherent in these provisions, rather than achieving
this through judicial intervention.
[1] Bamford & Ors v FC of
T 2009 ATC 20-105 at 42.