Journal of Australian Taxation
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ASSESSMENT OF BENEFICIARIES INCOME – HOW TO AVOID THE PITFALLS AND TRAPS
By Jack Stuk and Darren Sommers[*]
Despite being an issue of great importance, the question of who is assessed on the excess of statutory income over distributable income for a trust is still unclear. Recent developments have failed to shed light on the correct approach, and further uncertainty arises for the options open to beneficiaries who are taxed on income they cannot receive.
The taxation advantages of trusts are well documented. However, an interesting situation may arise where the net income for trust purposes does not equal the net income for taxation purposes. There is no inherent difficulty if the net income of the trust according to the Income Tax Assessment Act 1936 (Cth) ("ITAA36") ("ITAA income") is less than the income according to accounting principles ("distributable income"). However, a problem arises when the opposite is found. If the Commissioner believes that the ITAA income is greater than the distributable income, then there is an amount remaining to be assessed.
This article focuses on the latter situation where one of two undesirable results may occur. Either the beneficiaries are taxed on the amount which they may never receive, or the trustee owes tax on it at the maximum rate.
In deciding which situation gives rise to a less detrimental result, two issues should be considered:
1. How does the trust deed allow the calculation of net income to take place? How is it to be assessed in light of the current law?
2. If it is held that the beneficiary is to be assessed on income potentially never received, can the beneficiary disclaim his or her trust interest, leaving the trustee potentially liable to taxation on the unassessed income?
Taxation is imposed upon trustees and beneficiaries mainly under Div 6 of the ITAA36. The broad scheme of Div 6 is to ensure that the taxation liability for trust income is allocated and taxed at rates considered appropriate in each case.
Under s 97 of the ITAA36, where a beneficiary is not under a "legal disability" and is "presently entitled" to a "share of the income of the trust estate", the assessable income of the beneficiary shall include that "share of the net income of the trust estate". The "net income" of the trust estate is defined in s 95 of the ITAA36. A beneficiary who is "presently entitled" must have an indefeasible, absolutely vested, beneficial interest in possession of the trust income.[1] These rules of distributing income to beneficiaries are best illustrated by a simple example (see below):
Example A:
Suppose the distributable income for the 1997/98 financial year was $15,000. Assume that the trust deed gave the usual discretionary powers to the trustee to distribute the income. Suppose further, that the trustee decides to distribute the income on the following basis:
"$10,000 to beneficiary X, and any remaining amount to Y"
Therefore, at the end of the 1997/98 income year, X is presently entitled to $10,000 and Y is presently entitled to $5,000.
However, an issue arises if the Commissioner re-assesses the trust income and finds that the ITAA income is greater than the distributable income.
There are two alternative views regarding who is assessed on this excess amount. Hill J in Davis v FC of T[2] decided and Sundberg J in Zeta Force Pty Ltd v FC of T[3] preferred the view that it was the beneficiary who was assessed on the income. However, in Richardson v FC of T,[4] Merkel J took a different view. According to Merkel J, it is the trustee who is assessed at the penalty rate on the excess ITAA income.
Much of the debate concerning the interpretation of s 97 centres on the meaning of "share of the net income of the trust estate". In Davis, Hill J stated that there are two approaches to its interpretation:
1. Proportionate approach – The beneficiary's proportion or fraction of distributable income is used to calculate his proportion of the net income of the trust estate as calculated under the ITAA36.
2. Quantum approach – The beneficiary is liable for tax only on the dollar amount of his entitlement to distributable income. The remaining income (which is the difference between distributable income and ITAA income) is then income in the hands of the trustee and taxable at the penalty rate under s 99A of the ITAA36.
The difference between these approaches is best illustrated by the following example:[5]
Example B:
Suppose that the trust has distributable income of $100 and a taxable capital gain of $150 (which was not included in the distributable income) so that its ITAA income is $250. The beneficiaries are presently entitled to all the distributable income.
Under the proportionate approach, the beneficiaries are assessed on the extra $150 of ITAA income. Therefore, $250 will be included in their assessable income even though they are only entitled to be paid $100 by the trustee. However, under the quantum approach, the assessable income of the trustee is $150 and is taxed at the maximum rate. However, the trustee is generally allowed to recoup the tax paid from the trust assets.
