Ruling Compendium

The Draft TD would be better served if it was (simply) described as: Income tax: when will a gain or loss made by the trustee of a trust be on capital or revenue account?

No change proposed.

There should be 2 different determinations dealing with the 2 issues:

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can a trustee only make a gain or loss on capital account?

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what features may be relevant in deciding whether or not a trustee makes a gain or loss on revenue account?

As the preservation of the real value of the capital/corpus of a trust is a key factor for most (if not all) trustees, we think that at the very least a presumption should arise that the actions of a trustee which give rise to income are caused by the trustee discharging their fiduciary obligations to maintain the capital/corpus - i.e. that prima facie any gain made by a trustee will be on capital account.

Although footnote 2 suggests that the TD is not dealing with trading stock, examples 1 and 3 could well be circumstances where the investments are trading stock. That is, acquired and held for the purpose of sale in the ordinary course of business.

Many of the factors are either equivocal or indeed support the proposition that the investments are on capital account.

If an investment is in a security which "displays above-average earnings growth potential", the probability is that that investment will generate increased dividends in due course. This is consistent with a long term investment.

Another factor is that the trustee will downgrade its view of the growth prospects of some securities as a consequence of changes in financial markets, the wider economy or earnings forecasts. This is consistent with a trustee seeking to preserve capital, not necessarily a trustee seeking to invest for profit.

A further factor is that on average the turnover (which, in the writer's opinion, is a concept which needs to be defined), whilst varying from year to year, exceeds 10%. One needs to consider why the variations have occurred and not simply focus upon a generic turnover percentage.

Trust deeds typically provide the trustee with broad powers to vary investments and to distribute any part of the trust fund at any time: it would be rare to find a trust deed that does not provide for the trustee to have these powers.

Recognition of gains on securities at fair value is generally consistent with the adoption of appropriate accounting standards. Indeed, some unit trusts, particularly where they are managed investments, are required to do so.

With respect to the ATO, there is nothing "on balance" about the situation in Example 2 - the gains and losses made by the trust are clearly on capital account. In referring to the annual portfolio turnover of the trust being about 10% the ATO seems to be attributing a general significance to the decision in the London Australia case which we believe is not warranted.

In the years in question the beneficiary had substantial medical expenses. The trustee may have sought to meet those expenses by buying and selling shares at a profit, in a similar way to how, for example, the income needs of the income beneficiary in Orr v. Wendt & Ors [2005] WASCA 199 were met out of a strategy of buying and selling shares at a profit.

All of the relevant circumstances need to be considered when characterising any gain or loss.

We are concerned by paragraph 28 - for the ATO to suggest that there is any question about the gains or losses in this situation being anything other than on capital account is a worrying development for the middle market. In our view:

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the nature of the trust (i.e. to assist the family and to provide for the retirement of the husband and wife); and

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the trustee's duties to, at the very least, preserve the real value of the capital/corpus of the trust, both clearly point towards a capital account characterisation.

There are many trusts in the middle market that would operate in the same/a similar manner to the trust in this case. In our view ATO staff need to be informed in unequivocal language that they should accept that the gains and losses produced by these trusts are on capital account.

One purpose in establishing the trust in this example was to provide for the needs of the family. This might be best achieved through the buying and selling of investments at a profit. The nature and extent of the trustee's trading activities would need to be considered when characterising any gain or loss.

This paragraph should be removed from the Draft TD - just about every modern trust deed (and a fair number of older ones as well) will authorise a trustee to engage in a business. That is, to say that the mere fact that a trustee is authorised to do something supports a conclusion that the profits or losses made by the trust are on revenue account is akin to arguing that any gain/loss made by an individual will be on revenue account because an individual is allowed to be a share trader - the issue must always be whether the individual/trustee is actually trading on revenue account.

Paragraph amended to focus on a situation where having regard to the purposes of the trust it is clear that the trust exists with a view to generating profits from which distributions to investors can be made.

In other words, what is a "small family context" - is this measured by the number of family members, the $ value of the investment portfolio or a combination of the above - and what exactly is 'a large commercially managed share portfolio'?

There are a number of families in the middle market whose wealth is such that their investment portfolios either demand or justify being commercially managed. ATO staff should be encouraged not to automatically assume that just because a trust fund is commercially managed it is producing gains/losses on revenue account

The parts of TR 2005/23 that the ATO believes are relevant to the consideration of the subject matter of this Draft TD should actually be reproduced in the Draft TD - readers should not be forced to speculate as to what are the 'related issues' mentioned in paragraph 57 and nor should they have to 'second guess' as to whether a trust is established with 'similar objectives' to a listed investment company as per paragraph 58.