Case U111

Members:
Davies J

Tribunal:
Administrative Appeals Tribunal

Decision date: 12 May 1987.

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Davies J. (President)

These two reviews consider assessments of the Deputy Commissioner of Taxation, Melbourne, which treated two sums of interest of $2,822 each as income received by a trustee, S Pty. Limited, under separate trusts, one for a minor, DF, and one for a minor, CF. The F family discretionary trust was established by deed of trust dated 10 September 1972. Beneficiaries of the trust included F, his wife and their children DF and CF. The trustee was S Pty. Limited. Over the years of the operation of the trust, the trustee derived trust income and distributed that income annually. The net income returned for the year ended 30 June 1979, as defined in sec. 95 of the Income Tax Assessment Act 1936 (Cth) ("the Assessment Act"), was $17,330, calculated after taking into account as a deduction interest of $9,047 paid on moneys borrowed by the F family trust. This deduction included the two sums of $2,822 which are the subject of the reviews.

The moneys on which the subject interest was paid were the accumulated balances arising from the annual distributions made by the F family trust in respect of each of the two children. A resolution of the directors of S Pty. Limited on 29 June 1979 read "Resolved, pursuant to Clause 7(b) of the Trust Deed that interest at 16% p.a. be paid on the loan balances of [CF] and [DF]". On the same day, the directors of S Pty. Limited exercised their discretionary power to distribute the income of the F family trust for the year ended 30 June 1979. They resolved that it be set aside as to $1,040 for DF, as to $1,040 for CF, as to $4,500 for F and as to the balance for his wife.

The income of the F family trust was assessed as it was returned. The deduction sought for the interest paid was allowed.

As the children, DF and CF, were minors, the sum of $1,040 income set aside for each was income in respect of which, under sec. 98 and 101 of the Assessment Act, the trustee would have been liable to be assessed to tax. See
Re Vestey's Settlement, Lloyds Bank, Ltd. v. O'Meara & Others (1950) 2 All E.R. 891;
Commr. of I.R. (N.Z.) v. Ward 69 ATC 6050 and Case E47,
73 ATC 385; contra
Montgomerie v. Commr of Inland Revenue (N.Z.) (1965) 14 A.T.D. 102. However, if the sum was the only such income, no tax would have been payable by reason of sec. 6F(1) of the Income Tax (Rates) Act 1976 (Cth) ("the Rates Act"), set out below. The issue in these reviews thus arises from the two sums of interest of $2,822 each. It is alleged on behalf of the trustee that these sums were not assessable income of trust estates and certainly not assessable income of trust estates separate from the F family trust so as to bring into operation the provisions of sec. 7A(1) of the Rates Act.

Sections 6F(1) and 7A(1) and (2) of the Rates Act provided as follows:

"6F(1) Subject to section 7A, where -

• (a) the trustee of a trust estate (other than the estate of a deceased person) is liable to be assessed under section 98 of the Assessment Act in respect of a share of the net income of the trust estate to which a beneficiary under the age of 16 years on the last day of the year of income is presently entitled; and
• (b) the amount of that share of the net income does not exceed $1,040,

no tax is payable under sub-section 6E(4) in respect of that share of the net income.

...

7A(1) Subject to sub-section (2) of this section,... sub-section 6F(1) or (2) does not apply in relation to a trustee of a trust estate who is liable to be assessed and to pay tax in pursuance of section 98 of the Assessment Act in respect of the share of the net income to which a beneficiary under the age of 16 years on the last day of the year of income is presently entitled if -

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• (a) the beneficiary was presently entitled to a share of the net income of the year of income of one or more other trust estates of the kind referred to in paragraph (a) of that sub-section; and
• (b) the sum of the amounts of the shares of the beneficiary of the net incomes of the first-mentioned trust estate and that other trust estate or those other trust estates exceeds $1,040.

(2) Sub-section (1) does not apply in relation to a share of the net income of a trust estate to which a beneficiary under the age of 16 years on the last day of the year of income is presently entitled if the Commissioner is of the opinion that it would be unreasonable that that sub-section should apply in relation to that share of the net income."

The notices of objection read, inter alia:

"S... Pty. Ltd., as Trustee of the [F] Family Trust hereby objects against assessments issued to it, numbered... and... dated 19th December 1980, as Trustee for [DF] and [CF], and claims that the interest credited to the minor beneficiaries cannot in any way be classed as `income of a separate trust fund' and therefore cannot be assessed as such.

The reasons are as follows:

• 1. There is no separate trust fund.
• 2. The amount of interest in question was paid as a normal commercial transaction on funds loaned to the trustee by [DF] and [CF], and is only a commercial debtor/creditor transaction.
• 3. The amount of interest was paid following normal banking, and building society practice by being added to the original amount loaned, and was re-invested by [DF] and [CF] with the trustee, and is now a liability of the trust.
• 4. Any funds loaned to the trust are not held by the trustee in trust for any person, but are a normal commercial liability to be met by the trustee on demand. There can be no question that any loans or additions thereto create a separate Trust Fund.

