Trusts - discretionary trusts - observations on the meaning of the term "discretionary trust" and of the terms "general", "special" and "hybrid" powers.

Income Tax Assessment Act 1936

Administrative Appeals Tribunal Act 1975

Family Law Act 1975

Perlman v Perlman (1982) 155 CLR 272

Secured Income Real Estate (Australia) Ltd. v St. Martins

Investments Pty. Ltd. (1979) 122 CLR 596

Re Gulbenkian's Settlement Trusts (1975) AC 558

Re Baden's Deed Trusts (1971) AC 222

Re Clore's Settlement Trusts (1966) 2 All ER 272

Counsel and Solicitors A.H. Slater Esq. instructed by

for the Applicant: the Australian Government

Solicitor.

Counsel and Solicitors B.A. Coles Esq. instructed by

for the Respondent: D.G. Stuart Esq.

The decision of the Administrative Appeals Tribunal given on 12 April 1989 be set aside and in lieu thereof the disallowance of the applicant to the objection to the assessment for the year of income ending 30 June 1982 be confirmed and the objections in respect of the years ending 30 June 1982 and 30 June 1983 be remitted to the applicant for reassessment on the basis that the respondent should have returned as trust income for each year the sum of $3,504.

Note: Settlement and entry of orders is dealt with by Order 36 of the Federal Court Rules.

This is an appeal on questions of law by the Commissioner of Taxation ("the Commissioner") from a decision of the Administrative Appeals Tribunal (Taxation Appeals Division) ("the Tribunal"). The jurisdiction of this Court is original jurisdiction with which it is invested by s. 22 of the Administrative Appeals Tribunal Act 1975 ("the AAT Act").

2. The decision of the Tribunal was that the determinations of the Commissioner under review should be varied and that the objections of the present respondent ("the taxpayer") should be wholly allowed. The Commissioner had disallowed objection by the taxpayer to assessments in respect of the years of income ending 30 June 1982, 30 June 1983 and 30 June 1982. The taxpayer disputed that she ought to have returned as trust income the sums of $4,042, $4,004 and $3,504 for the three respective years of income. Before the Tribunal, the Commissioner relied on sub-s. 97 (1) and upon s. 101 of the Income Tax Assessment Act 1936 ("the Act"); no reliance was placed upon s. 25 of the Act. When the matter came before this Court, counsel for the Commissioner indicated that in respect of the years of income for 1982 and 1983, the Commissioner would not seek to support the assessments in respect of trust income beyond the amount of $3,504. The result is that in respect of each of the three years of income, the amount in issue is $3,504.

3. The taxpayer, Mrs Vegners, married Mr Ray Vegners in 1967. There are three children of the marriage. What was known as "The Vegners Family Trust" was established by Deed of Settlement ("the Trust Deed") made 29 April 1980 between Edvards Keris as settlor and Ray Vegners Pty. Limited ("the Company") as trustee. Both the taxpayer and her husband, together with other persons and entities, were included within the definitions in the Trust Deed of "Income Beneficiary" and "Capital Beneficiary". Paragraph 8 (f) gave the company power:

"to commence, carry on or join in any

business or transaction either alone or

jointly whether in partnership or

otherwise with another or others

including the (company) either on its own

behalf or as a Trustee for any other

person during such periods and upon such

terms and conditions as (the Company) in

its absolute discretion shall think

proper and fit and to employ in such

business or transaction the whole or part

of the trust fund . . ."

Clause 2 of the Trust Deed provided that the Company should stand possessed "of the income of the Trust Fund" upon the trusts spelled out in paragraphs (a) and (b) thereof. Paragraph (b) operated to make gifts over to inter alia Mr. Vegners' children, in default of an effectual determination under para. (a) on or before midnight on 30 June in each financial year. Paragraph (a) was in the following terms:

"(a) from time to time during a financial year to

pay or apply the same or any part thereof to

or for the benefit of the income

beneficiaries or any one or more of them

exclusive of the other or others who shall

be living or which shall be in existence at

any time during the financial year in such

shares or proportions as (the Company) in

its absolute discretion may from financial

year to financial year determine."

Clause 2 has to be read with clause 3 which provided:

"3. (The Company) may determine or resolve or

accumulate the whole or any part of the

income of a financial year whereupon such

income shall be held by (the Company) on

trust to accumulate the same and invest the

same and the resulting income thereof to the

intent that such accumulation and income

shall be ipso facto added to the capital of

the Trust Fund and follow the destination

thereof as from the date of commencement of

the next ensuing financial year."

