Case X1

Members:
PM Roach SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 6 December 1989.

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P.M. Roach (Senior Member)

In July 1974 an elderly man set his hand to his last will and testament. It was a complicated and lengthy document. It was prepared in a style used over the centuries by many who have sought to make provision for their families extending into future generations and to do so with minimum advantage to the Revenue. The present references arise out of unusual provisions the testator made for his successors. He provided for the establishment of trusts which would be authorised to carry on income-earning activities throughout a perpetuity period defined by a ``Royal lives'' clause. Provision was made for the establishment in all of 12 trusts of which five were in common terms. The applicant, at at least one point in time, was trustee of all five trusts in the latter class. The present applications are brought by the applicant as trustee of one of those five trusts: ``the No. 5 Trust''. I find that the No. 5 Trust was intended to operate for the benefit of a named daughter of the testator (``Paula''); her issue and dependants; and her husband (``Peter'') - one of two members of ``the Firm'' (yet to be mentioned). The trust was to be established by a bequest of $1.

2. Following the death of the testator in September 1974, the Supreme Court of New South Wales admitted his will to probate and confirmed the appointment of his widow as his executrix. That was in August 1975. She became responsible for administration of an estate with a net worth for probate purposes of less than $80,000. In discharge of her duties as executrix, she transferred $1 to the trustee nominated by the will. It was a proprietary limited company (``UNO''). I find that UNO accepted the $1 and the responsibilities of trusteeship which attended that. Those responsibilities had been defined by a schedule to the will. Next day, by deed, another proprietary limited company (``DUO'') became trustee of No. 5 Trust in succession to UNO. DUO is the present applicant.

3. Immediately following its appointment, DUO borrowed $10 from UNO on unidentified terms and then used $1 to purchase one of 10 units in a trust (``FIRM-TRUST'') which in turn held all the units in a trading trust (``SERVE-TRUST'') which provided unidentified services to a firm of solicitors (``the Firm''). Four of the remaining nine units in FIRM-TRUST were held by DUO as trustee of the other four trusts established under the will upon the same terms as Trust No. 5. The other five units were held by interests seemingly unrelated to the family of the deceased. I find that those interests were associated with the second of two principals in the Firm. I am satisfied that subsequently DUO, as trustee of the fifth trust, acquired from itself as trustee of the other four trusts their interests in the units of FIRM-TRUST.

4. In the years of income ended 30 June 1982 and 1983 DUO, as a trustee holding five units in FIRM-TRUST, derived assessable income. The result was that it had available for distribution a distributable income of $52,781 and $31,871 in each year. Pursuant to its wide discretionary powers as to the distribution of income, it effected a distribution among members of Paula's family as follows:

      Year ended 30 June                 1982              1983
                                           $                 $
      Peter                             39,741            21,871
      First child                       12,000
      Second child                                         5,000
      Third child                        1,040             5,000
                                        ------            ------
                                        52,781            31,871
                                        ------            ------
      

5. These references arise from the circumstance that the Commissioner proceeded to issue assessments against the trustee in relation to the first child for the year of income ended 30 June 1982 in the sum of $12,000 and against the other two children in the sum of

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$5,000 each in the year of income ended 30 June 1983. As to that, there is no dispute. The difference which has prompted the applicant to object to the assessments raised against it in respect of the children and, upon its objections being disallowed by the Commissioner, to request reference for independent review, lies in the circumstance that, as each child was under the age of 18 years, the Commissioner assessed the entirety of the taxable income to tax at the rate of 46 cents in the dollar rather than at the graduated rates of tax commonly applicable to the assessment of resident individuals. The difference between the claims of the Commissioner and the acknowledged liability to tax is as follows:

Year ended 30 June       1982          1983              1983
Beneficiary          First child    Second child     Third child     Total
                          $             $                 $            $
Tax assessed            5,520         2,300             2,300       10,120
Tax acknowledged        2,498           165               165        2,827
                        -----         -----             -----       ------
Difference              3,023         2,135             2,135        7,293
                        -----         -----             -----       ------
      

(Figures have been expressed to the nearest $1.)

6. One further set of findings needs to be recorded before proceeding to the substance of the issues. The entities referred to as UNO, DUO and FIRM-TRUST were legal fictions. They were the puppets of natural persons. I am satisfied UNO and DUO were controlled by the parents of the children; that FIRM-TRUST was effectively controlled by the two partners in the Firm; that the partners in the Firm were content to so arrange the affairs of the Firm and to have it enter into dealings with SERVE-TRUST so as to diminish the profitability of the Firm and thereby the amount of their respective shares in the profits of the Firm but only to the extent to which the advantages so forgone by the partners as partners would pass through FIRM-TRUST in equal shares to entities which served respectively the family interests of each partner. The significance of what the testator did was that he established a vehicle which, by way of discretionary trust, would enable the parents to determine upon the ultimate distribution of the benefits they controlled from FIRM-TRUST and which, should the submissions of the applicant in these references be correct, would enable income to pass to infant children of the parents on terms leaving them only liable to income tax at the graduated rate of tax commonly applicable to the assessment of resident individuals rather than the special flat rate of tax of 46 cents for each dollar of taxable income claimed by the Commissioner. That was a legitimate aim. The question for determination is whether what was done was effective in achieving it.

7. To put it another way, the problem is not to decide whether the income under consideration was derived by the trustee rather than by another. The question is not whether Pt IVA of the Act (or its predecessor, sec. 260 of the Act) operates to attribute to that other person income derived by the trustee. The instant question is whether the income which was derived by the trustee was derived in such circumstances as to make the trustee liable to assessment at the penal rates of tax applicable to income liable to be assessed under the provisions of Div. 6AA - Income of Certain Children - of the Income Tax Assessment Act (``the Act'').

