Damian O'Connor, Special Counsel
The High Court of Australia handed down its decision in the case of Bamford v Commissioner of Taxation on 30 March 2010.
This case is important for those people who have or advise on discretionary trusts, particularly if you have applied, or plan to apply, the small business CGT concessions on assets such as shares or land held through a trust. We expect that the Australian Tax Office's audit activity may now focus on these concessions and trust distributions.
This was a test case on the tax treatment of trust distributions, heard on appeal from the full Federal Court. Both the taxpayer and Commissioner appealed different parts of the Federal Court decision, and both their appeals were dismissed by the High Court.
Five judges heard the case and delivered a joint judgement, which, as a general rule, better clarifies the law than separate judgements, which may have differing views on certain points.
In practical terms, the Bamford decision carries significant weight and is authority for the following:
- Contrary to the Commissioner's view, 'income of the trust estate' includes capital gains (statutory income). This maintains the status quo and may be seen as a win for the taxpayer, as it continues to allow trustees to more favourably deal with trust capital gains.
- A strict 'proportionate approach' should be used to determine how much trust taxable income is allocated to a particular beneficiary. This is problematic for the taxpayer, because it means that where the trust income and net income of the trust for tax purposes are not the same, the beneficiary may be taxed on an amount to which they are not currently entitled under the terms of the trust deed itself.
Surprisingly, the Bamford decision did not provide definitive commentary on whether the terms of a trust deed could operate to redefine capital gains as income of the trust estate. Given that income of the trust estate in this case was found to include capital gains, the High Court appears not to have found it necessary to address the Commissioner's submission on this issue directly.
Our recommendations as a result of the Bamford case
Now that there is a High Court decision on the tax treatment of trust distributions, you should take the steps necessary to maximise the tax efficiency of your trust deed and trust distribution resolutions.
So that your trust distributions have the intended tax effect, every existing discretionary trust arrangement should be looked at for the following:
- Trust deeds - especially those drafted before September 1985 - should be reviewed and updated if necessary so that trustees have sufficient flexibility in determining how the income and gains of the trust are distributed.
- Trustee resolutions should be drafted:
- in accordance with the terms of the trust deed, keeping in mind that all trust deeds are not the same and applying a common 'pro-forma' approach may have unintended tax consequences;
- to manage default income distribution provisions that operate automatically at June 30 of each year; and
- reflecting the strict proportional approach that Bamford requires, to deal with the tax risk of a difference between trust income and net income of the trust.
You should keep in mind that as discretionary trusts often produce a desirable tax outcome, the ATO has a strong focus on them, and tax arrangements should be managed carefully.
For more information on this case or using trusts generally, please contact HopgoodGanim's Taxation and Revenue team.
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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.