Following Bamford and the cases leading to it, the announcement of the re-write of Division 6 and the interim streaming rules, the ATO has issued Draft TR 2102/D1 dealing with the meaning of “income of a trust”.
The draft ruling appears to be a yet another attempt by the ATO to restrict the meaning of income of a trust, especially in the SME segment of the taxpayer population. Despite High Court authority that the wording “income of a trust estate” in Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936) is defined by the law of trusts, including the terms of the trust deed (Bamford), the ATO suggests that the definition is something else. This is done not by giving a new definition but rather placing a boundary or fence around the trust deed definition.
The ruling suggests that the boundary is created by inference from the statutory context (ie the definition is not found in the words of the statute). The three boundaries are as follows:
- income is measured in respect of distinct years of income
- income is “a product of the trust estate”
- income is an amount in respect of which a beneficiary may be made presently entitled.
What is contentious about this ruling is that it suggests that what was capital at the beginning of a year cannot be income in that year. The ATO is in effect saying that re-characterisation clauses that permit trustees to treat corpus as income are ineffective. Further, the income cannot be more than the amount available for distribution to beneficiaries or accumulation by the trustee. Income is restricted to amounts that can be paid to beneficiaries or treated as accretions to capital.
The problem is obvious. Many trust deeds have clauses that equate income to taxable income, which means the trust income may include ‘fictional amounts’ such as franking credits.
The draft ruling does not deal with the calculation of taxable income; rather, it impacts on the taxation liability by impacting on the allocation of trust income. If, for example, an amount (eg a deemed capital gain) cannot be included in income resulting in a trust loss, the tax liability on any taxable income would fall on the trustee because there is no distributable trust income.
The draft ruling appears to be a yet another attempt by the ATO to restrict the meaning of income of a trust, especially in the SME segment of the taxpayer population.
More than a reasonably arguable position is required to escape penalties
In FCT v Traviati [2012] FCA 546 the Federal Court held that the reasonably arguable position test is an objective test that is independent of the reasonable care test in the context of imposition of penalties. Satisfying the reasonably arguable position test does not mean that the reasonable care test should be taken as being satisfied.
The taxpayer claimed deductions for deposits paid and outstanding payments due on investments in retirement village investment schemes. The Commissioner disallowed the amounts representing the unpaid contractual commitments on the investments and imposed a penalty of 25 per cent for failure to take reasonable care, which was remitted to five per cent because of voluntary disclosure.
The AAT reduced the penalty to nil as the taxpayer has a reasonably arguable position under the former 226K of the ITAA 1936. This was on the basis that a single judge in the Federal Court in a similar retirement village scheme case held that a deduction for unpaid contractual commitments was allowable (that decision was subsequently overturned by the Full Federal Court). The AAT held that a reasonably arguable position is a higher standard than the reasonable care test under the former 226G of the ITAA 1936 and if a taxpayer satisfied the reasonably arguable position test they should be taken to satisfy the reasonable care test. In any case the AAT held the Commissioner should have remitted the penalty to nil under the former s 227(3) of the ITAA 1936.
The Federal Court held that the reasonably arguable position test (purely objective test) and the reasonable care test (the subjective circumstances of the taxpayer judged against an objective standard) are independent tests. To fully escape penalty both tests must be satisfied. Having a reasonably arguable position does not mean the reasonable care test can be ignored. In exercising the Commissioner’s discretion to remit penalty the personal circumstances of the taxpayer must be considered. The imposition of GIC alone is not a relevant factor to be taken into account but may be considered along with other circumstances of the taxpayer.
