Greenhatch v FCT - CGT Streaming Appeal

On 10 May 2013, the High Court of Australia refused the taxpayer special leave to appeal FCT v Greenhatch [2012] FCAFC 84; [2011] AATA 479.

Accordingly, prior to 1 July 2010 and the amendments made by TLAM No 5 2011, differential streaming of capital gains between trust beneficiaries was ineffective. The beneficiaries of any trust that has differently streamed capital gains will have an exposure to audit activity, amended assessments and penalties.

The FCT will not be undertaking active compliance for the 2009/10 and earlier income years to correct differential capital streaming, unless there is a deliberate attempt to exploit Division 6 ITAA 1936 or the matter is otherwise selected for audit.

Legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax Assessment Act 1997 (ITAA 1997) and the Taxation Laws Amendments (2011 Measures No. 5) Act 2011 (TLAM No 5 2011).

Background

The Elke Trust distributed a capital gain equally to Mr & Mrs Greenhatch and the ordinary income to the related Homestock Trust in the 2008 tax year.

For Mr Greenhatch to be entitled to a deduction for a superannuation contribution, his salary had to be no more than 10% of his gross assessable income (which included the grossed up capital gain).

At issue was whether the assessable income of a beneficiary included a ‘blended’ amount of all classes of income and capital gains of a trust’s taxable income (sec. 97 ITAA 1936; FCT v Bamford [2010] HCA 10) and whether the part (if any) of the trust amount attributed to a trust gain is given a share/proportionate rather than a causative amount construction (sec. 115-215(3)(b) ITAA 1997 in which case Mr Greenhatch’s salary exceeded the 10% threshold.

Full Federal Court of Australia (FCAFC)

The FCAFC (Edmond, Greenwood and Robertson, JJ) held that:

  • ‘…what [Mr Greehatch] received  in the present case was a proportionate share of amounts having no single character’ (at [31]).
  • ‘…once the share/proportionality method under s 97 is used to give the trust amount, it is difficult to apply “part” in s 115-215(3)(b) as a non-proportionate concept.  If the trust amount is calculated as a proportion and “attributable” is given its ordinary meaning, then reconciling the trust amount with the trust gain itself involves a proportional concept’ (at [36]).
  • ‘…once the trust law distribution gave the share, it should not be used to determine, in a causative sense, the components of the s 97(1)(a) assessable income’ (at [36]).
  • ‘As to the words “if any”, the presumption is that they should be given an operation where that is possible…The phrase may therefore have been included in ss115-215(3)(b) and (c) from an abundance of caution.  More importantly the phrase is…inapt to qualify the relationship between the proportionate share of the artificial tax amount and a capital gain, to which we have referred’ (at [40]).

Accordingly, prior to 1 July 2010 and the amendments made by TLAM No 5 2011, differential streaming of capital gains between trust beneficiaries was ineffective.

High Court of Australia (HCA)

At HCA special leave application A. H. Slater QC and M. Y. Bearman (Counsel for Mr Greenhatch), asserted that:

  • The scheme of the Acts is that the liability of a beneficiary to tax on income depends not only on the amount of the beneficiary’s share or interest (the only issue in Bamford) but also on the character or quality of the distributable income and how for trust law purposes that income is distributed.
  • Each of the non-resident beneficiary (s 98A ITAA 1936), exempt income (s 97(1)(b) ITAA 1936), non-assessable, non exempt income (s. 97(1)(c) ITAA 1936), dividend, interest or royalty withholding (ss 128A, 128AF and 6B ITAA 1936), foreign tax credits (ss 770-130(3) and 770-10 ITAA 1997), franked dividends (s 207-35 ITAA 1997) and capital gains (s 115-215 ITAA 1997) provisions is concerned with fixing the liability to tax according to the beneficiary’s entitlement to a share or, individual interest in, or what is attributable and a construction under which some provisions treat a receipt as retaining its character while others result in an undifferentiated pro-rated allocation of the character does not achieve a construction with a harmonious result.
  • The FCAFC’s misapplied the reasoning in Bamford and ascribes to “attributable” in s 115-215 a simple proportionate allocation based on quantity regardless of the position at trust law and without the necessary nexus of character or source of income.
  • Special leave should be granted because the fiscal consequences of differential streaming potentially affects a significant proportion of the 700,000 trusts lodging tax returns in Australia and the proportional allocation issue is equally applicable to the TLAM No 5 provisions because there is no material difference between the meaning of “attributable to” and “referable to” in the new provisions.

The HCA (Crennan and Keane, JJ) refused special leave because no question of law of public importance was raised and there were insufficient prospects of success on any appeal to warrant the grant of special leave.

Consequences

The FCAFC decision requires a beneficiary to include in assessable income a ‘blended’ amount of all of the different types of income and capital gains included in the trust’s taxable income.  Accordingly, the beneficiaries of any trust that has differently streamed capital gains for the period prior to 1 July 2010 will have incorrectly recorded the taxation treatment of that distribution so have an exposure to audit activity, amended assessments and penalties.

PSLA 2010/1 at [10] states:

Because there had been considerable uncertainty before the decision in Bamford about the principles applicable to the operation of Division 6, it may be expected that some taxpayers will have lodged tax returns and/or administered their trusts on the basis of views that, with the benefit of the decision in Bamford, may be seen to be wrong. Accordingly, staff undertaking active compliance activities in respect of the 2009-10 and earlier income years should not select cases for active compliance just to correct such errors. However, if there is a deliberate attempt to exploit Division 6 (see paragraph 11 of the practice statement) or cases are selected for other reasons (for example, because there is a dispute about the quantum of the [tax] net income), and adjustments are to be made, the adjustments must be made on the basis of the law as explained in Bamford.

The FCT will not be undertaking active compliance for the 2009/10 and earlier income years to correct differential capital streaming, unless there is a deliberate attempt to exploit Division 6 or the matter is selected for other reasons (for example, because there is a dispute about the quantum of the [tax] net income etc).

PSLA 2010/1 provides limited protection from audit expansion, shortfall penalties and interest charges because PSLA 2010/1 is not administratively binding on the FCT as with Rulings and does not make any statements regarding tax penalties or other relevant issues that can be relied upon by a taxpayer as protection against shortfall penalty or interest charges.

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