Private ruling: Taxation treatment of trust income
Published: April 2014
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the trustees for the bankrupt estate liable to tax in relation to interest earned on the controlled money account (CMA) during the financial year ended 30 June 2012? | A1: No. | Q2: Are the Trustees liable to tax in relation to interest earned on the CMAs during the financial year ended 30 June 2013? | A2: Yes.

Relevant facts and circumstances: Trustees were appointed to a bankrupt estate under the Bankruptcy Act 1966 . The bankrupt was the registered owner of two properties which became subject to dispute upon their sale. Property one A contract was entered into to sell the property. A caveat was placed on the property by Person Z as they advised they had an equitable claim in the property. It was agreed that at settlement, a portion of the sale proceeds would be placed in a controlled money account (CMA) pending the resolution of the equitable claim. Entity Y was the trustee of the CMA ('the Entity Y CMA'). The sale proceeds were deposited into the Y CMA during the 2011-12 financial year and earned interest in the 2011-12 and 2012-13 financial years. No agreement existed between the Trustee, Person Z and Entity Y as to the treatment of the interest earned on the Entity Y CMA prior to the dispute being settled. No party had an indefeasible right to ask for the payment of the interest earned on the funds deposited in the Entity Y CMA prior to the dispute being settled. The dispute was settled during the 2012-13 financial year and the Entity Y CMA closed. Property 2 Property 2 was owned by the bankrupt and others. Person X advised they had a higher equitable claim than that shown on the title deed. A contract was entered into to sell the property. It was agreed that at settlement the net sale proceeds were to be paid into a CMA account pending the resolution of the equitable claim. Entity W was the trustee of the CMA ('the Entity W CMA'). The net sale proceeds were deposited into the Entity W CMA during the 2012-13 financial year and earned interest. No agreement existed between the Trustee, Person X and Entity W as to the treatment of the interest earned on the CMA prior to the dispute being settled. No party had an indefeasible right to ask for the payment of the interest earned on the funds deposited in the CMA prior to the dispute being settled. The dispute was settled during the 2012-13 financial year and the Entity W CMA was closed.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 97 | Income Tax Assessment Act 1936 Section 98 | Income Tax Assessment Act 1936 Section 99 | Income Tax Assessment Act 1936 Section 99A

Reasons for decision: Summary: The Trustees are not assessable on interest earned in the Entity Y during the 2011-12 financial year as the bankrupt estate was not presently entitled to the income earned during this period. The Trustees are assessable under section 98 of the Income Tax Assessment Act 1936 (ITAA 1936) on that portion of the interest earned on the Entity Y CMA and the Entity W CMA during the 2012-13 financial year which the bankrupt estate is presently entitled to. | Detailed Reasoning - Taxation of trust income: Where a trust earns assessable income in a financial year, it must be determined who has the obligation to pay tax on that income. The taxation treatment of trust income is contained within Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936). The obligation and rates of tax applicable are dependent upon various factors including: • if any beneficiaries were entitled to receive the income or have the income dealt with on their behalf (present entitlement) • if the beneficiary is under a legal disability, and • the source of the income. Section 97 of the ITAA 1936 states a beneficiary is assessable if the beneficiary is presently entitled to the income of the trust, is not under a legal disability and is a resident at the end of the income year. The trust income is included in the beneficiary's return and taxed at the individual tax rates. Section 98 of the ITAA 1936 states that a trustee is assessable on behalf of a resident beneficiary who is presently entitled to the income of the trust but is under a legal disability. A person is under a legal disability if they are a minor, a bankrupt or declared legally incapable because of a mental condition. The trust income is taxed at the individual tax rates. Where there is no beneficiary presently entitled to all or part of the income of the trust, the trustee is assessable on that portion of the net income for which no beneficiary is presently entitled. This income is taxed at special rates under section 99A of the ITAA 1936 except where the trust: • is a deceased estate • is a bankrupt estate administered by the Official Receiver or a registered trustee appointed under the Bankruptcy Act 1966 , or • consists