Alternatively, and completely without prejudice to the above, the Commissioner should exercise his discretion and allow the benefit of the zero-rate step in the tax scale."

The flaw in this objection is that S Pty. Limited was at all times a trustee under an express trust, the deed dated 10 September 1972, a provision of which read:

"3.(i) THE Trustee shall in each accounting period until the Vesting Day pay apply or set aside the whole or such part (if any) as it shall think fit of the net income of the Trust Fund of that accounting period to or for the benefit of or for all or such one or more exclusive of the others or other of the income Beneficiaries living from time to time in such proportions and in such manner as the Trustee in its absolute discretion and without being bound to assign any reason therefor shall think fit; any amounts set aside for any Income Beneficiary as aforesaid shall not form part of the Trust Fund as defined in Clause 1(3) hereof but shall upon setting aside be thenceforth held by the Trustee as a separate trust fund on trust for such beneficiary absolutely with power to the Trustee pending payment over thereof to such Beneficiary to invest or apply to deal with such fund or any resulting income therefrom or any part thereof in the manner provided for in Clause 6(d) hereof."

(the underlining is mine).

It was therefore a provision of the trust deed that the income of each year could be distributed among the beneficiaries. The net income of the year ended 30 June 1979, $17,330, was so distributed, $2,822 thereof to DF and $2,822 to CF. As the distribution was effected by way of resolution and book entry, the trustee retained the income in its hands. From the time of distribution, in accordance with cl. 3(i), each sum of $2,822 ceased to form part of the F family trust fund and was held separately on trust for each minor beneficiary. What occurred in this year occurred likewise in all previous years. The amounts distributed were held by the trustee for the infant beneficiaries and were accumulated subject to any application thereof that may have been made from time to time for the benefit of the infant beneficiaries.

Mr F, an accountant, who appeared for the trustee, submitted that when the trustee set aside moneys in its books for DF and CF, it

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held those moneys as creditor not as trustee. He submitted that the relationship of S Pty. Limited with DF and CF was that which would have existed had DF and CF invested moneys with a banker. He submitted that the banker would have been a creditor and that S Pty. Limited was likewise a creditor.

But plainly this is not so. S Pty. Limited was at all times a trustee and, as trustee, held moneys on trust for DF and CF. As Underhill's Law relating to Trusts and Trustees, 13th ed. (1979), p. 1 states, "A trust is an equitable obligation, binding a person... to deal with property over which he has control..., for the benefit of persons...", or, as Isaacs J. said in
Glenn v. Federal Commissioner of Land Tax (1915) 20 C.L.R. 490 at p. 503,

"... `Trusts,' says Lindley L.J. in In
re Williams (1897) 2 Ch. 12 at p. 18, are `equitable obligations to deal with property in a particular way'. Trustees have no equitable interest; that belongs to the person or persons for whom the benefit is intended..."

There is no doubt that S. Pty. Limited held moneys or assets, representing the two sums of $2,822 interest, as trustee. It held these moneys or assets as trustee under an express trust. The nature of the moneys or assets was recorded in trust books of account and the interests of the respective beneficiaries therein were also recorded. So also were all other transactions that ought to have been recorded in the trust's accounts. One such transaction was the payment and receipt of the two sums of interest of $2,822, recorded presumably first in the journal and subsequently in the appropriate ledger accounts. When S Pty. Limited recorded in the ledger account for each of DF and CF (both entitled, a loan account) that it had received $2,822 by way of interest, it was recording that it had received those sums as trustee for its beneficiary and that it held the accumulated balance recorded on trust for the beneficiary.

The accounts in which these matters were recorded were themselves trust documents. As Salmon L.J. said In
Re Londonderry's Settlement (1964) 3 All E.R. 855 at p. 863:

"... the beneficiaries have a proprietary interest in the documents and, accordingly, are entitled to see them..."

See also
Hawkesley v. May (1956) 1 Q.B. 304 at p. 315.

Accordingly, grounds 2, 3 and 4 of the notices of objection must fail. I should add that the view put by Mr F accorded with that expressed in the interesting article in Vol. XIII of Taxation in Australia (July 1978), p. 37, especially at p. 40. However, for the reasons I have mentioned, I do not agree with it.

I turn now to ground 1 of the notices of objection. When S Pty. Limited received on behalf of DF and CF the two sums of $2,822, it did so as trustee not of the F family trust but as trustee of separate trusts. The deed of trust, dated 10 September 1972, required the sums distributed to the minor beneficiaries from the income of the F family trust to be held by the trustee on separate trusts. And that is precisely how the sums were dealt with in the trustee's books of account. Once income was distributed from the F family trust, it was added to the moneys held by the trustee not as part of the general funds of the F family trust, which was a discretionary trust, but as part of the moneys held solely and absolutely for the beneficiary to whom the funds were credited. Those separate sums were then treated as lent by S Pty. Limited as trustee for the separate trusts to itself as trustee of the F family trust. Because of the loans from the separate trusts to the F family trust, the trustee of the F family trust came under a duty to pay interest on the borrowed moneys. The interest credited was claimed and allowed as a deduction to the F family trust.

