Australian tax - ATO 'give and take' on Bamford

Practical Law UK Legal Update 9-502-9193 (Approx. 3 pages)

Australian tax - ATO 'give and take' on Bamford

by Peter Capodistrias, Minter Ellison

Published on 29 Jul 2010 • Australia

This article is part of the PLC Global Finance July 2010 e-mail update for Australia.

The Australian Taxation Office (ATO) has published a Decision Impact Statement on the High Court decision in Commissioner of Taxation v Bamford; Bamford v Commissioner of Taxation. Bamford was a test case on the operation of certain provisions in Division 6 of Part III of the Income Tax Assessment Act 1936. This article considers key aspects of the judgment and the ATO's response to it.

Broadly, under Division 6 of Part III of the Income Tax Assessment Act 1936 (Division 6), the taxable income of most trust estates is assessable to the beneficiaries of that trust to the extent to which the beneficiary is 'presently entitled' to the 'income of the trust estate' for the particular financial year. The trustee is assessable only where there is 'income of the trust estate' to which no beneficiary is presently entitled (and in other limited circumstances, for example where a beneficiary is under a legal disability, or is not resident).

The meaning in Division 6 to "share" and "income" in the phrase 'presently entitled to a share of the income of the trust estate' has been a matter of contention between industry and the ATO for some time, particularly as changes to tax legislation have resulted in increasing differences between ordinary income and taxable income. Bamford was a 'test case' on the operation of these provisions.

In a single joint judgment, the Court dismissed the appeals from the Federal Court decision in Bamford. In doing so, it affirmed the approach taken by the Federal Court in earlier decisions Zeta Force and Cajkusic, holding that:

The "income of a trust estate", for purposes of allocating taxable income to beneficiaries, is determined by the trust deed and is not limited to 'ordinary income' for tax purposes.
Beneficiaries should be taxed on the taxable income of a trust in proportion to their percentage share of the distributable income of the trust.

In its Decision Impact Statement, the ATO states that, for practical purposes. the following 'general propositions' have emerged from the High Court's decision:

A provision of a trust instrument, or a trustee acting in accordance with a trust instrument, may treat the whole or part of a receipt as income of a period and it will thereby constitute 'income of the trust estate' for the purposes of section 97.
If a trust instrument does not specify when a receipt is to be treated as income of a period, and the trustee does not have any special power to characterise receipts, then the question of whether the whole or part of a receipt constitutes 'income of the trust estate' for the purposes of section 97 will fall to be determined in accordance with the general presumptions of trust law.
Similarly, the provisions of a trust instrument, or a trustee acting in accordance with a trust instrument, may determine whether an outgoing is properly chargeable against the income of a period (absent which the question will fall to be determined in accordance with the general presumptions of trust law).
Subject to the possible operation of provisions outside Division 6, the amount included in a beneficiary's assessable income under section 97 consists of an undissected or unallocated proportionate share of the entirety of the [tax] net income.

However, the ATO considers the following issues have not yet been resolved:

Amounts distributed to beneficiaries by trustees always retain the same character in the hands of the beneficiaries for trust and tax law purposes as they had in the hands of the trustees for those purposes; and
Division 6 is an exclusive code for the taxation of beneficiaries.

The ATO has also issued a Practice Statement (LA) 2010/1 which contains instructions for ATO officers dealing with trust tax issues. Broadly, the ATO will approach trust distribution tax issues as follows:

Issues arising on audit of a trust or beneficiary with be dealt with by a specialist trust tax manager within the ATO.
No case should be resolved without a detailed consideration of the trust deed (including any amendments that have been made to it) and all relevant documents including (but not limited to) relevant trustee resolutions and financial statements.
When undertaking active compliance activities, the ATO will not, in the usual course, seek to rely upon a distribution statement contained in a trust's tax return as the sole basis for determining who should be assessed on the trust's [tax] net income.
Given the prior uncertainty on trust tax issues, the ATO will not actively scrutinise 2010 and earlier trust distributions, but will apply the decision in Bamford if tax issues do arise, for example:
- if the ATO considers the tax provisions have been 'manipulated', including where the ATO considers:
- there is a deliberate mismatch between the beneficiaries' entitlements and the tax outcomes with the result that some or all of the tax liability in respect of the trust's [tax] net income is avoided;
- there are reasonable arguments to suggest that the general anti-avoidance provisions in Part IVA, or a specific anti-avoidance or integrity provision (such as trust stripping schemes) may apply to alter the way the [tax] net income is allocated between the trustee and the beneficiaries; or
- it is reasonably arguable, on the facts of the case that aspects of the arrangement that affect the application of Division 6 are a 'sham' or of no legal effect; or
- where there is a dispute as to the quantum of the taxable income of the trust.

Trustees should review their constitutions and distribution practices to ensure they are compliant with the decision in Bamford and the new ATO approach.

We note that the Australian Government has announced its intention to implement an elective statutory 'safe harbour' tax regime for certain managed investment trusts. The new regime is intended to apply from 1 July 2011.

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