Fundamental to the appeal is whether the resolutions were effective to produce the intended outcome.
20 It is clear from the material in the appeal that there was considerable uncertainty about how the intended outcome was to be achieved and whether the resolutions had achieved them. The person responsible for the form of drafting of the resolution was a Ms Beth Abbott who was the accountant for Mr Thomas and for the trustee of the trust. His Honour recorded the evidence concerning her intentions in drafting the resolutions at [242]-[257]:
Ms Beth Abbott
242 As Mr Thomas said in oral evidence, "I've mostly left everything up to the accountants": T, p 61, lns 15-16.
243 In Mr Thomas's affidavit material he says that he acted extensively on the advice of Ms Abbott.
244 Ms Abbott prepared the Monthly Position Statements showing an estimated year-to-date position and a notional ("as in possible", as she said) distribution or allocation of taxable income and a notional distribution of the franking credit benefits - the tax offsets, recognising however, that things might change as the taxable income changed, as can be seen in the comparison between the financial information set out at p 303 of the Monthly Position Statement to 31 July 2008 and p 307 of the statement to 30 September 2008.
245 Ms Abbott also prepared the tax returns and the financial accounts.
246 Ms Abbott's method in preparing the Monthly Position Statements for Mr Thomas and the trustee was this.
247 She would identify the profit, based on the monthly (year-to-date) P & L Statement.
248 She would then make adjustments so as to calculate the s 95 net income assuming no other transactions to year end for the sake of the exercise. The adjustments involved adding back non-deductible expenses and adding the franking credits related to the dividend distributions to the trustee of the trust - the required gross-up. Non-taxable capital gains were excluded and removed from the calculation resulting in the total taxable income at that date upon the hypothesis of no further transactions to year end: T, p 72, lns 3-4.
249 The next step was to notionally allocate the s 95 net income between MAPL and Mr Thomas to ensure that Mr Thomas did not receive an amount that would cause him to be paying more than 30c in the dollar as an average tax rate.
250 After having notionally allocated the s 95 net income, Ms Abbott would notionally allocate the franking credit offsets (benefits) between the two beneficiaries based on an amount sufficient to meet (and no more) MAPL's income tax liability based on the notional s 95 net income distribution with the balance allocated to Mr Thomas. Thus, the "only intention" in allocating a particular amount of offsetting franking credit benefits was to meet the tax otherwise payable by MAPL and no more. The remaining franking credits would then be allocated to Mr Thomas and applied against his tax payable. The assumption was that he would then be entitled to a refund of the surplus or unused franking credit benefits beyond offsetting the tax payable by him.
251 Ms Abbott accepted that these steps reflected her philosophy in preparing the documents throughout the relevant tax years: T, p 73, ln 8.
252 Ms Abbott also accepted that the same philosophy was applied to the determination of the actual resolutions passed each year for the trust: T, p 73, lns 10-11.
253 Having accepted that this was the method or philosophy adopted for each income year, Ms Abbott accepted that the s 95 net income was distributed by means of one resolution but further observed that "it was put into two" resolutions (although she said she might have misunderstood the proposition put to her): T, p 73, lns 13-15. Ms Abbott accepted that one resolution addressed a distribution of s 95 net income and the "other" concerned an allocation of franking credit benefits: T, p 73, lns 17-21. However, momentarily later, at T, p 73, lns 31-40, Ms Abbott observed seemingly by clarification in her mind, that the "other" resolution operated to distribute the franking credits. Mr Looney QC put to Ms Abbott that the subject matter of the resolution was the allocation of the benefits (that is, the potential offset entitlements) and Ms Abbott responded by describing the subject matter of the resolution, in her mind, as the distribution of the franking credit amounts to the beneficiaries: T, p 73, lns 31-45. Mr Looney QC then put to Ms Abbott that her reference to franking credit amounts is to be understood as the franking credit benefits - the "entitlement to claim the offset": T, p 74, lns 1-2. Ms Abbott responded: "Technically. But that's probably not what - the terminology I would use, no. Franking credit benefit - I don't know": T, p 74, lns 4-6.
