Howard v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (High Court (M115 of 2012))
Date published: 14 August 2014

Summary of decision:
Outlines the ATO's response to this case which concerns whether distributions of trust corpus received by an Australian resident individual in the 2006 income year from a Jersey Trust were assessable income of the taxpayer in that year.

Overview of facts:
The Esparto Trust was established in the Isle of Jersey. The trustee of the trust was also a resident of Jersey. | Shares in a company incorporated in Jersey, Esparto Ltd, were held by the Esparto Trust via two other companies acting as nominees (trustees of trusts again established in Jersey). One of these companies was called Juris Ltd and the trust of which it was a trustee was referred to as the Juris Trust. | The taxpayer, Mr Howard, an Australian resident, was a beneficiary of the Esparto Trust. | During the 2006 year, Mr Howard had paid to or applied for his benefit certain amounts totalling $6,339,733. The amounts consisted of distributions of corpus of the Esparto Trust that were sourced from corpus distributions from the Juris Trust and were received by the trustee of the Esparto Trust in its capacity as beneficiary of the Juris Trust. The distributions of corpus from the Juris Trust were in turn sourced from the proceeds of a share buyback received by the trustee of the Juris Trust in connection with a purchase back by Esparto Ltd of the shares held in the company by the trustee. | Thus in summary the facts were: Esparto Ltd paid an amount to the trustee of the Juris Trust in connection with a share buyback, a distribution of corpus was then made in favour of the trustee of the Esparto Trust which in turn made a distribution of corpus in favour of Mr Howard. | The Commissioner assessed Mr Howard on the basis that the amounts received by Mr Howard during the 2006 year from the Esparto Trust formed part of his assessable income for that year. | Administrative shortfall penalty was imposed at 75% for intentional disregard of the law. | Issues Decided by the Court | 1. Whether the amounts received by Mr Howard during the 2006 year from the Esparto Trust formed part of his assessable income for that year; and | 2. Whether, if so, an administrative penalty should be imposed. | Assessability of amounts received by Mr Howard | The Full Federal Court held that the amounts received by Mr Howard were included in his assessable income under subsection 99B(1) of the Income Tax Assessment Act 1936 . This was so because: - the amounts met the statutory description of 'property of a trust estate ... paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income'; and - subsection 99B(2) did not apply to reduce what would otherwise be included in Mr Howard's assessable income under subsection (1): while the amounts paid to or applied for the benefit of Mr Howard represented corpus of the Esparto trust estate, they were also 'attributable to amounts derived by [the Esparto Trust estate, namely distributions of corpus from the Juris Trust received by the trustee of the Esparto Trust] that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer' (see paragraph 99B(2)(a)). | - the amounts met the statutory description of 'property of a trust estate ... paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income'; and - subsection 99B(2) did not apply to reduce what would otherwise be included in Mr Howard's assessable income under subsection (1): while the amounts paid to or applied for the benefit of Mr Howard represented corpus of the Esparto trust estate, they were also 'attributable to amounts derived by [the Esparto Trust estate, namely distributions of corpus from the Juris Trust received by the trustee of the Esparto Trust] that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer' (see paragraph 99B(2)(a)). | The Full Court concluded that the distributions of corpus from the Juris Trust to the trustee of the Esparto Trust would have been included in the assessable of a resident taxpayer if they had been derived by such a taxpayer. This conclusion itself followed from the conclusion that the amounts received by the Juris Trust estate from Esparto Ltd would have been assessable income of the Juris Trust had the trustee of the Juris Trust been a resident taxpayer. | The Court explained this point as follows: 41. ...Section 99B(2)(a) will simply apply as many times as there are interposed layers of trusts. Each application of s 99B(2)(a) leads to a hypothetical question about whether the amounts received by the trust estate would have been assessable income if they had been earned by a resident taxpayer. Once an answer to that question is known at the level of the deepest trust the answer cascades back up to the original (genuine) resident taxpayer. To unpick that slightly: if the Juris Trust estate had been a resident taxpayer and the amounts received by it had been assessable income, then the amounts received by the Esparto Trust, although corpus, would have fallen within the parenthetic excision in s 99B(2)(a) and would