The main contention is the interpretation of s 97 of the ITAA36. Section 97(1) states:
Where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate ―
(a) the assessable income of the beneficiary shall include ―(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and
(ii) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia (emphasis added).
The proportionate approach is based upon a literal interpretation of s 97. In Case C36,[6] RK Todd summarises the situation by stating:[7]
But the statutory words, "share of the income of a trust estate" are part of a composite phrase, and cannot in any way be separated from the words "presently entitled" occurring in sec. 97 and sec. 98 ... [he then goes onto examine authorities relating to present entitlement] ...
Having regard to these authorities, I cannot see how the word "income" in the phrase "a share of the income of a trust estate", where it occurs in sec. 97 and in sec. 98 can in any circumstances be regarded as referring to gross income as opposed to net (trust) income. The initial enquiry therefore is as to whether a beneficiary is presently entitled to a share of the net (trust) income. ... If any beneficiary has such an entitlement, then in my opinion the natural reading of the opening portion both of sec. 97 and sec. 98 is that the quantum of that entitlement, expressed as a proportion of the net (trust) income, will determine what is that beneficiary's "share of the income of (the) trust estate" for the purposes of sec. 97 and sec. 98.
The matter first came before the Federal Court in Davis. There, Hill J examined s 97 and discussed the effects of both the proportionate and quantum approaches:[8]
It is quite clear that neither interpretation of sec. 97 produces a desirable result as a matter of tax policy and the scheme of Div. 6 calls out for legislative clarification, especially since the insertion into the Act of provisions taxing capital gains as assessable income. On the proportionate view a taxpayer may be assessed on amounts he neither did nor could receive; on the alternative view a taxpayer could be taxed on less than he received if the share of trust law income exceeded that part of the net income as is represented by trust law income, and the maximum rate of the tax under sec. 99A would be applicable to the balance.
His Honour, applying the literal rule of statutory interpretation, decided that the proportionate view was the better approach:[9]
However, the proportionate view does seem to me, as a matter of language, to be the better construction of the section and in the absence of any authority compelling me to adopt the alternative method, I propose to accept it. It was not argued by either side that the proportionate method was incorrect.
2.2 Richardson and the Quantum Approach
In Richardson, Merkel J of the Federal Court handed down a decision favouring the quantum approach in those circumstances where ITAA income exceeds distributable income. His Honour adopted a more purposive approach to the interpretation of s 97. He justifies the departure from the approach of Hill J as follows:[10]
I appreciate that the conclusion at which I have arrived is different from that expressed by Hill J in Davis. However, in Davis no submission was made or argument put to Hill J against the conclusion at which his Honour arrived. That is not so in the present case. Further, the approach to construction which I have adopted was not put to or considered by his Honour.Merkel J justifies his use of the purposive method of statutory interpretation by stating:[11]
As is clear from the above analysis and that of Hill J in Davis the words of s 97(1) – "that share of the net income of the Trust estate" – are not clear or unambiguous.
In such circumstances the modern rule of construction is to resolve the uncertainty as to their operation by giving effect to the legislative purpose: see for example s 15AA of the Acts Interpretation Act 1901 (Cth). I considered the authorities in that regard recently in Wang v Minister for Immigration and Multicultural Affairs [1997] FCA 70; (1997) 45 ALD 104 at 110 - 112. In Wang I said that where a judge concludes that the legislature could not have intended that a statute could operate in a manner which defeats its manifest object or purpose, then an alternative interpretation must be preferred. I referred to the substantial body of authority that supports that approach.
His Honour then gave his reasons for choosing the quantum approach in the case where the net income of the trust estate under s 95 exceeds the entitlement of the beneficiaries to the trust law income of the trust:[12]
In my view s 97(1) and the difficulties to which I have referred require that that principle of construction be employed to ensure that when trust income exceeds the trust's taxable income a proportionate approach is adopted to determining the distribution of assessable income to beneficiaries presently entitled under s 97(1). But, when the trust's taxable income exceeds the trust income a quantum approach is to be adopted to determine the distribution of assessable income in relation to the beneficiary presently entitled to the trust income under s 97(1). In the latter case the deficiency will be undistributed "income" to which no beneficiary is presently entitled and will be taxable income of the trustee under s 99 or s 99A of the Act.
