Beneficiaries Currently Entitled to Default Distributions Despite Disclaimers

The High Court unanimously upheld the Commissioner’s appeal against the decision of the full Federal Court reported to ATC 2020 ¶20-760; [2020] CFAF 150 in respect of amended valuations which included default distributions of trust income subsequently rejected by the affected taxpayers. The High Court held that the full court erred in holding that taxpayer disclaimers could apply retroactively so as not to apply s. 97(1) of ITAA1936 (and thereby nullifying the Commissioner’s rights), declaring that a beneficiary’s present right under s. 97(1) was to be determined immediately before the end of the fiscal year on the basis of the legal relationships then existing.

Facts

Taxpayers were all primary beneficiaries of the Whitby Trust. They were issued with assessments in respect of default distributions from Whitby Trust for the years 2011 to 2013. When the ratepayers waived the distributions, the commissioner acknowledged the waivers were effective, withdrew the assessments issued each taxpayer and made contributions to the Whitby Trust instead.

The taxpayers also each received an amended assessment for the year 2014 which included as taxable income one-fifth of Whitby Trust’s income on the basis that each taxpayer was “currently entitled” to such income within the meaning of s. 97(1). The taxpayers again sought to waive default distributions in terms similar to previous disclaimers. Where the Commissioner, in his ruling of objection, did not accept the second waivers as effective, each taxpayer executed a third waiver in broader terms.

The ratepayers requested that the Commissioner’s objection decision be reviewed by the AAT. Their challenge to the 2014 contributions was based on 2 main arguments: (i) that 100% of the income had been validly allocated to another trust (the Bernguard Trust) at a meeting on June 30, 2014 so that they could not take in default; and (ii) that even if there was no valid attribution of income to the Bernguard Trust, they had validly waived the relevant distribution either by the second or by the third waiver.

At first instance, the AAT did not accept either assertion and upheld the opposing decisions (Trustee for the Whitby Trust v FC of T [2019] AAA 5637). Relevantly, the AAT was not satisfied that the June 30, 2014 meeting had taken place or that a resolution to distribute 100% of the trust’s income to the Bernguard Trust had been passed. The AAT also concluded that while the third disclaimers may have been broad enough to exclude the gift, there was an implied acceptance of the gift due to the failure to disown it in full at an earlier time. The disclaimers also came too late, nearly 30 months after taxpayers learned of the donation.

The taxpayers appealed this decision to the Federal Court, where the issues were: (i) whether there had been a valid distribution of 100% of the trust’s income to the Bernguard Trust during the year 2014 (if applicable, the contributions issued in respect of this year under s 97 were necessarily excessive) and (ii) whether the second and third disclaimers were effective (the commissioner asserted that he was wrong to accept that the first disclaimers were effective and retroactive in their effect, that the second disclaimers were ineffective because ‘they were only intended to disclaim with respect to the year 2014, and that any disclaimer was nevertheless pointless because it could not apply retroactively).

Full court decision

The Full Federal Court allowed the appeal unanimously. He concluded that the AAT did not err in concluding that there had been no distribution to the Bernguard Trust during the year 2014. However, it erred in concluding that the third waivers were ineffective because the taxpayers had implicitly accepted the gift or were too late to withdraw. Where there had been no express acceptance of a gift, the implied or tacit acceptance was a matter of inference and presumption about particular facts. The AAT had to decide, on the basis of all available evidence, whether it should be inferred that, by their conduct in executing the first and second waivers prior to the execution of the third waivers, the ratepayers had tacitly accepted the donation. . The AAT failed to perform this part of its statutory function because it operated on an unstated erroneous premise that an ineffective waiver of a gift necessarily implied a tacit acceptance of the gift.

The full court said there was also no principle that a delay in the waiver necessarily implied a tacit acceptance of a gift. On the facts, there was only one reasonably open conclusion, and that was that the conduct of the taxpayers was consistently directed to an end — to deny any right to income from the trust. The third disclaimer was effective in excluding the default distributions of the year 2014.

The full court went on to state that the third disclaimers were not irrelevant for the purposes of s. 97(1). A beneficiary’s right to income under a trust operated for the purposes of s. 97 from the time it was born but, in the event of renunciation, the general law extinguished the right to the income of the trust ab initio. The waiver was conclusive against the commissioner in the application of s. 97 to the beneficiary because the effect of a waiver was that the beneficiary was to be treated as never having been entitled to the income for the purposes of s. 97 in respect of the relevant income year.

From that decision the Commissioner was allowed to appeal to the High Court on the ground that the full court had erred in finding that the third disclaimers operated retroactively so as not to apply s. 97(1) for the 2014 financial year. The main question to be decided was whether the current right of a beneficiary under Art. 97(1) — the present legal right to demand and receive payment of a share of the income of a trust estate — was to be determined immediately before the end of an income year on the basis of the legal relations then existing, or of the events after the end of the year of income, which may affect or modify these legal relationships, be taken into consideration.

The taxpayers argued that the phrase “is currently entitled” should be interpreted to mean “is actually” currently entitled for that income year, such that for “a reasonable period” after the end of the income year, subsequent events could subsequently disqualify a beneficiary who was entitled to it immediately before the end of the income year. It has been argued that when the presumption of proof of consent was rebutted (the third disclaimers here being proof of that rebuttal), it followed that one of the elements necessary for an effective donation was, and always had been, missing.

High Court decision

In another unanimous decision, the High Court upheld the Commissioner’s appeal. The court noted that the phrase “currently entitled to a share of the income of the estate in trust” in s. 97(1) spoke in the present. It targeted the position existing immediately before the end of the income year for the stated purpose of identifying the beneficiaries who were to be valued with the income of the trust — namely, the beneficiaries of the trust who, in addition to having an interest in the income of the trust that was invested in both interest and possession, had a present legal right to demand and receive payment of the income. The legislation was written to tax a beneficiary based on their current entitlement, not their receipt.

The court held that the taxpayer’s interpretation of the phrase “currently entitled” was contrary to the text of s. 97(1) and the object and purpose of Div 6 of the ITAA 1936. This would give rise to uncertainty as to the identification of beneficiaries currently entitled to a share of the income of a trust estate and the subsequent valuation of those beneficiaries. Depending on the interpretation of the taxpayer, the question of whether a beneficiary was currently entitled to a share of the income of an estate in trust may not be resolved for a long period of time, in some cases years. The resulting uncertainties, which would apply with equal force to the commissioner, the trustees, the beneficiaries and perhaps the settlors, would not be fair, practical or effective. The issue of a beneficiary’s current entitlement to income from a trust should be tested and reviewed at the end of the taxation year, not within a reasonable time after the end of that year.

Although it is not necessary to decide, the High Court went on to observe that, whether or not the third waivers had the effect of altering the rights and obligations of the trustee and the taxpayers, they were not effective in removing retroactively the Commissioner’s rights which existed on June 30, 2014 at midnight and which gave rise to the 2014 assessments. The presumption of assent was a strong presumption of right. Division 6 and, in particular, the “currently entitled” test in s. 97(1), was consistent with and made use of the presumption of law of assent. This presumption applied immediately before the end of the 2014 fiscal year to the legal operation of the trust deed.

Source: FC of T vs. Carter & Ors 2022 ATC ¶20-822; [2022] HCA 10April 6, 2022.

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