have been assessable income in its hands. This, in turn, provides the affirmative answer to the question posed by s 99B(2)(a) as to whether the amounts received by the Esparto Trust estate would have been assessable income on the hypothesis that the Esparto Trust estate was a resident taxpayer. But it is that answer on that hypothesis which applies to Mr Howard himself... | The amounts received by the Juris Trust estate from Esparto Ltd would have been assessable income had it been a resident taxpayer because "that hypothetical taxpayer would have been required to include in its assessable income the dividends paid out of profits deemed by s 159GZZZP(1) to have existed and by s 44(1)(a)(i) to have been assessable" (para 45). (Subsection 159GZZZP(1) deems the proceeds of an off-market share buyback above paid-up capital to be a dividend paid out of profits and paragraph 44(1)(a) includes in the assessable income of a resident shareholder of a company dividends paid to the shareholder by the company out of profits derived by it from any source.) | Penalty | The primary judge found that, rather than showing intentional disregard of the law or recklessness as to the operation of the law, Mr Howard had instead failed to take reasonable care to comply with a taxation law. | The Full Court held that Jessup J's conclusion that Mr Howard's shortfall did not result from an intentional disregard of the law or recklessness as to the operation of the law was "plainly correct" (para 56). The Full Court also agreed with the primary judge's conclusion that the taxpayer had failed to take reasonable care to comply with a taxation law and accordingly an administrative penalty applied at the rate of 25%. While Mr Howard had sought advice from counsel, he had not referred them to the fact that his return of capital had proceeded from a share buyback. The Full Court observed that: 61. ... [i]t was the critical effect of s 159GZZZP(1) which transformed the distribution to income. The lack of reasonable care identified by the primary judge related to the failure of Mr Howard, once he was aware that return of capital was to be accomplished using the means of a share buy-back, to take further advice on the issue.

Issues decided:
1. Whether the amounts received by Mr Howard during the 2006 year from the Esparto Trust formed part of his assessable income for that year; and 2. Whether, if so, an administrative penalty should be imposed. | Assessability of amounts received by Mr Howard: The Full Federal Court held that the amounts received by Mr Howard were included in his assessable income under subsection 99B(1) of the Income Tax Assessment Act 1936 . This was so because: - the amounts met the statutory description of 'property of a trust estate ... paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income'; and - subsection 99B(2) did not apply to reduce what would otherwise be included in Mr Howard's assessable income under subsection (1): while the amounts paid to or applied for the benefit of Mr Howard represented corpus of the Esparto trust estate, they were also 'attributable to amounts derived by [the Esparto Trust estate, namely distributions of corpus from the Juris Trust received by the trustee of the Esparto Trust] that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer' (see paragraph 99B(2)(a)). - the amounts met the statutory description of 'property of a trust estate ... paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income'; and - subsection 99B(2) did not apply to reduce what would otherwise be included in Mr Howard's assessable income under subsection (1): while the amounts paid to or applied for the benefit of Mr Howard represented corpus of the Esparto trust estate, they were also 'attributable to amounts derived by [the Esparto Trust estate, namely distributions of corpus from the Juris Trust received by the trustee of the Esparto Trust] that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer' (see paragraph 99B(2)(a)). The Full Court concluded that the distributions of corpus from the Juris Trust to the trustee of the Esparto Trust would have been included in the assessable of a resident taxpayer if they had been derived by such a taxpayer. This conclusion itself followed from the conclusion that the amounts received by the Juris Trust estate from Esparto Ltd would have been assessable income of the Juris Trust had the trustee of the Juris Trust been a resident taxpayer. The Court explained this point as follows: 41. ...Section 99B(2)(a) will simply apply as many times as there are interposed layers of trusts. Each application of s 99B(2)(a) leads to a hypothetical question about whether the amounts received by the trust estate would have been assessable income if they had been earned by a resident taxpayer. Once an answer to that question is known at the level of the deepest trust the answer cascades back up to the original (genuine) resident taxpayer. To unpick that slightly: if the Juris Trust estate had been a resident taxpayer and the amounts received by it had been assessable income, then the