The approach I have adopted to the operation of s 97(1) ensures that those entitled to the trust income, including the trustee in respect of "income" to which no beneficiary is presently entitled, bear their commensurate "share" of the tax liability in respect of the trust's income. I would add that where the trustee is assessed under s 99 or s 99A no capricious, unfair or anomalous result arises. The situation is usually one which is avoidable by the trustee, if it so desires, by exercising its power under the deed to ensure that there has been a distribution of all of the assessable income. In any event it is difficult to perceive any unfairness in the trustee's tax liability being borne by the trust estate, rather than the beneficiaries who did not become entitled to the "income" giving rise to the liability.
It is clear that Richardson presents a radical departure from the existing principles. Merkel J is of the view that the aim of the legislation is frustrated by the proportionate approach where the ITAA income exceeds the distributable income (but not vice-versa), as it is clearly unfair to the beneficiary in the sense that he is taxed upon income he never received. However, under the quantum approach, which is ostensibly fairer to an entitled beneficiary in isolation, the trustee is taxed at the penalty rate, meaning a lesser amount of income available to the trust beneficiaries as a whole.
Zeta Force involved an objection by a default beneficiary whose taxable income had been reassessed. The applicant was the beneficiary of a family trust, which in turn was the holder of 30% of the units in a unit trust. In the 1990/91 income year, the unit trust made a distribution to the family trust. The ITAA income of the unit trust was $427,333 greater than its distributable income. The family trust had calculated its ITAA income on the basis that its assessable income only included its share of the unit trust's distributable income and not its proportionate share of the unit trust's ITAA income. The Commissioner purported to make an assessment on the basis that the family trust had derived assessable income in proportion to the unit trust's ITAA income. The facts and the calculations are complex, but the family trust was found to have derived, on the proportionate basis, further assessable income of $138,969.[13]
The trust minutes of the trustee recorded a distribution of $5,000 to one beneficiary and the remainder to the applicant. According to the Commissioner, the applicant was entitled to the increased income of the family trust and was therefore assessed on $130,431[14] using the "proportionate method". It seems to have been common ground that although the first beneficiary was entitled to a fixed dollar amount, he was still liable to a re-assessment based on the proportionate approach.
In his judgement, Sundberg J examined ss 95 and 97 and decided that the meaning of the word "share" is "proportion rather than part or portion". His Honour stated:[15]
The words "income of the trust estate" in the opening part of s 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument. That the words have this meaning is confirmed by the use elsewhere in Div 6 of the contrasting expression "net income of the trust estate". The beneficiary's "share" is his share of the distributable income.
Having identified the share of the distributable income to which the beneficiary is presently entitled, s 97(1) requires one to ascertain "that share of the net income of the trust estate". That share is included in the beneficiary's assessable income. The expression "net income of the trust estate" in par (a)(i) has the meaning given it by s 95(1) − taxable income as opposed to distributable income. The words "that share" in par (a)(i) refer back to the word "share" in the expression "a share of the income of the trust estate", and indicate that the same share is to be applied to an income amount calculated according to a different formula (taxable income as opposed to distributable income). Since the income amount may differ according to which formula is applied, the natural meaning to give to "share" where it appears for the second time is "proportion" rather than "part" or "portion". When Parliament wanted to convey the latter meaning, as it did in ss 99 and 99A, it used the word "part".
In examining whether Parliament intended that the quantum approach be adopted, his Honour stated:[16]
The contrast between the expressions "share of the income of the trust estate" and "that share of the net income of the trust estate" shows that the draftsman has sought to relate the concept of present entitlement to distributable income, and not to taxable income, which is, after all, an artificial tax amount. Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the notion of present entitlement has served its purpose, and the beneficiary is to be taxed on that share (or proportion) of the taxable income of the trust estate.
That construction of s 97(1)(a) seems reasonably clear to me, although it may, as I have indicated, result in unfairness to beneficiaries. Had the legislature intended a beneficiary to be assessed on no more than the amount of the distributable income to which he is presently entitled, it could easily have said so.
After presenting his own views, Sundberg J evaluated cases which applied the proportionate approach. These could be summarised as:
• Cases such as Davis and Richard Walter Pty Ltd v FC of T,[17] which applied the proportionate approach, however neither side in these cases gave much support to the quantum approach.