254 I mention this exchange because it suggests that at least up until that moment in Ms Abbott's cross-examination (and the putting to her, as a frame of reference, that the intention of the resolution at the time of making it was to distribute entitlements called franking credit benefits), Ms Abbott thought that she was framing a resolution which was allocating franking credit amounts and that as a matter of taxonomy or terminology she did not consider (at the time) the resolution as allocating franking credit benefits, so described.
255 Ms Abbott accepted, however, that the franking credits resolution did not seek to do anything with the franking credit income, that is, the amount of the gross-up (T, p 74, lns 17-20; lns 37-38) and observed that the purpose of the resolution was "to indicate who those benefits ["referable to the franking credits that came with the dividend"] were to go to": T, p 74, lns 22-24. It thus seems that although Ms Abbott was not thinking about these things at the time by reference to the term franking credit benefits, the substance and subject matter of her thinking involved the allocation of a benefit in the form of an offset.
256 Nor was there any intention to deal with the original dividends paid to the trust in passing the franking credits resolution: T, p 74, lns 33-35.
257 Ms Abbott seemed to accept that the dividend income and the amount of the franking credit gross-up were included in ("captured in") the s 95 net income resolutions: T, p 74, lns 40-47.
(Emphasis in original.)
Similar evidence had been given to Applegarth J in the proceedings in the Supreme Court of Queensland which had been commenced by the trustee against Mr Thomas and MAPL under the Trusts Act 1973 (Qld) for the proper construction of the trust deed and the resolutions: see Thomas Nominees Pty Ltd v Thomas (2010) [2010] QSC 417; 80 ATR 828 at [21]-[28]. In that proceeding Applegarth J made declaratory orders concerning, as between the trustee and beneficiaries, the proper construction of the resolutions which had been made for the income years in these proceedings which will be considered below.
21 The net income distribution resolution in the 2006 year purported on its terms to distribute the whole of the net income of the trust estate to MAPL except for $21,600 which was distributed to Mr Thomas. There was thus, accordingly, no further net income of the trust estate in that year available for distribution by the franking credit distribution resolution despite the fact that its terms also purported to apply "the net income of the trust estate". The person drafting the resolutions seemed, however, to believe that a trustee could distribute separately the credits attaching to the income of a trust estate from the distribution of the income itself. That belief may have been caused by the terms of the amendments which had been made in 1992 to the trust deed which, amongst other matters, contemplated the keeping of separate accounts in the trust for income with different qualities. Whatever the belief, and whatever may be their effect, the two resolutions combined show what their drafter intended: namely, that one beneficiary (Mr Thomas) was to receive the benefit of the bulk of the franking credits (but only $21,600 of the net income of the trust fund) and that the other beneficiary (MAPL) was to receive the benefit of a smaller amount of franking credits (but the balance of the net income of the trust fund). The resolutions themselves do not reveal whether the two resolutions independently achieved the same outcome; that is the resolutions above do not reveal whether a distribution of $21,600 of the net income of the trust estate for the 2006 year by the net income distribution resolution was a distribution to Mr Thomas of the "share amount" of the trust income for the 2006 year which, for the purposes of Div 207, would result in Mr Thomas having the benefit of franking credits to the extent of the $2,416,217.92 in the franking credit distribution resolution for that year.
22 The application of Div 207, however, depended upon determining the share amount of each beneficiary of the trust's net income for the income year covered by s 97(1)(a) of the 1936 Act. That amount for each of the beneficiaries would appear to be the amount distributed by the net income distribution resolution and not by the franking credit distribution resolution. The latter could not distribute to either beneficiary any amount or share of the trust's income covered by s 97(1)(a) of the 1936 Act if it had been distributed by the net income distribution resolution. One reading of the two resolutions is that the net income distribution distributed the net income of the trust estate in the year in question and that the franking credit distribution resolution purported to distribute the franking credits separately as if they were separate items of income or property which did not automatically "flow" to the beneficiaries by force of Div 207 from the terms of the net income. Whatever effect the franking credit distribution resolution may have had for the purposes of the trust between the beneficiaries amongst themselves and as between them and the trustee, the resolution, on one reading of its terms, did not distribute to any beneficiary any amount or share needed to have been distributed for the effect of Div 207 to have "flow" to them the amount of franking credits stated in the second resolution. The franking credits available in the 2006 year to each of Mr Thomas and MAPL, on that view, for example, would be that proportion of the total franking credits received as corresponds to their respective proportions of the amounts distributed to them by the net income distribution.
