The widespread use of trusts in Australia is well documented and listening to talkback radio I hear the common view that trusts are used to avoid tax. The tax profession has long recognised the advantages of trusts from a tax planning and asset protection perspective but what is not readily understood is the complexity of the trust relationship. Tax advisers think in terms of entities. A trust, like a company, is an entity for tax purposes, but unlike a company, a trust does not have legal personality. A trust is notoriously di fficult to define, and with the danger of oversimplification, it is a relationship between
a trustee holding trust property for the benefit of beneficiaries. It is this fiduciary relationship that is a source of much litigation particularly where distributions are made with the only consideration being the minimisation of tax.
There are many cases that document how a simple distribution of income can give rise to unintended tax consequences. A recent decision in the AAT – Alderton and Commissioner of Taxation (Taxation) [2015] AATA 807 – highlights this issue.
Facts of the case
Lisa Alderton (‘Taxpayer’) commenced a relationship with Mr Trapperton, a medical professional in 2010. At that time the Taxpayer was about 18 years of age and Mr Trapperton was 42-43 years of age. The relationship lasted about 10 years: from 2000 to 2010.
The Taxpayer was entirely dependent on Mr Trapperton throughout the relationship. Initially Mr Trapperton provided the Taxpayer with money but from 2006 onwards the Vo Vo Trust was established with Mr Trapperton and the Taxpayer named as primary beneficiaries. The Taxpayer accessed trust funds via a bank debit card.
The 2009 trust tax return was lodged in May 2010, after the relationship between the taxpayer and Mr Trapperton had ended, showing a net income of $79,880. All the trust income was distributed to the Taxpayer. It appears that the Taxpayer was not aware of the distribution of income and the present entitlement to trust income, and in June 2014 the commissioner made a default assessment of her taxable income for the 2009 income year. The distribution from the Vo Vo Trust was the major component of the assessment (without it the Taxpayer would have been well below the taxable threshold). The commissioner also raised an assessment of administrative penalty (75 per cent of the assessed tax liability) for the Taxpayer’s failure to lodge the 2009 tax return.
In November 2014 the Taxpayer’s solicitors wrote to Mr Trapperton (the trustee of the Vo Vo Trust) disputing the lawfulness of the distribution and disclaimed any past or future interests in the Vo Vo Trust.
The Taxpayer’s argument and the decision
The Taxpayer said that she was aware of the creation of the Vo Vo Trust but she knew nothing of its affairs. As far as the Taxpayer was concerned, the purpose of the Vo Vo Trust was to save Mr Trapperton tax. The Taxpayer’s only involvement was using a debit card in the trust’s name to access the funds provided to her by Mr Trapperton. Essentially the argument may have been put as follows: ‘I was not aware of the distribution, so I should not have to pay tax on it’.
On the authority of Vegners v Commissioner of Taxation (1991) 21 ATR 1347 and Federal Commissioner of Taxation v Ramsden (2005) 58 ATR 485, it was held the entitlement to the income of the Vo Vo Trust was valid notwithstanding the fact that the Taxpayer did not know of the distribution.
The entitlement to income is operative for the purposes of the taxing provisions in section 97(1) of the = ITAA 1936 unless there is a valid disclaimer of the distribution.
The Taxpayer was a beneficiary of the Vo Vo Trust, the trust income was distributed in accordance with the terms of the deed and the Taxpayer did receive physical cash distributions from the Vo Vo Trust.
The disclaimer made in 2014 was not effective because there was on absolute rejection of the gift or distribution. The Taxpayer had already accepted the benefit of the distribution by using and benefiting from the funds paid to her by the Vo Vo Trust, and such acceptance could not be disclaimed.
Lessons from the case
The following practical lessons arise from this case:
- For a beneficiary to avoid taxation liability from a trust distribution, particularly where the funds remain unpaid, the renunciation of the distribution or gift should be made immediately.
- If a beneficiary does not wish to benefit from a trust, the beneficiary should execute a deed of renunciation of interest in the trust and give the trustee a copy. This should, in most cases, deal with future distributions of income and capital and is an important issue to consider in relationship breakdowns.
- Default assessments usually carry a heavy penalty. Notifying beneficiaries of their entitlements in a way that allows the beneficiary to meet his/her tax obligations mitigates that risk.
- Because of the potential difference between trust income and taxable income, the tax liability for a beneficiary arising from the taxable income may be greater than the trust distribution.
- In order to avoid disputes between trustees and beneficiaries communication is important. Beneficiaries should be notified of their entitlements. Even in family situations transparency is important in avoiding future problems.
George Kolliou is the principal of KolliouTax.
