Tax Effective Trust Distributions - Bamford's case

The High Court has handed down its decision in the Bamford case: Commissioner of Taxation v Bamford; Bamford v Commissioner of Taxation [2010] HCA 10.

The decision from the highest court in the land provides certainty to trustees and their tax agents when it comes to working out how the income of a trust can be distributed to beneficiaries and taxed in their hands.

There were two main issues the court needed to decide on, each of which dealt with different years of

income. Both involved the interpretation of S.97(1) of the Income Tax Assessment Act 1936 (ITAA 1936), which provides that, where a beneficiary is presently entitled to "a share of the income of the trust estate", their assessable income must include "that share of the net income of the trust estate."

 

The 2000 year of income

Facts

The taxpayers, Mr and Mrs Bamford, were beneficiaries of the Bamford Trust (a "discretionary trust").

The trustee of the trust determined that the income of the trust for the year ending 30 June 2000 would be distributed to a number of beneficiaries, as to specific amounts, including $68,000 to each of the taxpayers, with the balance going to the Church of Scientology Inc.

The Trustee determined that the income of the trust was $187,530, after treating certain contributions to an offshore superannuation fund (of $191,701) as expenses and, in error, treated them as allowable deductions in computing the net income of the trust estate.

Upon making the distributions in accordance with the determination, there was insufficient remaining to provide the $68,000 to the taxpayers (they each received $33,872), and no balance to go to the Church.

The Commissioner disallowed the trust’s deduction and assessed the taxpayers by calculating the ratio which the actual distributions of $33,872 bore to the total of $187,530, and then applied that ratio to the excess of the net income addition of $191,701 over the distributable income.

The taxpayers contended that their “share” of the net income of the trust estate and thus the amounts included in their assessable incomes should have been ascertained as if the terms of the trust deed, including the effect of any exercise of power of appointment over income, applied to the calculation of that "net income".

 

Decision

The High Court upheld the Full Federal Court’s decision that "that share of the net income" in S.97(1) meant that beneficiaries are to be assessed on the net income of the trust by reference to their proportion of distributable (i.e., trust) income, and not specific amounts.

That is, they held that the so-called “proportionate approach” was preferable to the “quantum approach”.

 

The 2002 year of income

Facts

In respect of the 2002 year of income, the Trustee treated a net capital gain of $29,227 arising from the sale of certain property as income available for distribution (clause 7(n) of the trust deed of the trust empowered the trustee to determine whether any receipt "is or is not to be treated as being on income or capital account").

That capital gain was divided equally and included in the distribution made to the taxpayers for that year.

However, the Commissioner considered that the capital gain was not included in "the income of the trust estate" as it was not "income according to ordinary concepts", with the result that there was no income of the trust estate for that year and that the trustee itself was to be assessed under S.99A of the ITAA 1936.

 

Decision

The High Court held that "income of the trust estate" meant income according to trust law, including the provisions of the trust deed (if any), and not income according to "ordinary concepts."

Therefore, the trustee was entitled to include a net capital gain as part of the "income of the trust estate" of the trust.

 

What does this mean for trusts?

The issue that advisers must now consider after the Bamford decision is “what is the income of each trust?” and how is it “shared”?

Mr Carramatta, the accountant for Bamford, provided the AAT with evidence in his affidavit that “accounting standards….required the capital profit….to be taken to revenue account.”

Mr Carramatta’s position is typical of the dilemma faced by every accountant – How do I deal with the difference between accounting concepts and taxable income? The Bamford decision provides that guidance.

Every trust should now be reviewed to determine “what is income?”

If the review finds clauses of concern in the trust deed, then the deed should be referred for amendment.

 

What are we doing at Cabrera Partners to ensure our clients are protected?

We have encouraged our clients with trusts that are affected to have their deeds reviewed and amended where necessary.

We have engaged the services of a leading supplier of corporate services to undertake that trust deed review for our clients.

We have reviewed trust distribution practices for our clients and made sure that the most up to date distribution resolutions are used.

We tailor each trust distribution for each client to ensure the requirements of their particular trust deed are considered first and are not in conflict with the Bamford principles.

We consider the tax implications of any trust distributions before those distributions are made.

If you are unsure about the implications for your particular trust or would like advice specific to your circumstances, please contact us.

 

This publication is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render advice. No reader should act on the basis of any matter contained in this publication without first obtaining specific professional advice. This article is copyright. For permission to reproduce this article please email Jose Cabrera: This e-mail address is being protected from spambots. You need JavaScript enabled to view it