Question 1(a) - 'presently entitled' within the meaning of s 97(1) of the 1936 Act
22 The second basis of the Commissioner's rejection of the applicant's analysis in Question 1(a) is that, even accepting that the applicant is the relevant beneficiary for the purposes of s 97, it is not "presently entitled to a share of the income" of the Wholesale Fund and therefore s 97(1) does not apply. The definitive statement on the meaning of 'presently entitled' is to be found in Harmer v Federal Commissioner of Taxation (1991) 173 CLR 264.
23 Harmer concerned money paid into court by a company, Riverhall Pty Ltd, which itself made no claim to the money but which was faced with competing claims by parties with whom it had had previous dealings. Subsequent to the court order that Riverhall pay the money into court, a further order was made that the money be invested with a building society in the names of the solicitors for the respective claimants. The solicitors, in their capacity as trustees of the money, were assessed for tax on interest earned at a time prior to the resolution of the conflicting claims. The High Court held that at issue in the appeal was "whether the interest constituted income to which there was no beneficiary 'presently entitled' for the purposes of s 97(1)". If there were no such beneficiary then the trustees were liable to be taxed on the interest pursuant to s 99A.
24 The High Court accepted, at 271, that a beneficiary is 'presently entitled' to a share of the income if, and only if:
(a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.
The Court added that the question whether any of the claimants was presently entitled to the interest in this sense, or had a "vested and indefeasible interest" in it (see s 95A(2)), "must be answered as at the time when the interest was derived, that is to say, during the tax years".
25 In Harmer the interests of the competing claimants were contingent on orders resolving the dispute being made by the Supreme Court of Western Australia. Those interests vested only when the orders were made, which was after the relevant tax years. For that reason the High Court held that the claimants were not 'presently entitled' during those tax years, explaining:
The fact that orders were subsequently made for payment of the interest earned in the tax years to one or other of the claimants does not assist the appellants unless those orders represented a judicial recognition of a present or relevantly vested beneficial entitlement to the interest which existed at the time when the interest was derived, that is to say, which existed independently of the actual order.
26 In Bamford the High Court was called on to construe the undefined expression, "the income of the trust estate" in s 97(1). The Court held that the content of the expression was to be found in the general law of trusts and affirmed the construction of 'presently entitled' given in Harmer. The High Court, at [37]-[39] also commented more generally on the opening words of s 97(1):
The opening words of s 97(1) speak of "a beneficiary of a trust estate" who is "presently entitled to a share of the income of the trust estate". The language of present entitlement is that of the general law of trusts, but adapted to the operation of the 1936 Act upon distinct years of income. The effect of the authorities dealing with the phrase "presently entitled" was considered in Harmer v Federal Commissioner of Taxation1 where it was accepted that a beneficiary would be so entitled if, and only if,
(a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.
…
The identification in s 97(1) of "a trust estate" of which there is "a beneficiary" also bespeaks the general law of trusts. It is true that s 97(1) must be read with s 96. This is addressed to "a trustee", and the effect of the decisions to which reference has been made is that there may be a trustee of a trust created by the operation of a legislative regime not by settlement inter vivos or testamentary disposition. Nevertheless, there must be a "trust estate".
Further, the phrase "presently entitled to a share of the income" directs attention to the processes in trust administration by which the share is identified and entitlement established. The relevant operation of those principles, supported by a review of the authorities, was described as follows by Bowen CJ, Deane and Fitzgerald JJ in Federal Commissioner of Taxation v Totledge Pty Ltd2. Their Honours said:
A beneficiary under a trust who is entitled to income will ordinarily only be entitled to receive actual payment of the appropriate share of surplus or distributable income: the trustee will be entitled and obliged to meet revenue outgoings from income before distributing to a life tenant or other beneficiary entitled to income. Indeed, circumstances may well exist in which a trustee is entitled and obliged to devote the whole of gross income in paying revenue expenses with the consequence that the beneficiary entitled to income may have no entitlement to receive any payment at all. This does not, however, mean that a life tenant or other beneficiary entitled to income in a trust estate has no beneficial interest in the gross income as it is derived. He is entitled to receive an account of it from the trustee and to be paid his share of what remains of it after payment of, or provision for, the trustee's proper costs, expenses and outgoings.