23 It becomes necessary to consider, however, whether the operation of Div 207 was affected by the orders made by Applegarth J in the Supreme Court of Queensland in November 2010. The Commissioner had notified the trustee in May 2009 of an intention to commence an audit for the tax years ended 30 June 2005 to 30 June 2009. Correspondence on behalf of the trustee to the Commissioner in November 2009 raised the possibility of errors having been made in the tax returns for the relevant years. On 24 August 2010 the trustee commenced proceedings in the Supreme Court of Queensland seeking directions under s 96 of the Trusts Act 1973 (Qld) as to the proper construction of the trust deed and of the two sets of resolutions passed in the 2006, 2007 and 2008 years of income. Mr Thomas and MAPL, as beneficiaries of trusts, were the respondents in the application but they supported the trustee's application and there was no controverter in the proceeding. The Commissioner was notified of the proceeding but informed the applicant's solicitor that it was not considered appropriate for the Commissioner to be a party to the application: Thomas Nominees Pty Ltd v Thomas [2010] QSC 417; (2010) 80 ATR 828, [11].
24 The application was heard on 29 September 2010 by Applegarth J who gave reasons for his proposed orders on 11 November 2010. His Honour's published reasons expressed conclusions about the issue of construction but the formal direction on that day was for the parties to that application to be heard concerning the form of orders to be made in light of his Honour's published reasons and conclusions. Senior counsel informed the Court in this appeal that what next occurred was that senior counsel for the trustee in that application prepared and filed short minutes of orders which his Honour formally made on 12 November 2010 as follows:
1. The court directs the applicant under s 96 of the Trusts Act 1973 (Qld), and declares, that:
(a) on the proper construction of the Income Tax Assessment Act 1997 (Cth), franking credits in respect of a franked distribution made to the trustee of a trust confer a financial advantage which falls to be dealt with by the trustee of the trust; and
(b) on the proper construction of the trust deed for the Thomas Investment Trust and of the resolutions of the directors of the applicant for the years ended 30 June 2005 to 2008, those resolutions were effective to:
(i) allocate to the following beneficiaries in the following amounts the benefits pertaining to the franking credits; and
(ii) entitle those beneficiaries to those benefits in the proportions which those amounts bear, each to the other:
Date of Resolution Martin A Thomas Martin Andrew Pty Ltd
30 June 2005 $282,631.49 $17,860.51
30 June 2006 $2,416,217.92 $228,900.38
30 June 2007 $4,765,353.11 $548,488.89
30 June 2008 $1,030,838.70 $42,780.30
(iii) confer on each of those beneficiaries respectively a vested and indefeasible interest in possession in a share of the distributable income that is consistent with the above allocation to those beneficiaries of the benefits pertaining to the franking credits;
(iv) distribute all the distributable income of the Trust in each year among the above beneficiaries in accordance with those resolutions.
2. The court orders that the application for equitable rectification of those resolutions be dismissed.
One of the orders which had been sought in the application heard by Applegarth J had been for equitable rectification of the resolutions, but the application for rectification was, by order 2, dismissed by his Honour. Counsel for the taxpayers in these appeals under Part IVC of the Taxation Administration Act 1953 (Cth) ("the Administration Act") informed the Court that senior counsel for the trustee in the Supreme Court application (who also appeared as senior counsel in these appeals) had informed Applegarth J that the draft orders to be submitted to him would include the order dismissing the application for rectification of the resolutions.