The expression "the Trust Fund" was defined in clause 1 as meaning:

"the sum of Ten Dollars ($10.00) paid by

the Settlor to (the Company) and all

accretions thereto moneys investments and

property of every description paid to or

acquired by (the Company) in any manner

whatsoever from time to time and accepted

by it as representing the same or as

additions thereto and all accumulations

of income made as hereinafter provided."

4. The Company was incorporated in 1980 and at all material times the whole of its issued share capital was held or controlled by Mr. Vegners. At all material times, the directors were Mr. Vegners and his eldest son (by another marriage). In 1980, the taxpayer and her husband separated and they were subsequently divorced. On 2 July 1981, the taxpayer and her husband executed a deed ("the Part VIII Deed") and on the same day it was approved by the Family Court of Australia pursuant to s. 87 of the Family Law Act 1975 (the "Family Law Act"). In relation to the financial matters dealt with in this agreement, this deed operated in substitution for any right to the parties to it under Part VIII of the Family Law Act. The only parties to the Part VIII Deed were the taxpayer and her husband. The Company was not a party. The approval of the Family Court had as one consequence that the agreement was enforceable as if it were an order of that Court; Family Law Act ss. 87 (7), 88, Perlman v Perlman [1984] HCA 4; (1984) 155 CLR 474 at 484-485, 490-491, 495, 505-506, 508.

5. It was recited in the Part VIII Deed that the parties had separated on 20 March 1980, and that they had lived separately and apart since that date, that they desired to have crystallised once and for all the financial matters in dispute between them, and that each of the parties had been independently advised by his or her legal representative of their respective rights under Part VIII of the Family Law Act. Clause 5 of the Part VIII Deed was in the following terms:

"The Wife shall receive payment from the

Trustee of the Vegners Family Trust by

way of further property settlement, the

lump sum of Thirty-nine thousand one

hundred and twenty-eight dollars

($39,128.00) by one hundred and

thirty-four equal calendar monthly

instalments of Two hundred and ninety-two

dollars ($292.00) per month, the first of

such instalments to be paid on the 9th

April, 1981 and thereafter on the 9th day

of each and every succeeding month. The

payments by the Trustee shall be by way

of allocation of trust income and only in

the event that the trustee at any time or

from time to time does not make such

payments as prescribed, the Husband shall

make the particular payment or payments

until such time as the Trustee shall

resume making the payments specified

PROVIDED HOWEVER that in the event of the

death of the Wife during the term of

payment of the said instalments, all

further instalments shall cease and there

shall be no further liability for payment

of instalments which would otherwise have

fallen due after the date of death."

6. Clause 5 of the Part VIII Deed was drafted by the solicitor acting for Mr. Vegners in conjunction with the taxpayer's solicitor. The taxpayer's solicitor reviewed the document and discussed it with her before she signed it. The taxpayer had not previously heard of the Vegners Family Trust, had no clear understanding of its nature and was not aware that she was included in the class of "income beneficiaries" under that trust.

7. In the three years of income in question, the taxpayer received payments equivalent to those specified in clause 5 by cheques drawn each by the Company upon its bank account and banked by the taxpayer. The amounts received by the taxpayer were $3,504 in each of the three years of income. In addition, the taxpayer received $3,000 per annum on account of the three children of the marriage, but nothing immediately turns upon this, save that for convenience the one monthly cheque drawn by the Company would cover payments to the taxpayer personally and to her on account of the children.

8. Mr. Vegners is a consulting engineer. In the years of income, the Company acted as trustee of a "trading trust", consistently with the power contained in para. 8 (f) of the Trust Deed. The trading activities involved the conduct of the consulting engineering practice of Mr. Vegners. The Company maintained a cheque account which was used as the only trading account for the engineering consultancy practice. Mr. Vegners was the only signatory to the account. The receipt from the practice went into the account and expenses were paid out of it. At one stage, the Company had opened a separate account for the trust but it was never used, because, as Mr. Vegners put it in cross-examination, "there was no need of it".

9. On 30 June of each of the three years of income, the Company passed a resolution expressed to be "in terms of clause 2 (a) of the Trust Deed relating to the Vegners Family Trust". The resolutions followed the same form. That passed on 30 June 1984 was in the following terms:

"Extract of Resolution

In terms of clause 2 (a) of the Trust Deed relating

to Vegners Family Trust it was resolved to

distribute the following amounts to:-

(i) Raymond Vegners

for the benefit, maintenance, schooling &

well being of -

Mark N. Vegners $1000-00

Karl Vegners $1000-00

Kurt Vegners $1000-00

and for each of the following:-

Raymond M. Vegners $7862-89

Helena Vegners (the taxpayer) $3504-00

for their own benefit

Distribution is in relation to income of the

Financial year ended 30th June, 1984."