• Cases on Pt IVA of the ITAA36 such as Peabody v FC of T[18] and Grollo Nominees Pty Ltd v FC of T[19] which reassessed income under s 97, accepted that the correct position was the proportionate approach, even though the point was not argued.
• The recent case of FC of T v Prestige Motors Pty Ltd,[20] whereby Hill and Sackville JJ commented in obiter that the proportionate approach was "the usual position".[21]
Sundberg J then summarised his position in relation to Richardson as follows:[22]
Richardson's starting point is that the clear purpose of s 97 is to ensure that the tax assessed on trust income is borne by the beneficiaries in shares which are commensurate with their entitlements ... As is apparent from what I have said ... the language used by the legislature does not make that purpose clear to me.
Sundberg J continued, stating that a purposive approach to legislative interpretation cannot authorise different interpretations of the same phrase according to the facts of the particular case. In essence he is critical of the approach in Richardson which allows for different constructions of the Statute depending upon the facts. Sundberg J comments:[23]
It seems to me, with respect, that the line which divides enlightened construction from reconstruction was passed in Richardson.
Support for the criticism of Merkel J's approach has recently been found in the comments of Sir Daryl Dawson, former Justice of the High Court.[24] In a recent convention, Sir Daryl Dawson was asked to comment on the following quote from Richardson:
... where a judge concludes that the legislature could not have intended that a statute could operate in a manner which defeats its manifest object or purpose, then an alternative interpretation must be preferred.
Sir Daryl Dawson, in his analysis of the approach of Merkel J, stated:[25]
What Justice Merkel did, I think, was to rewrite s 97 of the Income Tax Assessment Act by substituting for the word "share" a word of different meaning, namely, "amount" and to do so only in some circumstances...
Whether that was the purpose or object of s 97 (and it is no part of my argument to dispute Justice Merkel's conclusion that it was, even though there may be more than one view on the matter), according to the accepted rules of interpretation, a court can only implement the purpose or object of a statute by using the language that is there and cannot introduce language of its own that is not there, particularly when it is inconsistent with the language that is there. I recognise that there are cases in which it has been held that a word or phrase may be added or omitted to achieve the object of a statute, but that can only be done by way of construction and by way of reconstruction.
While Sir Daryl Dawson is no longer a member of the High Court, his comments add to the weight of arguments against Richardson. Other judges have acknowledged the unfairness to beneficiaries of the proportionate view, and have done so with the qualification of a conservative approach to statutory interpretation. Unlike Merkel J, the courts in cases such as Zeta Force and Davis, have been reluctant to depart from the text of the statute. Any notion that a court may adopt its own view of the appropriate means of achieving the object or purpose of the section in substitution for that adopted in its language, would, it seems in their Honours view, be a fundamental departure from the common law.
From a practical perspective, the lack of certainty concerning a well known taxation issue is not comforting. Even though Zeta Force was the first case to deal with this issue as part of its ratio,[26] the competing view in Richardson should still be considered (perhaps limited to the quantum approach regardless of whether ITAA income exceeds or is less than distributable income). Practitioners giving advice in this area should be well aware of these approaches and be wary that either position may be accepted by a higher court in years to come and take appropriate measures in drafting minutes, trust deeds and ancillary documents. After the law is settled, entitlements to trust income of previous years cannot be altered merely because the taxation consequences are found to be different than had been supposed.
A solution for a beneficiary who receives an amended assessment from the Commissioner may be to rely on the doctrine of disclaimer. It is well established that a donee of a gift may disclaim the gift. The application of this principle to the taxation of trusts suggests that an object of a distribution of capital or income from the trust may disclaim the distribution before he or she accepts it.[27] However, the effect of a disclaimer may depend on the drafting of the instrument distributing and calculating the income or capital.
In relation to distributions of income, there are three methods commonly found in trust deeds which define how trust income is to be calculated:
1. The trust deed or a resolution by the trustee calculates income according to accounting principles only and determines what is distributed to whom (and what if anything is accumulated).
