Decision in Bamford v Commissioner of Taxation

On 30 March 2010, the High Court of Australia delivered its much awaited decision in Bamford v Commissioner of Taxation, a case of fundamental importance in the taxation of trusts.

In a comparatively brief judgement, the court affirmed the decision of the Full Federal Court of Australia and dismissed both the appeals of the Commissioner and that of the taxpayer.

What is the importance of the decision?

1. This case confirms the 'proportionate view' in relation to the taxation of the net income of the trust estate. For the purposes of working out a beneficiary's tax liability the same proportion (rather than 'part') of the share of the income the beneficiary is entitled to, in relation to the 'trust' income, is applied to the 'taxable' income in working out the beneficiary's liability. Even if the 'share' of the trust income is expressed as a defined dollar sum bears to the total income is then applied to the tax income, to work out the tax.

2. This case confirms that the terms of the trust are important in working out what is the 'trust' income and in working out who has 'present entitlement', which then determines the ultimate liability in paying tax. The terms of the trust deed may, for example, reclassify receipts to determine where the ultimate liability to tax will lie. A capital gain, for example, which is statutory income, might be reclassified as 'income' for trust purposes in order to be allocated to a person or entity of choice.

So what should you do?

The Bamford Case emphasises that the terms of the trust deed determines whether there is any income of the trust estate for the purposes of section 97 of the Income Tax Assessment Act.

According to the terms of the trust deed, the trustee can reclassify a receipt as capital or income depending on the circumstances, which will avoid the situation where the beneficiary is taxed on money that he or she has not received if the trust or accounting income differs from tax income.

It is therefore important to consider the terms of your client's discretionary trust deeds and consider whether they warrant amending. Deeds can be amended to incorporate additional changes regarding classification powers, to income provisions which:

• Define the trust estate's income based on a number of criteria; to enable the trustee to choose (for section 97 of the Income Tax Assessment Act purposes) between tax income, accounting income, or accounting income, as modified by the administrative powers contained in the trust deed.

• Reclassify receipts and distributions to achieve a flexible tax outcome; i.e. to reclassify both capital receipts as income receipts and vice versa and capital distributions as income distributions and vice versa;

• Allocate expenses against income or capital; at the trustee's choice; and

• Recoup losses out of either current year profit or capital; at the trustee's choice.

Amending a pure discretionary trust incorporating these administrative powers does not, by law, give rise to resettlement issues unless there is a possibility the beneficiary's interests will be affected.

Reckon Docs can amend your deeds to incorporate the above provisions.

Please contact Help Desk on 1300 139 001 to find out what is required.