of certain types of property specified in section 102AG(2)(c) of the ITAA 1936, for example, damages for loss or parental support or for mental or physical injury. Where an exception applies, the trustee will be taxed under section 99 of the ITAA 1936 at individual tax rates. | Detailed Reasoning - Present entitlement: Present entitlement is a trust law concept. A beneficiary of a trust will be considered to be presently entitled to trust income where they have an indefeasible, absolutely vested, beneficial interest in possession of the trust income. That is, the beneficiary has a right to the trust income, either immediately or in the future. The beneficiary must also be able to demand immediate payment of the trust income, or would have been able to demand immediate payment had they not been under a legal disability. A beneficiary must be presently entitled to income by the last day of the income year in which the income is derived by the trust (that is, by 30 June in the case of a trust with a regular accounting period). In Harmer & Ors v. FC of T 91 ATC 5000; (1991) 104 ALR 117; (1991) 66 ALJR 89; (1991) 22 ATR 726; (1991) 173 CLR 264, ( Harmer's case ) the High Court considered the issue of present entitlement to disputed funds held on trust. In that case, the taxpayers were three solicitors acting for parties in dispute (the claimants) over certain moneys. The money was deposited into a building society account held in the names of the three solicitors as trustees awaiting an order to be made by the court. Interest was earned on the deposited funds both prior and after the court order was made. The taxpayers were assessed in their capacity of trustees of an alleged 'Court Trust' on the interest earned prior to the court order. The taxpayers disputed this assessment on the basis that the claimants were presently entitled to the income of the 'Trust' even though the amount each party was entitled to could not be quantified. The Court determined that until the order regarding the disputed funds was made, no claimant had a vested interest in the moneys lodged with the building society, in the interest earned on it or in the rights of the taxpayers as legal creditors of the building society. It followed that none of the claimants were presently entitled to the income of the fund and, accordingly, the taxpayers were assessable pursuant to section 99A of the ITAA 1936 in respect of interest earned in the years prior to the court order being made. | Detailed Reasoning - Interest earned in the 2011-12 financial year: Interest was earned on the Entity Y CMA during the financial year ended 30 June 2012. As stated above, the depositing of the funds into the Entity Y CMA resulted in the creation of a trust. Present entitlement is generally determined on the last day of the income year, in this situation, 30 June 2012. As the dispute had not been resolved on this date and no agreement existed as to the treatment of the interest the principle established in Harmer's case should be followed. That is, no beneficiary has present entitlement to the interest income earned in the Entity Y CMA. As the bankrupt estate was not presently entitled to any of the Entity Y CMA interest income, this interest income is not included in calculating the bankrupt estate's net income. Therefore, the Trustees are not liable to tax on the interest earned in the Entity Y CMA during the 2011-12 financial year. | Detailed Reasoning - Interest earned in the 2012-13 financial year: Interest was earned on the Entity Y CMA and the Entity W CMA during the financial year ended 30 June 2013. The Entity Y CMA was closed during the 2012-13 financial year. The date the CMA was closed is the date this trust ceased and therefore is the date used to determine present entitlement. As the dispute regarding the Entity Y CMA funds was settled prior to the CMA being closed, the bankrupt estate had present entitlement to the interest earned on this account. Similarly, the Entity W CMA was closed during the 2012-13 financial year. Again, the date the CMA was closed is the date this trust ceased and therefore is the date used to determine present entitlement. As the dispute regarding the Entity W CMA funds was settled prior to the CMA being closed, the bankrupt estate had present entitlement to the interest earned on this account. As the present entitlement exists on the last day the respective trusts derived income, the bankrupt estate's share of each CMAs interest income is included in calculating the net income of the bankrupt estate for the year ended 30 June 2013. As bankrupts are considered to be under a legal disability, the Trustees are liable for the tax on the interest earned during the 2012-13 financial year on the Entity Y CMA and the Entity W CMA. This income will be included in the trust income and taxed under section 98 of the ITAA 1936 using the individual tax rates.