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ATO to ignore Bamford decision

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The Australian Tax Office, in a recent Practice Statement, has instructed its staff to continue to administer its own interpretation of the trust law, despite a recent Federal Court ruling.  This may have significant implications for the taxation of trusts within Australia.

The Bamford ruling

In June, the Full Court of the Federal Court handed down its decision in Bamford v Commissioner of Taxation, which appeared to offer greater clarity regarding the taxation of trusts and was widely hailed as a win for taxpayers.   The decision considered the basis upon which beneficiaries of trusts should be assessed for tax purposes.   It dealt specifically with two operational elements of the Income Tax Assessment Act 1936, Division 6.

  • Firstly, Bamford endorsed the 2006 case of Cajkusic by confirming that the phrase “income of the trust estate”, for the purposes of the Act, is income as established by the relevant trust instrument.
  • Secondly, the decision established that a proportionate method is to be used to assess the taxable entitlement of beneficiaries.

The finding in Bamford meant that given appropriate construction, the trust deed could designate what was to be considered trust income, which provided a great deal of flexibility to the taxpayer in administering trust distributions.  For trustees with appropriate trust deeds, Bamford appeared to remove the danger that capital gains made by the trust could be assessed at penal rates, which instead would be taxed as income of the beneficiaries.

The ATO approach

However, the ATO has sought leave to appeal the decision to the High Court, disputing the first of the above points.  The Tax Office’s view, rejected by the Federal Court in Bamford, is that trust estate income should be established according to ordinary concepts, independent of the trust instrument’s specifications.  Further, it holds that the trust law does not allow capital gains made by the trust to be classified as trust income by the trust instrument.

Pending a final decision by the High Court, the Tax Office has released a Practice Statement outlining how it will apply the law.   Circulated 20 August 2009, the statement directs ATO staff to continue to apply the “Commissioner’s administrative practice”; this being the conventional policy of the Tax Office, and the position it advanced during Bamford.  Although as yet no date has been set for such a hearing, an authoritative reading of this part of the Act would put to bed a great deal of uncertainty.

What does this mean for trustees and beneficiaries?

The Commissioner’s Practice Statement instructs ATO staff to target trusts believed to be deliberately effecting a mismatch between the beneficiaries’ entitlements and tax liability.  According to the statement, staff may undertake active compliance work solely with a view to applying the Commissioner’s interpretation of trust income upon discovery of sham setups.

Nevertheless, apart from exceptional cases, the ATO has stated that it will not pursue legitimately structured trusts merely to apply the position it advanced in Bamford.  The Commissioner has indicated that the ATO will notify taxpayers if the Bamford appeal is likely to affect their case’s ruling, objection or appeal.  Further, so far as is as feasible it will seek the consent of involved parties to delay any relevant decision until the resolution of Bamford in the High Court.  The ATO has said that it will not penalise trustees and beneficiaries who have gauged their tax position based on the Full Federal Court’s decision in Bamford or on an alternative view on the operation of Division 6 that is reasonably open.

Whatever the High Court’s eventual decision, now is the time for prudent trustees and beneficiaries to consider trust deed compliance in order to stay out of the ATO’s firing line.

Authors:  John Sier and Thomas Matthews