amounts received by the Esparto Trust, although corpus, would have fallen within the parenthetic excision in s 99B(2)(a) and would have been assessable income in its hands. This, in turn, provides the affirmative answer to the question posed by s 99B(2)(a) as to whether the amounts received by the Esparto Trust estate would have been assessable income on the hypothesis that the Esparto Trust estate was a resident taxpayer. But it is that answer on that hypothesis which applies to Mr Howard himself... The amounts received by the Juris Trust estate from Esparto Ltd would have been assessable income had it been a resident taxpayer because "that hypothetical taxpayer would have been required to include in its assessable income the dividends paid out of profits deemed by s 159GZZZP(1) to have existed and by s 44(1)(a)(i) to have been assessable" (para 45). (Subsection 159GZZZP(1) deems the proceeds of an off-market share buyback above paid-up capital to be a dividend paid out of profits and paragraph 44(1)(a) includes in the assessable income of a resident shareholder of a company dividends paid to the shareholder by the company out of profits derived by it from any source.) | Penalty: The primary judge found that, rather than showing intentional disregard of the law or recklessness as to the operation of the law, Mr Howard had instead failed to take reasonable care to comply with a taxation law. The Full Court held that Jessup J's conclusion that Mr Howard's shortfall did not result from an intentional disregard of the law or recklessness as to the operation of the law was "plainly correct" (para 56). The Full Court also agreed with the primary judge's conclusion that the taxpayer had failed to take reasonable care to comply with a taxation law and accordingly an administrative penalty applied at the rate of 25%. While Mr Howard had sought advice from counsel, he had not referred them to the fact that his return of capital had proceeded from a share buyback. The Full Court observed that: 61. ... [i]t was the critical effect of s 159GZZZP(1) which transformed the distribution to income. The lack of reasonable care identified by the primary judge related to the failure of Mr Howard, once he was aware that return of capital was to be accomplished using the means of a share buy-back, to take further advice on the issue.

ATO view of decision:
Assessability of amounts received by Mr Howard | As to the court's approach to the existence of a nominee structure between the Esparto Trust and Esparto Ltd, see below under the heading 'Administrative Treatment'. | As to court's approach to the application of section 99B, the views expressed by the Full Court (applying to a distribution of corpus from a non-resident trust estate), including its approach to paragraph 99B(2)(a), are consistent with the Commissioner's view regarding the operation of the section. | One point regarding the Full Court's treatment of section 99B is however worthy of note. | In considering the assessability of the amounts received by Mr Howard, the Full Court found it unnecessary to consider first the application of section 97. This was so although the framework of Division 6 gives priority to the operation of section 97: by reason of subparagraph 99B(2)(c)(i), the amount that would otherwise be included in assessable income under subsection 99B(1) is reduced by 'so much of the amount as represents ... (c) an amount: (i) that is or has been included in the assessable income of the beneficiary in pursuance of section 97 ...'. | At first instance, Jessup J analysed in detail the operation of section 97 to the affairs of Mr Howard. Jessup J's conclusion was that of the sum of $6,339,733 distributed to Mr Howard: - $3,944,682.61 was included in his assessable income under section 97 (this figure being Mr Howard's share of the net income of the Esparto Trust as calculated using the methodology prescribed in section 96C (specifically in subsection 96C(2)) as required by section 96B) and; - the balance, $2,395,050.39 was included in his assessable income under section 99B. (Refer para 182 of Jessup J's judgment) | - $3,944,682.61 was included in his assessable income under section 97 (this figure being Mr Howard's share of the net income of the Esparto Trust as calculated using the methodology prescribed in section 96C (specifically in subsection 96C(2)) as required by section 96B) and; - the balance, $2,395,050.39 was included in his assessable income under section 99B. | (Refer para 182 of Jessup J's judgment) | The Full Court was able to confine its consideration to the application of section 99B because 51 ... whatever is not included under s 97 will [in this case] be included by the necessary operation of s 99B(2)(c). That provision is a catch-all and, if necessary, as such is apt to catch the whole of the distribution to Mr Howard even if it be not brought to tax under s 97. | Note: while sections 96B and 96C have been repealed, with the repeal taking effect from the 2010-11 year of income, the statutory scheme remains otherwise as described by the Court.