2. The trust deed or a resolution by the trustee calculates income according to the "net income of the trust", as calculated under the ITAA36 and determines the distributions to be made and what income is accumulated.[28]
3. The trust deed allows the trustee to use either method of calculating the income of the trust at its discretion.
In the case of the first method, the proportionate view would leave the beneficiary liable to be taxed on the additional ITAA income arising from the amended assessment, whereas the quantum approach would impose tax for it on the trustee. However, if the beneficiary were to disclaim his interest and assuming this was valid, the trustee would be liable for tax on this additional ITAA income regardless of which approach is applied. In the case of the second and third methods, the trustee would also be taxed on any excess ITAA income as a result of a valid disclaimer by the beneficiary.
In Income Taxation Ruling IT 2651, the Commissioner released a ruling concerning the disclaimer of income by beneficiaries who were not aware of their interests in the trust. The ruling dealt with a number of issues, however, the relevant issue is whether the distributable income can be disclaimed from the trust for a particular year, or whether the entire interest of the beneficiary in the trust must be disclaimed.
The Commissioner takes the view that only the entire interest in the benefits of the trust may be disclaimed. He states:[29]
In a recent AAT decision, Case X30 90 ATC 287 ... , it was held that, in order for a disclaimer to be effective, it must be an actual disclaimer of the whole interest, not part of an interest, created under a discretionary trust. In other words, the taxpayer had a right to disclaim the property the subject of the discretionary family trust ― he or she could disclaim the benefit of the trust ― but not simply disclaim the income for a particular year.
In Case X30,[30] CJ Bannon QC decided that a partial disclaimer of only the income component of the interest was ineffective. He stated:[31]
It is stated in Lewin on Trusts 1939 14th ed p 176 that a person may not disclaim trusts as to portion of the trust property. In Re Lord & Fullerton's Contract [1895] UKLawRpCh 185; [1896] Ch 228 however, a trustee in bankruptcy may disclaim portion of a bankrupt's estate. ... Whatever may be the position as regards assignment, the balance of opinion appears to favour Mr Bloom's proposition. Research into Norton on Deeds (1928) 2nd ed p 23 elicited this proposition.
"A disclaimer must be an actual disclaimer of all interest."
The proposition may obtain some support from the case of Re Young [1913] UKLawRpCh 8; [1913] Ch 272, therein cited.
There are two problems with the approach of CJ Bannon QC. Firstly, the member or those presenting arguments before him failed to consider a long line of relevant old English and recent Canadian authorities (see Part 5.2 below). Secondly, he has relied on Re Young, which in the authors' view is distinguishable (see Part 5.3 below).
There are a number of old English authorities on the issue of disclaimer which are succinctly reviewed by Addy J in the Canadian case of Re Skinner:[32]
In the case of Hawkins v. Hawkins [1880] UKLawRpCh 24; (1880), L.R. 13 Ch.D. 470, where a residuary legatee had elected to accept the residue, it was held that he must accept the leasehold which formed part of the residue.
In Green v. Britten (1873), 42 L.J. Ch. 187, where there was a gift of six leasehold villas together with an ornamental park for life, it was held to be one entire gift and the legatee could not take the villas without the park.
In Frewen v. Law Life Assurance Society, [1896] 2 Ch. D. 511, where there was a tenant for life of several estates settled by will, it was held that the estates were devised as a whole and that he could not claim one life estate and disclaim the others.
In Re Joel, [1943] 1 Ch.D. 311, where there was a bequest of a house together with contents, it was held to be a single gift and the legatee could not disclaim the gift of the house while accepting its contents.
In Re Hotchkys [1886] UKLawRpCh 111; (1886), 32 Ch.D. 408, where there was a gift of "all my freehold and leasehold estates", the Court held this to be one gift and the tenant for life could not accept one life tenancy and refuse the other.
In Parnell v. Boyd, [1896] 2 I.R. 571, where all the property of a testator was devised to one person, it was held that that person could not disclaim only part, he must either take or disclaim all.
After evaluating these authorities, Addy J concluded:[33]
The law is clear that, where there is a single undivided gift, the donee must take the whole or disclaim the whole: he cannot disclaim part. This principle has been approved many times in the English Courts and, in my view, is also the law of our Province: Guthrie v Walrond [1883] UKLawRpCh 12; (1883), L.R. 22 Ch.D. 573 at p. 577: "... when two distinct legacies or gifts are made by a will to one person he is, as a general rule, entitled to take one and disclaim the other ..." But where there is a single undivided gift"... such a gift is prima facie evidence that it was the testator's intention that the gift shall be one, and that the legatee shall either take it all or take none of it."