25 His Honour's dismissal of the application for rectification is significant because his Honour's orders did not operate to alter the resolutions made by the trustee. His Honour's declaration may, however, nonetheless bind the Commissioner (as the Commissioner correctly conceded) to the extent that his Honour's orders conclusively determined the rights of the beneficiaries and the trustee. In Executor Trustee and Agency Co of South Australia v Deputy Federal Commissioner of Taxes (South Australia) [1939] HCA 35; (1939) 62 CLR 545 Latham CJ said at 562-3:
The Commissioner of Taxation who takes moneys from a taxpayer as a contribution to the revenue cannot be described as a privy in estate to the taxpayer where rights have been determined in a proceeding to which the commissioner was not a party. But when, in duly constituted proceedings before a competent court, the rights of a cestui que trust against a trustee and the corresponding duty of the trustee towards the cestui que trust have been defined, there is no means whereby those rights can be otherwise defined, because each party is conclusively bound by the order of the court. If the right in question is a right of the cestui que trust to receive money, such as income, from the trustee, the order necessarily and in the nature of the case finally determines, so far as it goes, the nature and extent of the right of the cestui que trust. When the revenue authorities come to impose a tax in relation to such rights, they must, in my opinion, take them as they in fact actually exist between the parties. Thus, although the commissioner cannot be said to be "bound" by the order of the Supreme Court as res judicaia or in any other way, he has no option but to assess the trustee or the cestuis que trust upon the basis of their duties and rights as declared by the order.
Dixon J (with whom Evatt J agreed) said at 569-570:
Even if these two orders had not been made and the construction of the will were altogether open, I should not place upon it the interpretation for which the appellant contends. The orders, however, fix the rights of the beneficiaries in relation to the income of the land upon which the tax is levied, and, in my opinion, they control the situation.
There is no question of res judicata or issue-estoppel. But the rights in question being measured by the nature and extent of the interests which are taken in the land as at 30th June 1938, we must look at all operative instruments which define those interests. The orders define the interests of the six beneficiaries. It is true that they do not purport to give new interests and that in law they operate only as declarations determining, as between trustee and beneficiary, the interests otherwise existing, that is, arising under the will. But it is none the less true that the beneficiaries can, after the making of the orders, have no interest in the land inconsistent with the orders.
McTiernan J at 572 said:
It was said that, as the commissioner was not a party to the proceedings, the orders were not binding in this appeal. It is true that none of the questions decided in those proceedings is binding on the commissioner as if it were a res judicata. But the will and the orders made by the Supreme Court determine the interests which according to the law of South Australia the annuitants have in the income from the land. I agree that the interests were liable to taxation upon the basis that they were correctly declared by the orders.
It is respectfully correct to say, as was observed by Greenwood J at [425]-[445], that the Commissioner is not bound by the construction of Div 207 adopted by Applegarth J, but for present purposes the relevant question is whether his Honour's orders relevantly determined conclusively the rights of the beneficiaries as against the trustee in such a way that Div 207 would operate as the taxpayers contended.
26 The issue before Applegarth J was whether the trustee had distributed to the beneficiaries franking credits upon the footing that the franking credits were trust property able to be distributed separately pursuant to the terms of the trust. At [40] his Honour identified the issue as put to him in the proceedings as follows:
The issue in this matter is whether the franking credits which formed part of the trust property in each relevant year were distributed to the beneficiaries in accordance with the resolutions that recorded them being applied, being resolutions that dealt specifically with the franking credits. The issue is whether the resolution that was intended to distribute franking credits was effective to pass them to the beneficiary recorded in the resolution that dealt with franking credits, or whether, as the ATO apparently suggests, franking credits were allocated in accordance with the other resolution. The ATO's suggestion is at odds with the terms of the resolutions which were executed contemporaneously, and does not accord with the clear intent of the trustee. That said, I apprehend that the essential issue in respect of which the trustee seeks direction pursuant to s 96 of the Trusts Act 1873 (Cth) is whether the Deed permits a differential allocation of franking credits so as to achieve the outcome intended by the trustee's resolutions. If it does not, the trustee seeks rectification of the resolutions.
(Emphasis added.)
At [50] Applegarth J concluded that the resolutions purported to allocate the franking credits differentially according to the terms of the trust.
