High Court upholds Bamford trust taxation decision

The High Court decision in the Bamford case (on appeal from the Full Federal Court) was recently handed down and will have an impact on the taxation of all trusts.

The case addressed some key elements of trust taxation, in particular the meaning of "income of the trust estate" and the "share" of net income that is assessable to a beneficiary. Following is a brief summary of the findings of the High Court case.

Income of the trust estate
The tax law requires beneficiaries to include an amount in their assessable income where they are presently entitled to a share of the "income of the trust estate".

The term "income of the trust estate" is not defined in the tax law and has historically led to mixed interpretation - particularly from the Commissioner of Taxation. In the Bamford case, the Commissioner argued that "income of the trust estate" meant income according to ordinary concepts and could not be dictated by the terms of a trust instrument such as a trust deed.

The High Court has confirmed that "income of the trust estate" is income as defined in the trust instrument.

In the case of Bamford, this meant that capital gains made by the trust could be distributed to and taxable to income beneficiaries instead of being taxable to the trustee.

What share?
The law then requires beneficiaries presently entitled to a share of trust income to include "that share" of net income of the trust estate (as calculated for tax purposes) in their assessable income.
 
In situations where there has been a disparity between the net income and the distributable income of a trust estate, the meaning of "that share" has also been the subject of debate.

The Bamfords' position was that the taxable amount attributable to a beneficiary should "follow from the distribution of income according to the terms of the trust" and accordingly, beneficiaries should only be taxable on an amount equal to their distributable income.

The High Court rejected this submission and upheld the previous position of the Full Federal Court that the taxable net income of the trust estate should be allocated to beneficiaries based on their share or proportion of distributable income from the trust estate.

This decision confirms the commonly held view that the "proportionate" approach is the correct way to allocate taxable income to beneficiaries.

Implications of the decision
The High Court findings in Bamford upheld those made by the Full Federal Court and therefore do not change existing law. However, it may change the Commissioner's approach to these issues and we will be watching for releases by the Commissioner.

In dealing with these issues, the terms of every trust deed are critical, and in particular how they define "income" of the trust estate.

This will determine the ability of trustees to distribute amounts such as capital gains. All distribution minutes for trusts must be drafted in accordance with the terms of the trust deed.
 
Some other issues that need to be considered in light of this decision include the ability of trustees to distribute fixed amounts to minors and other beneficiaries, and to stream classes of income to selected beneficiaries.

For more information on the recently updated draft R&D legislation , contact your usual Grant Thornton advisor or the author of this article.

Author, Peter Godber, April 2010

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