10. Mr. Vegners' understanding of the Part VIII Deed was that the payments stipulated in clause 5 were to be made "through the trust". He did not regard the authority for the payments to the taxpayer as coming at the end of the financial year with the passage of these resolutions. Mr. Vegners said in cross-examination:

"There is a Family Court order that those

payments must be made. It is not a

question of whether you choose to or not;

they just have to be made."

It will be recalled that clause 5 of the Part VIII Deed stipulated that the payments by the Company to the taxpayer "shall be by way of allocation of trust income . . .". The Company was not a party to that deed but clause 5 contains one of the fundamental obligations in the deed, and given the factual matrix in which clause 5 was placed, one should (and this was not seriously disputed) treat the husband's covenant as importing an obligation to do all that might properly be done to achieve an exercise by the Company of its powers under the Trust Deed to bring about the necessary allocation of trust income; see Secured Income Real Estate (Australia) Ltd. v St. Martins Investments Pty. Ltd. [1979] HCA 51; (1979) 144 CLR 596 at 607 per Mason J. In any event, that is what appears to have happened in each of the three years of income.

11. Sub-section 97 (1) of the Act relevantly provides:

"97. (1) Where a beneficiary of a trust estate

who is not under any legal disability

is presently entitled to a share of

the income of the trust estate -

(a) the assessable income of the

beneficiary shall include -

(i) so much of that share

of the net income of

the trust estate as is

attributable to a period

when the beneficiary was

a resident;

. . ."

The expression "net income" in relation to a trust estate is relevantly defined in sub-s. 95 (1) of the Act as meaning:

"the total assessable income of the trust

estate calculated under this Act as if

the trustee were a taxpayer in respect of

that income and were a resident, less all

allowable deductions . . ."

Section 101 provides:

"101. For the purposes of this Act, where a

trustee has a discretion to pay or apply

income of a trust estate to or for the

benefit of specified beneficiaries, a

beneficiary in whose favour the trustee

exercises his discretion shall be deemed to

be presently entitled to the amount paid to

him or applied for his benefit by the

trustee in the exercise of that discretion."

12. There was some discussion by counsel of the term "discretionary trust" and related terms. A fixed trust is used to describe a species of express trust where all the beneficiaries are ascertainable and their beneficial interest are fixed, there being no discretion in the trustee or any other person to vary the group of beneficiaries or the quantum of their interests. The expression "discretionary trust" is used to identify another species of express trust, one where the entitlement of beneficiaries to income, or to corpus, or both, is not immediately ascertainable. Rather, the beneficiaries are selected from a nominated class by the trustee or some other person and this power may be exercisable once or from time to time. The power of selection is a special or hybrid power; a power exercisable in favour of any person including the donee of the power would be a general power and thus would be tantamount to ownership of the property concerned, whilst the objects of a special power would be limited to some class, and the objects of a hybrid power would be such that the donee might appoint to anyone except designated classes or groups.

13. The trust will be "purely discretionary" where income and capital may be withheld altogether but this would not be so where the donee of the power of selection had a discretion only as to the time or method of making payments to or for beneficiaries; see Scott on Trusts, 4th Ed., para 155. In this regard, the special or hybrid power would be further classified, or, sub-classified as a trust power or a bare power within the meaning of those expressions as discussed by the House of Lords in Re Gulbenkian's Settlement Trusts (1970) AC 508 and Re Baden's Deed Trusts [1970] UKHL 1; (1971) AC 424. However, some courts and commentators have used the expression "discretionary trust" only to describe cases where the power involved is a trust power rather than a bare power; see, for example, Re Baden's Deed Trusts (No. 2) (1973) Ch 9 at 26 and Hanbury & Maudsley, "Modern Equity", 12 Ed., 1985, pp 199.

14. It will be apparent that unlike the division of trusts between purpose trusts and non-purpose trusts, and between express trusts, implied or resulting trusts and constructive trusts, and the classification of powers between general, special and hybrid powers, and between trust and bare powers, the usage of the term "discretionary trust" is essentially descriptive rather than normative. The meaning of the term is primarily a matter of usage, not doctrine.

15. Section 101 of the Act has the result, with regard to discretionary trusts, that where the power in question is vested in the trustee and the trustee exercises the discretion in favour of an object of the power, then that person is deemed to be presently entitled to the amount paid to him or applied for his benefit. In the case of objects of the power who were sui juris, s. 101 would, in such cases, add little to what would already be the work done by s. 97 of the Act. However, it may be noted that powers of maintenance and advancement, whether conferred by statute or express power in a settlement, may permit a trustee with a power to maintain or advance beneficiary X to pay the moneys in question to Y. A striking example is provided by Re Clore's Settlement Trusts (1966) 2 All ER 272, where it was held that trustees would properly exercise a power of advancement by making a donation to a charity to which the beneficiary had a moral obligation to contribute. Section 101 would appear to have the result that in such cases the moneys so paid to Y would be part of the present entitlement of X, for the purposes of the Act.