This would clearly seem to support the position of the Commissioner. However, the approach of Addy J was later overruled in Re Coulson:[34]
It may be of significance when examining the judgement of Addy, J., in the Skinner case, that no reference is made to the decision of Gillanders, J.A., of the Court of Appeal, sitting as a High Court Judge in Re Graydon, O.W.N. 130, [1942] 2 D.L.R. 306. Gillanders, J.A. did allow the life tenant to renounce the balance of her life interest under an estate after having received the income therefrom over a period of years. There were qualifications put upon that rule as found and applied by Gillanders, J.A., but those qualifications do not apply here. Furthermore, it may be helpful in considering the question raised before the court in the Skinner case to appreciate that the cases relied upon by his Lordship are cases in which the beneficiary of the estate attempted to accept the beneficial bequests and reject more onerous bequests under the estate in question. Again we have no such circumstance here.
Having considered the decisions of this Court and the decisions of the Courts of England, we are all of the view that the Skinner decision is wrongly decided.
In Re Graydon,[35] Gillanders JA explained the conditions upon which a disclaimer of income can be made:[36]
It is submitted that upon acceptance of any part of the income provided for her that a life estate is now vested in her and cannot be disclaimed. She has, however, refused to accept further payments of income from the trustee; there are no conditions or obligations attached to the receipt of this income, nor to the receipt of any payments she has received in the past. When no-one else is prejudicially affected by her action and she has so formally renounced her claim and refused to accept further payments, I fail to see why the income on hand and that accruing should be forced upon her or held for longer for her. Under the circumstances here I think she is entitled to renounce, but whether her refusal to accept further benefits from the trustee should be called a disclaimer or not is probably not important.
One question arising from this analysis is whether our High Court would follow these Canadian decisions. The Canadian decisions are based upon English authority and there is no strong authority to support the contrary view. It may be however, if Re Graydon is followed, that if a discretionary beneficiary wishes to disclaim a distribution, he has to do so from that point on.
In the AAT decision, CJ Bannon QC cites Re Young in support of his decision. However, this case did not consider whether or not a partial disclaimer of income was valid. In Re Young, the beneficiary disclaimed her interest in the income from a will letting it pass to her son. However, after eight years her son died, she wished to renounce her disclaimer. The court upheld her claim and if anything, supported the proposition that a disclaimer of part of an interest is possible. Swinfen Eady J stated:[38]
The trustees accepted the money and held it in trust. For a time with the plaintiff's consent they paid income to her son. Now that he is dead the plaintiff says that she merely voluntarily relinquished her right to the income for the time being, but never gave up her life interest, to which she says she is still entitled. I think that is the true legal position and that the plaintiff is entitled to the income from her son's death.
From these comments, it may be inferred that a partial disclaimer of income for a period of time is possible, and the end result is that this is not a disclaimer of a full interest. At no point does his Honour state that a partial disclaimer is invalid.
Following these authorities, we believe that the position adopted in Income Taxation Ruling IT 2651 is incorrect. In basing his views only on a decision of the AAT, the Commissioner has ignored the old English and recent Canadian decisions. These decisions clearly show that under the law of Canada and England, a beneficiary may disclaim part of an interest in property granted under a trust. Furthermore, the recent Canadian decisions display that the income component of an interest may be disclaimed, and that this disclaimer may also be for a fixed period of time.
If a beneficiary can disclaim the income component of an interest in a trust, can a beneficiary accept only part of the income given under the trust, or must he accept the whole?
While there is no common law authority regarding the disclaimer of an income distribution from a trust, some guidance can be taken from the pre-mentioned English authorities which relate to the distribution of a residuary estate. These cases tend to support the position that part of a benefit can be disclaimed only where the benefits themselves can be divided into distinct proprietary objects. An example would be if a beneficiary were given two tables under a will. Based on their approach, he could disclaim one table and keep the other.
However, this has two qualifications. Firstly, the beneficiary cannot disclaim the onerous obligations upon him and keep the benefits. Secondly, if the property is seen to be given as one entire gift, then the beneficiary cannot disclaim part of the gift.