27 Applegarth J's declaration in 1(b)(iii) is, perhaps surprisingly, that the resolutions which the trustee had made in the years ended 30 June 2005 to 30 June 2008 had conferred upon each of the beneficiaries a vested and indefeasible interest in the distributable income consistent with the intended flow of franking credits. That had been the intention of the trustee when making the relevant resolutions in respect of each of the four years and his Honour was persuaded that the resolutions required that they be read in that way. The application before his Honour required the Court to make sense of what may, perhaps not unfairly, be described as confused resolutions. The resolutions purported to do something and an ultimate intention could fairly be discerned however ineptly the two resolutions may have been drawn. However the rights of the beneficiaries flowing as against the Commissioner from Div 207 of the 1997 Act depended wholly upon the effect of the rights created as between the trustee and the beneficiary by whatever the resolutions may have achieved. The rights to be created by the trustee as against the Commissioner were a matter wholly within the control of the trustee and it was in the jurisdiction of the Supreme Court to make declarations concerning the proper construction of what the trustee had done pursuant to a domestic trust. The Commissioner was not obliged to participate in that proceeding, and may not be bound by the construction of Div 207, but the Commissioner is bound by a declaration concerning the effect of the resolutions if the declaration conclusively determines that a beneficiary has a share of the trust's net income for a year of income that is covered by s 97(1)(a) of the 1936 Act. His Honour's declaration in paragraph 1(b)(iii) is to that effect and determined conclusively as against the Commissioner the beneficiary's share of the trust's net income for the years covered by his Honour's orders. It follows that the appeal should be allowed in respect of those years and that the objection decision for those years should be remitted to the Commissioner for reassessment. It follows also that it is unnecessary to consider the Commissioner's notice of cross-appeal although it is perhaps desirable to say that if the taxpayer's appeal had been dismissed it would have been necessary to consider whether Greenwood J nonetheless erred in not determining that each of the beneficiaries were entitled to so much of the franking credits as was referrable to the share of the trust income distributed by the first of the resolutions.
28 The taxpayers appeal also the decision in this Court in respect of the 2009 year which was not covered by orders of Applegarth J. The resolutions passed in respect of the 2009 year were to the same effect as those which had been passed for the years considered by Applegarth J in the Supreme Court proceeding. Trust resolutions, therefore, proceeded upon the same misunderstanding of the proper operation of Div 207; that is, upon the misunderstanding that franking credits could be distributed separately. The intention of the person drafting the resolution, however, was consistent with the intention found by Applegarth J. The trustee intended to pass resolutions which would trigger the operation of Div 207 so that Mr Thomas would receive the greater benefit of the franking credits in the 2009 year although he would receive a lower proportion of net income than MAPL. It is difficult to embrace the conclusions of Applegarth J and to see the combined effect of the two resolutions as, in effect, contradicting part of the otherwise clear terms of the net income distribution resolution for 2009 (which is expressed to distribute that upon which Div 207, and in particular s 207-50(3)(b)(i) is to operate). The franking credit distribution resolution is explicable only by a fundamental confusion in the mind of the person drafting the resolution to achieve an outcome which could not be achieved by the resolutions upon their terms. Applegarth J, however, was persuaded that the terms of the two resolutions taken together in the previous years should be read to give effect to what can be accepted as having been the intentions of Mr Thomas and Ms Abbott upon the basis of their belief about the operation of Div 207 and the terms of the trust. His Honour said at [19]-[27]:
19 Mr Thomas' and Ms Abbott's states of mind in relation to the resolutions the subject of this application, and in particular the taxation outcome that they intended to achieve, are relevant facts. As Bowen LJ stated in Edgington v Fitzmaurice, "the state of a man's mind is as much a fact as the state of his digestion."
20 Mr Thomas and Ms Abbott each believed that by reason of the operation of the tax legislation:
(a) The trustee was required each income year to calculate the amount liable to taxation in accordance s 95 of the Income Tax Assessment Act 1936 (Cth) (the ITAA 1936), being assessable income less allowable deductions. This amount is referred to as "the s 95 net income".
(b) The amount of the dividends and other income was assessable income.
(c) The amount of the franking credits was assessable income.
(d) The trustee's expenses were allowable deductions.
(e) In relation to s 95 net incomes, all of it must be distributed by the trustee among the beneficiaries lest the trustee be liable to tax at the highest marginal tax rate under s 99A of the ITAA 1936.
