By its decision in Bamford,1 the Full Federal Court ("FFC") has (subject to reversal by the High Court or legislative change) confirmed the following in respect of trust deeds and discretionary trust distributions:
- The ability of a trustee to determine the
"income"2 of the trust estate for s 97(1)
ITAA363 purposes via the terms of the trust deed, the
consequences being that:
- if the deed adopts s 95(1) ITAA36 concepts, then that is the prevailing income concept (this has several benefits, but adopting s 95(1) concepts without modification can also create problems);4
- if the deed adopts Australian Accounting Standards concepts, then that is the prevailing income concept; or;
- if the deed is silent, then 'income according to ordinary concepts' applies.
Moreover, the trustee may from year to year be given a discretion to determine which income concept applies, with default to such concept as is specified in the deed in the absence of a trustee determination (or simply to 'ordinary concepts' where no default concept is pecified).5
This discretion extends to treating capital gains as "income" for the purpose of determining the proportion of the "net income" of the trust assessable to the beneficiaries personally, where the trustee is provided with appropriate power to do so under the trust deed (obviating the need to rely upon Practice Statement PS LA 2005/1 (GA)).6
To complicate this, the ATO has in practice tolerated a 'hybrid approach', particularly in respect of distributions of the maximum amounts possible to infant beneficiaries whilst still avoiding Division 6AA ITAA36 penalty tax rates.7
- The application of the 'proportionate approach'8 in determining a beneficiary's "share" of the "net income" of the trust estate where the trust's taxable income is amended, which simply provides that whatever share of "income" (regardless of which of the above concepts applies) a beneficiary is presently entitled to, that beneficiary will have included in its assessable income that same proportionate share of the s 95(1) "net income" (ie taxable income) of the trust.
Bamford has many practical implications for taxpayers and their advisors:
- Understanding which income concept applies, and in turn how alternate distribution methods will operate, in respect of any particular trust is critical.
- The adoption of one standard, welldrafted discretionary trust
deed for all clients (or as many as possible) not only protects
those clients' interests directly, it also streamlines and adds
certainty to the process of preparing distribution minutes by the
In reality however, advisers will need to deal with several different types of trust deeds, in which case it is vitally important to have an appropriate system in place to ensure that differences between trust deeds are appropriately catered for. Part of this system should involve reconciling the financial accounts, prepared in accordance with Australian Accounting Standards, with the entitlements of beneficiaries to "net income" of the trust via application of the applicable "income" concept and the 'proportionate approach'.
- Trustees can adopt the 'proportionate approach' without concern.
- There is no need to rely on PS LA 2005/1 (GA) if the s 95(1) "income" concept applies to the trust.
High Court Appeal?
The FCT maintains his position that 'income according to ordinary concepts' always applies, and that allowing trustees via the trust deed to effectively dictate who will pay the tax on trust income (and therefore the overall tax outcome) should not be permitted (despite the FFC clearly having considered and rejected the FCT's position in Bamford).9
The FCT and the taxpayer have both sought special leave to appeal to the High Court.10 However, the High Court previously rejected a special leave application vis-a-vis Cajkusic based upon much the same issues.
If special leave is denied re Bamford, it won't be for lack of effort on the FCT's part, who has encouraged professional associations to lodge public interest affidavits with the High Court. The ATO has also drawn considerable media attention of late towards trusts and trust distributions,11 none of which can hurt the chances of special leave being granted.
If the High Court were to grant special leave and reverse the Bamford decision visa-vis the "income" issue (adopting instead the FCT's position), trustees would be required to identify which trust receipts constitute 'ordinary income' and which deductions can properly be expensed against them at general law. This would impose a huge burden/workload upon trustees and their advisers, though it might also precipitate the legislative overhaul of Division 6 ITAA36 that many (including members of the judiciary) have been calling for for decades.
Pending determination of the special leave applications and any consequential High Court appeal(s), the ATO has issued Practice Statement PS LA 2009/7 providing taxpayers with a certain level of comfort regarding the ATO's administration of the relevant law as follows:
- The ATO will apply the Commissioner's views regarding
"income" of a trust (ie 'income according to ordinary
concepts'), contrary to the FFC's decision in Bamford,
- it will not select cases for compliance review solely to apply the Commissioner's views in Bamford, except where (in the ATO's opinion) the trustee and beneficiary have deliberately sought to exploit Division 6 ITAA36 (eg to effect a mismatch between beneficiary entitlements and tax outcomes); and
- it will, to the extent possible, seek the agreement of relevant parties to defer the determination of any application for ruling, objection or appeal until the special leave applications and any consequential High Court appeal(s) in respect of Bamford are resolved; and
- it will not impose penalties where trustees and beneficiaries have assessed their tax position in line with the FFC's views in Bamford (or any other view reasonably open based upon other relevant authorities);
- The ATO will apply the 'proportionate approach', consistent with the FFC's decision in Bamford; and
- The ATO's existing compliance activity regarding trusts engaged in aggressive tax planning and to detect under reporting will continue unaffected.
1 Bamford v FCT  FCAFC 66.
2 As distinct from the "net income" (or taxable income) of the trust estate, as defined in s 95(1) ITAA36.
3 Income Tax Assessment Act 1936 (Cth).
4 This has several benefits, but adopting s 95(1) concepts (without modification) can also create problems.
5 Stone and Perram JJ confirmed in Bamford that the decision in Cajkusic v FCT  FCAFC 104 was to this same effect. This was despite the Commissioner arguing, both in Bamford and his Decision Impact Statement on Cajkusic, that the conclusion on this issue in Cajkusic was merely obiter dicta.
6 However, where the trust deed adopts either 'ordinary concepts' or 'financial accounting' income, the need to rely upon PS LA 2005/1 (GA) remains. See also the recent decision in Wood v Inglis  NSWSC 601 per Brereton J, dated 30 June 2009, which gave effect to a power of a trustee to determine that a capital receipt (even an unrealised one) be treated as income.
7 Indeed it appears that no proportionately increased assessments were issued to the children in Bamford, who received distributions of $643 each. However, the better view is that the fixing of an unchallengeable set quantum for children is no longer possible unless the trustee/deed adopts the s 95(1) "income" concept.
8 The FFC endorsed the 'proportionate approach' emphatically over both the competing 'quantum approach' and the half-way house 'hybrid approach' advanced on behalf of the taxpayer in Bamford.
9 It must be noted that, in any case, the FCT retains a number of anti-avoidance powers with which to attack clear cases of tax system abuse in respect of trust distributions, such as s 100A of ITAA36 (specifically redressing 'reimbursement agreements') in addition to the Part IVA general anti-avoidance provisions.
10 The FCT having agreed to fund the taxpayer's High Court appeal should its application be successful, two bites at the cherry being better than one from the FCT's perspective.
11 One recent example appearing in the Financial Review on Thursday 17 September 2009, suggesting a broadened re-interpretation of the scope of 'loans' under Division 7A of ITAA36 by the ATO.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.