It would be quite inconsistent with this manner of dealing with the moneys which S Pty. Limited held on trust, for it to be alleged that all the moneys were held not in separate estates but as part of the one trust estate. Had they all been held as part of the one trust estate, the trustee of the F family trust would not have been entitled to deduct the two sums of $2,822 as interest paid on the moneys borrowed. Had all the capital remained in the one trust estate no deduction would have been allowable, for the capital on which the interest was paid would not have been borrowed.

The terms of the trust deed and the manner in which the funds were dealt with in the accounts of S Pty. Limited accords with the structure established by Div. 6 of the Assessment Act. The two sums of $2,822 were interest which

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was received by a trustee for beneficiaries. Of what trust estate or estates for the purposes of Div. 6 were those sums income? It is clear that they were income of the trust estates held by S Pty. Limited absolutely for each of the two minor beneficiaries. The sums which, as I have said, were assessable income in the recipients' hands, were certainly not income of the F family trust. They were not income of that trust estate, they were outgoings of that trust estate. They were income of S Pty. Limited as trustee for DF and CF. For the purpose of Div. 6 of the Assessment Act and of sec. 6F(1) and 7A(1) of the Rates Act, a trust estate is the income earning entity of which assessable income and allowable deductions can be assessed as if the trustee thereof were a taxpayer: See sec. 95 of the Assessment Act. As Menzies J. said in
Union Fidelity Trustee Co. v. F.C. of T. 69 ATC 4084 at p. 4091; (1969) 119 C.L.R. 177 at p. 190, "... the Division is essentially concerned with estates having a particular source of income...". In the present case, the accumulated funds held for each of the infant beneficiaries were income earning trust estates which derived the interest credited thereon.

In these reviews, it was not argued and, indeed, it was not within the ambit of the notices of objection to argue, that the course taken by the trustee, S Pty. Limited, with the funds held for the infant beneficiaries, was not a course authorised by the trust instrument for it involved an unauthorised mixing of the funds of more than one trust estate. Clause 6(d) provided:

"6. THE Trustee may at its absolute discretion notwithstanding anything to the contrary herein contained or otherwise provided: -

• ...
  • (d) while any Beneficiary is under any legal disability the Trustee may on behalf of such Beneficiary invest any income which it may resolve to set aside for or pay to such infant pursuant to Clause 3(i) hereof by investing the same and the resulting income thereof in any of the investments hereby authorised...."

Clause 7(b) authorised the trustee "... to advance and lend moneys to... any persons...". There may be a question as to whether these provisions authorised the trustee to lend the separate trust moneys of the infant beneficiaries to itself as trustee of the F family trust. I make no comment upon that. Whether or not it did, the moneys which S Pty. Limited held for each of the infant beneficiaries was money of a separate trust estate and the tracing of the moneys would have provided no difficulty, for the accounts recorded the extent of the moneys and the manner of dealing with them.

It follows that each of the infant beneficiaries, DF and CF, was presently entitled to the net income for the year ended 30 June 1979 of two trust estates, namely, the F family trust and the accumulated funds held and invested by S Pty. Limited as trustee for each. Ground 1 of the notices of objection therefore fails.

Accordingly, unless the discretion conferred by sec. 7A(2) is favourably exercised, the provisions of sec. 7A(1) will apply and will override the provisions of sec. 6F(1). In his address, Mr F did not put forward any reason why the Commissioner or the Tribunal ought to be of the opinion that it would be unreasonable that sec. 7A(1) should apply in relation to either income of $1,040 or $2,822; however, I have myself considered the issue and have had regard to the matters set out in sec. 7A(3). The manner in which the affairs of the trusts were managed, that is to say, the obtaining of a deduction totalling $5,644 in respect of the two sums of interest for the F family trust and a distribution to each of DF and CF of only $1,040, the total allowed by sec. 6F(1), appears to have been selected with a view to obtaining a favourable tax position for the F family. As to this I offer no criticism, but it does not seem to be unreasonable that the normal taxation rates should apply to a situation so brought about. Furthermore, in a case such as this, it would not accord with the policy of sec. 6F(1), which limits the non-taxable trust income to a total of $1,040, and of sec. 7A, which is designed to limit avoidance of tax through trust splitting, not to apply the provisions of sec. 7A(1).

For these reasons, the Deputy Commissioner was correct in his assessments.

In the course of his submissions to the Tribunal, Dr R.A. Sundberg Q.C., senior counsel for the respondent, referred to principles of acknowledgement, particularly to

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the decision in
Shamia v. Joory (1958) 1 Q.B. 448, which Dr Sundberg submitted to have been wrongly decided. I hope Dr Sundberg will pardon me for concluding that it is not necessary to discuss the interesting issues which he raised.

For these reasons, the decisions on the objections will be affirmed.