(f) In relation to franking credits, they can be allocated by the trustee among the beneficiaries and, in that case, 2 statutory advantages are conferred on the beneficiary to whom a franking credit is allocated:
(i) a rebate of tax otherwise payable by that beneficiary, and
(ii) in the case of an individual (that is, Mr Thomas) but not a company (that is, Martin Andrew Pty Ltd), a cash entitlement as against the Commissioner of Taxation in relation to the excess not used for (i).
21 In each of the income years, before formal distribution resolutions were made, Ms Abbott and Mr Thomas discussed what distributions should be made, having regard in particular to the amount of s 95 net income and the statutory advantages conferred by the franking credits on those beneficiaries entitled to them under Div 207 of the ITAA 1997.
22 The 2 principal taxation factors referred to above - the desirability of distributing all the s 95 net income and the statutory advantages of allocating franking credits among individual and corporate beneficiaries effectively - were known to and informed the discussions between Mr Thomas and Ms Abbott.
23 The over-riding factor in Mr Thomas' and Ms Abbott's view was to ensure that the full benefits of the franking credits were obtained, especially that Mr Thomas as an individual beneficiary would be allocated the franking credits to allow him to claim cash from the Commissioner of Taxation. Mr Thomas ordered his affairs based on the anticipated franking credits that he would receive from the Commissioner.
24 Mr Thomas gave Ms Abbott instructions to draft resolutions that would be effective to: (i) distribute all of the s 95 net income each year so that the trustee would not be liable to tax under s 99A; and (ii) confer on himself and on Martin Andrew Pty Ltd the maximum advantages related to the franking credits, being: (a) to reduce the tax otherwise payable by himself and by Martin Andrew Pty Ltd to nil; and (b) to confer on himself the statutory right to cash as against the Commissioner of Taxation in relation to the excess not used in (a).
25 For each of the income years Ms Abbott calculated the expected s 95 net income for the year and determined the amount of franking credits available for allocation. The franking credits available for distribution far exceeded the s 95 net income in each income year.
26 Ms Abbott then chose to draft dual resolutions for simultaneous execution (rather than one resolution) based on Mr Thomas' wishes. The first resolution purported to deal with the franking credits and other special tax income (namely, a foreign tax credit). In terms, it distributed the vast bulk of the franking credits to Mr Thomas and distributed to Martin Andrew Pty Ltd only so much as was required to pay the tax payable by that company. The second resolution purported to deal with all the trust income that did not relate to franking credits or other special tax income. It distributed a cash amount to Mr Thomas and the balance to Martin Andrew Pty Ltd.
27 For each of the income years Mr Thomas as director of the trustee made formal resolutions in the terms as drafted by Ms Abbott, believing that they were effective to achieve his intentions.
Although his Honour dismissed the application for rectification, at [53] he expressed the view that he would have ordered rectification of the resolutions if he had reached a different conclusion about the proper construction of the resolutions in respect of the 2005 to 2008 years.
29 A similar conclusion to the order made by Applegarth J should be reached in respect of the 2009 resolutions albeit with reluctance. It would, indeed, perhaps be impossible to embrace his Honour's construction of the resolutions had they been made after those drafting them had become aware of their inherent problems. The resolutions for the 2009 year were made, however, on 31 August 2009 and were plainly made upon the same misguided misunderstanding of how Division 207 operated. The terms of the two resolutions taken together only make sense if construed as conferring upon Mr Thomas, as a share of the trust's net income covered by s 97(1)(a) of the 1936 Act in the 2009 year, so much of the trust's net income for that year as would see him receive the benefit of franking credits in the amount stated in the franking credit distribution resolution notwithstanding that the amount of income purportedly distributed to him in the 2009 year was $16,000 and to MAPL $157,143. This conclusion fits uneasily with the words of the resolutions but is consistent with the intention of the trustee reflected in the mind of the person drafting the resolutions. Accordingly the appeal in the 2009 year should also be allowed and the decisions remitted to the Commissioner for reassessment, although the formal orders in those years may be affected by the fact that the Commissioner had assessed under s 99A of the 1936 Act.
30 It becomes unnecessary to consider the questions concerning penalties.
31 The appeal should be allowed with the parties directed to submit a form of order in each of the proceedings to give effect to these reasons.
I certify that the preceding twenty-five (25) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Pagone.
Associate:
Dated: 12 April 2017