Reliance was placed by the Commissioner upon a passage in Federal Commissioner of Taxation v Australia and New Zealand Savings Bank Ltd3. There was, however, in that case no submission to the effect that the trust deed could operate to treat as capital receipts what otherwise might have been included as income of the trust estate. This is apparent from the argument in the Full Court of the Federal Court in that case4, and the argument there, as in this Court, was, as the Trustee submitted in this appeal, upon other issues.
1 (1991) 173 CLR 264 at 271.
2 (1982) 40 ALR 385 at 393.
3 (1998) 194 CLR 328 at 337 [15]; [1998] HCA 53.
4 Australian and New Zealand Savings Bank Ltd v Commissioner of Taxation [No 2] (1997) 75 FCR 25 at 32.
27 Bamford establishes that the provisions of the relevant trust deed may empower a trustee, for s 97(1) purposes, to characterise as "income of the trust estate" that which may not otherwise be so characterised. The Commissioner's reasons for the private ruling stated that, "even were the provisions of a trust instrument to seek to alter the character of amounts in the hands of the trustee for trust purposes, such a recharacterisation would not be effective for income tax purposes". In the light of the High Court's decision in Bamford this statement is clearly incorrect. Indeed, given that at the time it was made there was a Full Federal Court decision (which was later upheld in the High Court) to the same effect, it was not a position open to the Commissioner at that time; Bamford v Federal Commissioner of Taxation (2009) 176 FCR 250 (Bamford (FC)); see also Commissioner of Taxation v Indooroopilly Children Services (Qld) Pty Ltd (2007) 158 FCR 325 at [3]-[7] per Allsop J. The proposition was not advanced at the hearing in this proceeding.
28 Before examining the submissions that were put forward by the Commissioner in this proceeding it is necessary to consider cl 12 of the Wholesale Fund Constitution (including the proposed amendments) which provides for the redemption of units and the calculation of the Redemption Amount. Clause 12 provides for the Redemption Amount payable to a unitholder on redemption of a unit to be calculated by dividing the Net Trust Value by the sum of the total number of Units (including those which have accrued to the Responsible Entity). The Net Trust Value is the total value of all Trust Property less all Trust Liabilities. Trust Property and Trust Liabilities are defined terms however their precise meaning is not of present concern. The amount calculated (or the cash portion of that amount if there is to be an in specie transfer of assets) is to be adjusted for Redemption Transaction Costs, if any.
29 Clause 12 provides that an entitlement to a Redemption Amount must be "satisfied within a reasonable time after the request for redemption is received". It also provides for the Responsible Entity, in its "absolute discretion" to appropriate the Redemption Amount as between the Corpus Account, the Short Term Capital Gain Account and the Long Term Capital Account as set out at [6] above.
30 Accepting that the Responsible Entity could validly allocate parts of the Redemption Amount to one or more of the accounts nominated in cl 12, the Commissioner nonetheless submits that the decision in Harmer applies to the circumstances postulated in Question 1(a) so that, on the facts postulated in Question 1(a) the applicant cannot be 'presently entitled' for the purposes of s 97(1).
31 This analysis relies on the fact that, as provided in the amended cl 12 of the Wholesale Fund Constitution, whether the Redemption Amount payable to the applicant is attributed in part to the Corpus Account and/or the Short Term Capital Gain Account is a matter for the Responsible Entity of the Wholesale Fund in the exercise of its discretion; (see [6] above). As cl 12 provides that this determination will be made "after the end of the financial year during which the entitlement to that Redemption Amount arises", the respondent submits that:
It follows that the entitlement of the unit-holder to a Redemption Amount arises before the Responsible Entity is able to allocate retrospectively, the "Gain part" to the unit-holder. Bearing in mind that a present entitlement must exist at the time the income to be distributed is received by the trustee, it is impossible for the test in Harmer to be satisfied having regard to the manner in which, and the time at which, the source(s) of the Redemption Amount is determined.
The applicant rejects this analysis, contending that the proposition is "unfounded in any precedent or relevant statutory provision".