16. In the present case, the Trust Deed conferred on the Company a discretion to pay or apply "income of the Trust Fund" to or for the benefit of the taxpayer. It was, in my view, not to the point that the taxpayer herself had no understanding of the existence of such a power. The taxpayer did not take any action at any time to refuse receipt of or otherwise reject the moneys paid to her by the Company.

17. The Tribunal said that the responsibilities of the Company as trustee to the taxpayer as one of the "income beneficiaries" were responsibilities "it could not shed" and which "were no less because she had no knowledge of them". But the Tribunal concluded that the taxpayer had persuaded it that she did not derive assessable income as a trust beneficiary as alleged by the Commissioner. The Tribunal expressed as "findings of fact" that it was "not persuaded" that the distributions were made to the taxpayer "in accordance with the terms of the resolutions" passed at the end of each of the three years of income, the resolutions being "nothing more than an attempt to give efficacy as trust distributions to the payments which had already been made". The Tribunal further said that upon any effective determination of the Company to distribute income to the taxpayer, she became entitled to the benefits of the distribution "only if she chose to accept them". It was said that no such choice "could be made until such time as she learned of the existence of the Trust and the passing of the resolution" and that this knowledge did not come to her until the assessment came to her notice and inquiries led to the discovery of her entitlement.

18. Before this Court, counsel for the taxpayer did not place his case primarily upon what was said above in the reasons of the Tribunal. The Tribunal in saying it was "not persuaded" that the distributions had a certain character (which character would favour the revenue) appears to have reversed the burden which lay upon the taxpayer. Further, as I have said, the Part VIII Deed clearly contemplated the receipt of payments by the taxpayer from the Company as trustee of the Vegners Family Trust. That instrument was signed by the taxpayer in the circumstances I have earlier described, and she received the proceeds of the cheques in question which were provided to her by the Company. If what happened otherwise involved the receipt by her of assessable income it would, in my view, not be to the point to say that she had no clear understanding of the legal mechanism by which was triggered the making of payments in her favour.

19. Nor, in my view, was it essential for the effective exercise of the power contained in para. (a) of clause 2 of the Trust Deed that a payment or application of the income of the Trust Fund be preceded by some formal resolution on the part of the Company as trustee. In my view, the effect of the resolutions passed at the end of each financial year was confirmatory rather than dispositive. Further, in my view, the making of each payment itself involved the exercise by the Company of a discretion as trustee within the meaning of s. 101 of the Act.

20. The Trust Deed is not drawn as well as may have been, in that the definition of "the Trust Fund" is more apt for an investment trust of the traditional type, than for the conduct of a "trading trust". Counsel for the taxpayer pointed to the definition in the Trust Deed of "the Trust Fund" and to the necessity there expressed for further moneys paid to or acquired by the Company to be accepted by the Company as representing the same. Counsel pointed to the use of the Company to conduct Mr. Vegners' practice as a consulting engineer, as something distinct from its role as trustee. But the Company carried on this business as a "trading trust" and this was consistent with the terms of the Trust Deed.

21. The Trust Deed must be construed as a whole, including the "trading trust" power in para. 8 (f), and "the income of the Trust Fund", referred to in para. 2 (a), should be read accordingly. In my view, the Tribunal fell into error and the taxpayer did not make out her case that the payments she received were not paid out of the income of the Trust Fund within para. (a) of clause 2 of the Trust Deed, and were not made by the Company in the exercise of its discretion as trustee within the meaning of s. 101 of the Act.

22. I should add that the taxpayer could place no reliance upon s. 23 (1) of the Act, as it stood during the relevant years of income. This was, if for no other reason, because s. 23 (1) was concerned with income received by way of periodical payments in the nature of alimony or maintenance by a woman from her husband or former husband, and these payments were received from the Company and received as a share of the net income of a trust estate, within the meaning of Division 6 of Part III of the Act.

23. It follows, in my opinion, that the decision of the Tribunal given 14 April 1989 should be set aside. The determination of the Commissioner in respect of the objections to the assessment for the year of income ending 30 June 1984 should be confirmed. The objections in respect of the years ended 30 June 1982 and 30 June 1983 should be remitted to the Commissioner so that there may be reassessments on the footing that the taxpayer ought to have returned as trust income for each year the sum of $3,502, rather than $4,042 and $4,004 respectively. In accordance with an arrangement between the parties which was outlined to the Court by counsel, there should be no order as to costs.