Administrative treatment:
As noted above, the relevant shares that were bought back were held by the Esparto Trust via Juris Ltd, pursuant to a nominee arrangement. The remaining shares held by the Esparto Trust in Esparto Ltd were also held via another entity, again under a nominee arrangement. | As also noted above, in contrast to the approach adopted by the Full Court, Jessup J approached the case by first determining how much of the amount received by Mr Howard was assessable to him under section 97, before considering the application of section 99B to the remainder. | In recognition of the nature of the existence of the nominee arrangements, the Commissioner put forward various alternative arguments as to how sections 159GZZZP(1), 44, 96B, 96C and 97 worked together to assess Mr Howard on a share of the net income of the Esparto Trust. | Justice Jessup however proceeded on the basis that "the existence of Juris between [the trustee of the Esparto Trust] and Esparto [Ltd] cannot be ignored" (para 112). His Honour observed that the "reality" of the case was that Juris Ltd as trustee was the registered holder of the shares in Esparto Ltd that were bought back, not the trustee of the Esparto Trust (para 146): In the present case, there was on any view a distinct trust, albeit a very simple one, interposed between [the trustee of the Esparto Trust] and the share register of Esparto.. [para 156] | This approach is consistent with the Commissioner's view as expressed in the Decision Impact Statement for Colonial First State Investment Ltd v Commissioner of Taxation [2011] FCA 16 that: ... so-called 'bare trusts' (including those referred to as nominee or custodian arrangements) are recognised for all income tax purposes (except pursuant to relevant CGT provisions and in cases materially the same as those in Colonial First State). | Nonetheless, as stated in that DIS: ... the Commissioner understands that there is a current practice of essentially ignoring bare trusts for most income tax purposes, except in situations where the trustee has an obligation to withhold tax or is otherwise liable to pay tax in respect of a beneficiary (for example, pursuant to section 98 of the ITAA 1936)... | The Commissioner therefore concluded in the DIS that: ... notwithstanding his view on this issue, the Commissioner will not generally seek to disturb the current practice (as described above) while [reform options to address this issue] are being considered [by Government]. | Amendments to the law to address the position of bare trusts of the type contemplated in the Colonial First State DIS have not to date been legislated. However, in recognition of the continued prevalence of the practice of essentially ignoring bare trusts for most income tax purposes, and the minimal risk associated with this practice in most instances, the Commissioner proposes to maintain the approach to bare trusts that he has taken in that DIS. We propose to consult with practitioners about the best way to more formally restate this approach. | Implications for impacted ATO precedential documents (Public Rulings & Determinations etc) | N/A | Implications for impacted Law Administration Practice Statements | N/A

Legislative references: Income Tax Assessment Act 1936 Div 6 Pt III sections 44(1) 95 96B 96C 97 99B 159GZZZP(1) 264 Taxation Administration Act 1953 subparagraph 14ZZO(b)(i) subsection 284-90(1) of Schedule 1
Case references: Colonial First State Investment Ltd v Commissioner of Taxation (2011) 192 FCR 298 [2011] FCA 16 (2011) 81 ATR 772 (2011) 2011 ATC 20-235 Federal Commissioner of Taxation v Comber (1986) 10 FCR 88 (1986) 17 ATR 413 (1986) 86 ATC 4171 Federal Commissioner of Taxation v R & D Holdings Pty Ltd (2007) 160 FCR 248 [2007] FCAFC 107 (2007) 2007 ATC 4731 (2007) 67 ATR 790 Howard v Commissioner of Taxation (No 2) [2011] FCA 1421 (2011) 2011 ATC 20-298 (2011) 86 ATR 753 Union Fidelity Trustee Company of Australia Limited v Federal Commissioner of Taxation (1969) 119 CLR 177 [1969] HCA 36 (1969) 69 ATC 4084 (1969) 1 ATR 200
Subject references: Income Tax Non-resident trusts Trust distributions Discretionary trusts