32 In relation to Question 1(a) it is the appropriation of the Gain part of the Redemption Amount to the Short Term Capital Gain Account that is relied on to include the Gain part in the (distributable) income of the Wholesale Fund. Pursuant to the amended cl 12 this appropriation can only occur "after" the end of the relevant financial year. Given the Responsible Entity's discretion as to the allocation of the Redemption Amount between the relevant accounts, until that discretion is exercised and the allocation made, any capital gain realised by the Wholesale Fund could not have been included in the income of the trust estate to which the applicant was presently entitled. The difficulty for the applicant is that Harmer makes clear that for s 97(1) purposes, the applicant needs to be presently entitled "at the time when the interest was derived that is to say, during the tax years". I reject the respondent's submission that the beneficiary must be presently entitled "at the time" the income to be distributed is received by the trustee. It is clear from Harmer that it is "during the tax years" that the entitlement must arise.
33 The applicant's written submissions contend that once there has been an appropriation from the Short Term Capital Gain account and payment to the applicant, there has been an exercise of the trustee's discretion to pay income of the Wholesale Fund trust estate to the applicant as beneficiary and therefore s 101 of the 1936 Act applies to deem the unitholder to be presently entitled to that amount. This submission has the same flaw as the above analysis in that the beneficiary would not be presently entitled "at the time" as the income to be distributed is received by the trustee.
34 The facts postulated in Question 1(iv) do not include information as to when in relation to the relevant tax year the appropriation from the Short Term Gain Account was made. It must, however, be the case that it was made after the end of the tax year to which the Gain part relates; that is unless one were prepared to assume that the Responsible Entity had acted contrary to the provisions of the Wholesale Fund Constitution and without the benefit of the year end accounts. The applicant does not make such an assumption. Rather the applicant makes the following point:
The "share" of the income of the trust estate (and in consequence of the sec 95 "net income") is the proportion which the amount to which the beneficiary is presently entitled bears to the whole of "the income of the trust estate," and that share is, and can only be, ascertained at the end of the year of income, when all the components of the calculation are ascertainable.
35 In its written submissions in reply the applicant submitted that the present entitlement of a beneficiary is relevant to the operation of the Act at the end of the year of income. It added that:
The function of present entitlement in the statutory scheme is that it serves to fix the share of the net income of the trust estate which is included in the assessable income of a beneficiary or taxed to the trustee.
36 There is no disagreement about that. The position was put clearly by senior counsel for the Commissioner, Mr Robertson who said in oral submissions that the steps are:
[Y]ou identify the share of the distributable income to which the beneficiary is presently entitled, that's step 1. Once you've identified that share then the notion of 'present entitlement' has served its purpose … Then the third step is you apply that proportion to the taxable income and then that gives you the beneficiary's assessable income.
37 As the above comments of each party recognise, s 97(1) clearly sets out as a precondition to the operation of the section that there be "a beneficiary of a trust estate who ... is presently entitled to a share of the income of the trust estate". Harmer establishes that the precondition will not be met unless the beneficiary has an interest in that share which is vested in interest and in possession. Without that, a share of the net income of the Wholesale Fund cannot, pursuant to s 97(1), be taken into the net income of the Retail Fund (and hence into the assessable income of the Retail Fund).
38 I have concluded that, having regard to the manner in which, and the time at which, any part of the Redemption Amount is allocated to one or other of the relevant accounts, and the fact that the allocation is in the discretion of the Responsible Entity, it is impossible to satisfy the Harmer requirement that the present entitlement arise within the relevant tax year.
39 The applicant submits that this proposition, advanced by the Commissioner, "mistakes the question on which the ruling requested was made" in that the factual premise of each of Questions 1 to 5 "is that the trustee's appropriation from the relevant account precedes or is concurrent with the payment". For reasons given in [34] that submission must be rejected.
40 The applicant refers to the proposition in the Commissioner's written submissions that "the extent to which [the Redemption Amount] will be sourced from the Short-Term Capital Gains Account, corpus or some other account will only be determined at the end of the financial year". The applicant submits that this argument ignores the fact that paragraph 47 of the private ruling application on which this proposition is based "in fact states (as part of the scheme for ruling) that the Applicant will make allocations at the time of redemption but inform unitholders of the character of their receipts at or after year end". That is not, however, what is postulated in the facts set out in the questions. The correctness of the Commissioner's ruling can only be assessed on the basis of the given facts and in the light of the terms of the Wholesale Fund Constitution as proposed to be amended. It is not necessary, therefore, to consider this submission further.
41 For the above reasons I find that the requirement of present entitlement in s 97(1) is not met on the facts as postulated in Question 1.