A good example of both situations is Parnell v Boyd.[39] In that case, a will left a leasehold interest in a house and its contents to the beneficiary. The beneficiary wanted to disclaim the interest in the lease of a house as the rent was in arrears, however, he still wanted to keep the contents. Homes J held that "the devisee who accepts the portion that is beneficial cannot repudiate what is onerous."[40] Furthermore, Johnson J stated "that the devise, being an aggregate of landed property, the defendant could not pick and choose, but was bound to accept or refuse the entire."[41]
When considered in the context of a re-assessment of the returns of a beneficiary or the trust, it seems that a beneficiary cannot keep the original distribution of income and disclaim the reassessed amount. This is because most trust instruments grant the income as one identifiable portion and not separate individual allotments. In such a case, a beneficiary will have a choice to accept or disclaim the whole amount without any intermediate possibility. Furthermore, a beneficiary's right to disclaim, like a present entitlement, would seem to relate to the distributable income amount and not a notional concept such as ITAA income. It seems that if a beneficiary wished to disclaim the difference between the ITAA income and distributable income, he would have to disclaim the entire amount as ITAA income arises solely out of the present entitlement to distributable income, assuming that the proportionate and not the quantum approach is the correct method.
A donee of property cannot disclaim the gift once he has accepted it.[42] This principle dictates that a beneficiary who has already received the income from the trust cannot later disclaim it. In the case of an amended re-assessment by the Commissioner of the trustee or the beneficiary, it seems that a beneficiary will not be able to disclaim the initial distribution.
However, this will only apply where the gift has been accepted. It will probably not apply where the trust distributions have not been paid to the beneficiary[43] or where the trust deed or a resolution by the trustee provides that any amended assessment as determined by the Commissioner be gifted as a separate amount.
The central issue is whether a disclaimer of the income of the trust will constitute a "CGT event" for capital gains tax ("CGT") purposes. An examination of s 104-125 of the Income Tax Assessment Act 1997 (Cth) ("ITAA97") provides that "CGT Event C2" occurs when:
(1)... your ownership of an intangible CGT asset ends by the asset:(a) being redeemed or cancelled; or
(b) being released, discharged or satisfied; or
(c) expiring; or
(d) being abandoned, surrendered or forfeited.
The central issue is whether a disclaimer amounts to a cancellation, release, discharge, surrender or abandonment of the income.
In Yvonne Joyce Probert v Commissioner of State Taxation,[44] the Court had to decide whether a disclaimer amounted to a conveyance for the purposes of stamp duty. In examining s 71 of the Stamp Duties Act 1923 (SA), Olsson J had to decide whether a disclaimer constituted a "surrender, release or avoidance". His honour stated:[45]
It seems to me that, in the absence of any specific legislative provision to the contrary, the authorities quite clearly establish the proposition that a formal disclaimer of a benefit conferred by a Will does not act positively as an assignment or disposition of property.
While this case was concerned primarily with the disposition of property, a number of important issues were highlighted. Firstly, a disclaimer is the refusal to accept a gift and does not amount to a transfer or disposal of an asset. Furthermore, there is no cancellation/surrender, etc, of the asset as the beneficiary has not received the gift to cancel/surrender it. However, in disclaiming the gift, it may be argued that a beneficiary is surrendering or abandoning his right to have the trustee perform his obligations under the trust deed to deliver the asset. This may be a separate CGT event over a different asset, being the chose in action as stated. Olsson J, also identified such a chose in action, stating:[46]
The sole effect of the disclaimer, as and when it took effect, was to divest the disclaimer of the right to call upon the executor, upon assuming the mantle of trustee, to execute the trust in her favour in accordance with the Will of the testator.
Furthermore, the fact that one beneficiary disclaiming his interest may result in a disposition of a greater interest vesting in the remaining beneficiaries of the trust, will probably not mean that the disclaimer was a disposition by the disclaiming party. In relation to the issue of stamp duty in Yvonne Joyce Probert, Olsson J comments:[47]
The mere fact that, following the disclaimer, Ms Hannaford became solely entitled to the residuary estate, when that estate was ascertained at some future date, was no more than an indirect legal incident of the disclaimer. The disclaimer itself did not effect the assuring to or vesting of any property, as such, in anyone... what repercussive effect flowed from that was incidental.
Note that when assessing the CGT implications of a disclaimer, even if it is a "CGT event", one must always pay attention to the market value of the relevant asset and any cost base implications. In the case of an asset being the chose in action against the trustee, the valuation of the asset may be a difficult task and further the asset may have no value as, in essence, the chose in action is the right against the trustee for a beneficiary to have delivered a gift he never wanted.