8. Division 6AA of the Act was enacted with effect for the year of income commencing 1 July 1979 (sec. 102AB). It applies to ``prescribed persons'' being persons less than 18 years of age on the last day of the year of income, if they are not excepted persons (sec. 102AC). It is not disputed that the infants in question were ``prescribed persons''. Section 102AE provides:

``(1) For the purposes of this Division, the eligible assessable income of a year of income of a person is so much of the assessable income of the person of the year

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of income as is not excepted assessable income''

and sec. 102AG provides:

``(1) Where a beneficiary of a trust estate is a prescribed person in relation to a year of income, this Division applies to so much of the share of the beneficiary of the net income of the trust estate of the year of income as, in the opinion of the Commissioner, is attributable to assessable income of the trust estate that is not, in relation to that beneficiary, excepted trust income.''

9. The applicant contends that in each instance the income is ``excepted trust income'' within the meaning of sec. 102AG(2) which provides that income shall be:

``excepted trust income in relation to a beneficiary of the trust estate to the extent to which the amount -

• (a) is assessable income of a trust estate that resulted from -
  • (i) a will...; or
  • ...
• (d) is derived by the trustee of the trust estate from the investment of any property -
  • (i) that developed for the benefit of the beneficiary from the estate of a deceased person;
  • (ii)...; or
  • ...
• (e) is derived by the trustee of the trust estate from the investment of any property that, in the opinion of the Commissioner, represents accumulations of -
  • (i) assessable income derived by the trustee... that... is excepted trust income;
  • (ii) assessable income derived by the trustee during a year of income in relation to which this Division does not apply, being assessable income that would, in the opinion of the Commissioner, have been excepted trust income in relation to the beneficiary if this Division were applicable in relation to the year of income during which the assessable income was derived; or...''

10. The evidence does not persuade me that the latter provision is applicable. But I am well satisfied that the provisions of sec. 102AG(2)(a) are satisfied. That provision only requires that the trust estate should result from the will and as to that I am satisfied. It does not require that the assessable income itself be sourced in the will or the property of the deceased.

11. However, notwithstanding that finding the Commissioner contends that subsec. (3) and (4) of sec. 102AG operate to deny the status of ``excepted trust income'' to the income in question. Those subsections, and subsec. (5) which directly qualifies subsec. (4), provide as follows:

``(3) Subject to sub-section (4), where assessable income is derived by a trustee, directly or indirectly, under or as a result of an agreement (whether entered into before or after the commencement of this sub-section) any 2 or more of the parties to which were not dealing with each other at arm's length in relation to the agreement and the amount of the assessable income so derived is greater than the amount (in this sub-section referred to as the `arm's length amount') of the assessable income that, in the opinion of the Commissioner, would have been derived by the trustee, directly or indirectly, under or as a result of that agreement if the parties to the agreement had dealt with each other at arm's length in relation to the agreement, sub-section (2) does not apply in relation to that assessable income to the extent to which the amount of the assessable income exceeds the arm's length amount.

(4) Sub-section (2) does not apply in relation to assessable income derived by a trustee directly or indirectly under or as a result of an agreement that was entered into or carried out by any person (whether before or after the commencement of this sub-section) for the purpose, or for purposes that included the purpose, of securing that that assessable income would be excepted trust income.

(5) In determining whether sub-section (4) applies in relation to an agreement, no

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regard shall be had to a purpose that is a merely incidental purpose.''

12. I commence by a consideration of sec. 102AG(3) of the Act. In my view it is clear that assessable income was derived by the trustee; that it was derived under or as a result of an agreement; that it is immaterial whether the agreement was entered into before or after the commencement of the subsection; and that the parties to the agreement were not dealing with each other at arm's length (cf.
Australian Trade Commission v. W.A. Meat Exports Pty. Ltd. (1987) 75 A.L.R. 287); and that the Commissioner was correctly of the opinion that the income derived pursuant to that agreement was greater than it would have been if the parties had dealt with each other at arm's length. I reach the latter conclusion upon recognising that, although the testator had established the trust and had conferred upon the trustee wide-ranging powers such as could make the trust a convenient income-earning vehicle for the grandchildren, that alone was not enough to generate any income, let alone a substantial income. Whether any substantial income would ever be generated depended not only upon the willingness of the trustee under the direction of the parents to embark upon agreements such as those generating the income in this case, but also more particularly, upon finding third parties who would be willing to enter into agreements with the trustee which would confer substantial benefits upon the trustee and its beneficiaries without such a return to the other party as would be expected upon an arm's length transaction. That being so, in my view, the cause of the applicant must fail.

13. It remains to mention subsec. (4). I find the subsection difficult of construction. As with subsec. (3), the subsection purports to have an application in relation to agreements which were entered into or carried out ``whether before or after the commencement of this sub-section''. As to that I find no difficulty in so far as its effect is merely to make immaterial the date upon which the agreement was formed. But the subsection goes on to refer to ``the purpose'' for which the agreement was entered into or carried out as the case might be, stipulating that the subsection would be effective if one of the purposes was that of ``securing that that assessable income would be excepted trust income'': a concept which could not have existed until the commencement of the subsection. In the circumstances I do no more than note the difficulty, preferring not to attempt its resolution.

14. The determination of the Tribunal is that the decisions of the Commissioner upon the objections under review shall be confirmed.