The Trustee for MH Ghali Superannuation Fund and Commissioner of Taxation

Court Citation(s):
[2012] AATA 527
2012 ATC 10-266

Venue: AAT
Venue Reference No: 2010/4923-4924
Judge Name: SM Fice
Judgment date: 10 August 2012
Appeals on foot:No
Decision Outcome: Favourable to Commissioner

Administrative Treatment (Implication on current Public Rulings and Determinations)

Relevant Rulings/Determinations:

 Taxation Ruling TR 2006/7: Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income)

Subject References:
Superannuation fund
Unit trust
Fixed entitlement
Arm's length income
Special income
Distributions of income

Précis

Outlines the ATO's response to this case which concerned a superannuation fund that received distributions of income from a unit trust. The question before the AAT was whether those distributions were special income under s 273(6) or (7) of the ITAA36.

Brief Summary of Facts and Issues

The MH Ghali Superannuation Fund (the Super Fund) held units in the Ghali Unit Trust (the Unit Trust) and derived income as a beneficiary of the Unit Trust. The main question for resolution in the case was whether such income of the Super Fund was 'special income' (otherwise known as non-arm's length income) and so taxable at the rate applicable to the special component of the income of a complying superannuation fund.

There were two bases on which the income could be special income. The first was if the income was derived 'other than by virtue of holding a fixed entitlement to the income' (s 273(6) of the Income Tax Assessment Act 1936 (ITAA36)).

The trust deed relevantly provided at clause 2.7 for:

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the Trust Fund initially to be divided into a number of $1 units classified as A Class, B Class, C Class and D Class units;

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A Class units [of which the Super Fund was the majority holder] to carry an entitlement to a share in the capital of the Trust Fund upon the termination of the trust;

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the distribution of the income of the trust in accordance with the provisions of clause 12;

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the right to one vote in respect of each unit held; and

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the right to resolve by unanimous agreement with other A Class unit holders the amount of the income to be distributed to the holders of B, C and D Class units.

The trust deed also provided certain discretions to the Trustee in respect of the income, including:

12.3.1 The Trustee may subject to the provisions in this clause and subject to any special rights or restrictions provided in clause 2.7 in relation to units of any class distribute at any time to any one or more of the classes of Unitholders or to any one or more of the unitholders within a particular class to the exclusion of other unitholders such of the income of the Trust Fund as the Trustee may in its absolute and uncontrolled discretion decide .

...

12.3.11 The Trustee shall in its absolute discretion determine which class of Unitholders shall be presently entitled to such Income of the Trust Fund as is agreed upon in accordance with the requirements of clause 12.3.1 and in default of such determination the Unitholders in the same proportions as they hold units in the Trust Fund shall notwithstanding classification be presently so entitled .

The second basis on which the income would be special income was if a fixed entitlement to the income (or the income itself) was derived under an arrangement some or all of the parties to which were not dealing at arm's length and the amount of income was greater than might have been expected to have been derived if the parties had been dealing at arm's length (s 273(7) of the ITAA36).

The Tribunal made findings of fact concerning the circumstances in which units were acquired and circumstances in which the income was distributed. In broad terms, the Tribunal considered that there was non-arm's length dealing.

There were two further issues in the case that are not discussed in detail in this Decision Impact Statement. One was whether a capital gain was properly taken into account in the 2006 year in calculating the net income of the Unit Trust, and hence assessable income of the Super Fund. The other was the application of shortfall penalties.

Issues decided by the Tribunal

The Tribunal decided that:

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The Super Fund held a fixed entitlement to income for the purposes of s 273. The Tribunal considered that fixed entitlement was defined in Schedule 2F to the ITAA36, and that relevantly the Super Fund held a vested and indefeasible interest.

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The Super Fund did not acquire the fixed entitlement, or derive the income, pursuant to an arrangement where the parties were dealing at arm's length, and the income was more than might have been expected had the parties been dealing at arm's length. Accordingly, the Tribunal concluded that the relevant amounts were 'special income' of the Super Fund.

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The capital gain was properly included in the net income of the Unit Trust in the 2006 income year.

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The 25% shortfall penalty was not unjust or excessive.

ATO view of Decision

The case concerned the application of the 'special income' rules in s 273 of the ITAA36. That section has now been replaced by the 'non-arm's length income' rules in s 295-550 of the Income Tax Assessment Act 1997 (ITAA97). The new section is relevantly in the same terms. Accordingly, while the comments below concern s 273, they are equally applicable to s 295-550.

The Commissioner was successful in this case because the Tribunal considered that the relevant trust entitlement was acquired, and income derived, through non-arm's length dealing.

However, the Tribunal's reasoning differed from the Commissioner's on one issue, namely whether the income derived by the Super Fund was by virtue of a fixed entitlement to income.

In that regard, there are two aspects of the Tribunal's reasoning that warrant further comment:

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The Tribunal considered that 'fixed entitlement' in s 273 takes the meaning provided in s 272-5 in Schedule 2F to the ITAA36. This is contrary to, and would be less favourable to taxpayers than, the Commissioner's existing approach.

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Section 272-5 of Schedule 2F provides that if a beneficiary has a vested and indefeasible interest in a share of income of a trust that the trust derives from time to time, the beneficiary has a fixed entitlement to that share of income. The Tribunal made some observations regarding the nature of that test which are discussed further below. Because of the way the case was argued, the Tribunal did not have the benefit of submissions on the way in which the test operates including relevant case law.

Because the Commissioner's objection decision was affirmed, the Commissioner could not appeal and seek to have these issues considered further by the Federal Court.