This article has sought to highlight the issues which may arise upon the re-assessment of the income of a trust and incidentally whether the doctrine of disclaimer may assist an affected beneficiary. Furthermore, it highlights the dangers which may occur if the trust document is not drafted to properly reflect new developments in current tax law. Due to the recent development of Richardson's case, trustees should be wary of the drafting of their trust minutes and trust deeds, and the implications of an injudicious appointment of income or capital to a beneficiary. Considerable planning is necessary to avoid the undesirable results which may occur from a re-assessment of the income of the trust.
Jack Stuk has practised in taxation law for over 20 years. He is an external consultant to a number of taxation accountants and bodies and regu-larly gives lectures and publishes articles on taxation law and practice. He is one of the two founding partners in the eight partner business law firm of Jerrard & Stuk.
Darren Sommers is a former Monash University student. Admitted to practice this year, Darren, with a rare computing and law background, currently practises exclusively in the areas of taxation and information technology law and has co-written a number of articles on significant taxation issues.
[*] Please note that any errors or omissions are those of the authors. The information contained in this article is by way of information only. Neither the authors or Jerrard & Stuk can accept any responsibility for actions taken on the basis of this information. In order to obtain meaningful advice on particular circumstances, detailed instructions should be provided to an appropriate taxation professional.
[1] See FC of T v Whiting [1943] HCA 45; (1943) 68 CLR 199; Taylor v FC of T 70 ATC 4026.
[2] 2 89 ATC 4377 ("Davis")
[3] 98 ATC 4681 ("Zeta Force").
[4] 97 ATC 5098 ("Richardson").
[5] For a recent example in the courts, see FC of T v Australia and New Zealand Savings Bank Limited 98 ATC 4850.
[6] 71 ATC 156. Note that both Zeta Force and Davis confirmed that the "share of the income of the trust estate" refers to the share calculated by reference to distributable income and not ITAA income.
[7] Ibid 163-164. This literal approach was again followed by the AAT in Case R32, 84 ATC 298.
[8] Davis 89 ATC 4377, 4403-4404.
[9] Ibid 4404.
[10] Richardson 97 ATC 5098, 5113.
[11] Ibid 5111.
[12] Ibid 5113.
[13] This figure was different to that calculated by the Commissioner, but was agreed upon by the Tribunal and Sundberg J.
[14] According to the judgment (although not expressly stated), the real increase to the applicant's assessable income was $136,879.
[15] Zeta Force 98 ATC 4681, 4686.
[16] Ibid 4686-4687.
[18] [1992] FCA 463; (1992) 24 ATR 58.
[20] 98 ATC 4241
[21] Ibid 4257.
[22] Zeta Force 98 ATC 4681, 4692.
[23] Ibid 4693.
[24] Sir D Dawson, "The Role of the High Court in Interpreting Tax Legislation", Taxation Institute of Australia, 37th State Convention, 10-12 September 1998.
[25] Ibid 5-6.
[26] Although Sundberg J interpreted Davis as having a ratio on this point.
[27] See Vegners v Commissioner of Taxation 91 ATC 4213.
[28] However, this solution may not always be practical as some income amounts may be non-assessable.
[29] Income Taxation Ruling IT 2651, para 10.
[30] 90 ATC 287.
[31] Ibid 294-295.
[32] (1970) 12 DLR (3d) 227, 230.
[33] Ibid 229.
[34] (1977) 78 DLR (3d) 435, 438.
[36] Ibid 310.
[37] [1913] UKLawRpCh 8; (1913) 1 Ch 272.
[38] Ibid 276-277.
[40] Ibid 579.
[41] Ibid 589.
[42] See Re Hodge, Hodge v Griffiths [1940] Ch 260; Re Wimperis, Wicker v Wilson [1914] UKLawRpCh 3; [1914] 1 Ch 502.
[43] One must also consider the issue of what constitutes payment to the beneficiary, and whether such payment is sufficient to be regarded as an acceptance of the gift.
[44] [1998] SASC 6896 ("Yvonne Joyce Probert").
[45] Ibid para 30.
[46] Ibid para 37.
[47] Ibid paras 37-38.
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