Federal Commissioner of Taxation v Thomas; Federal Commissioner of Taxation v Martin Andrew Pty Ltd; Federal Commissioner of Taxation v Thomas Nominees Pty Ltd; Federal Commissioner of Taxation v Thomas

The High Court has allowed one appeal, partly allowed a second appeal, and dismissed two appeals from a decision of the Full Federal Court on the taxation of franked distributions from trusts. In 2006 to 2008, the trustee (Thomas Nominees Pty Ltd) of a trust (the Thomas Investment Trust), received franked distributions within the meaning of div 207. Division 207 of pt 3-6 of the Income Tax Assessment Act 1997 (Cth) lays out the tax implications of trust income that includes franked distributions. In those years, the trustee passed resolutions that sought to distribute the franking credits between the trust’s beneficiaries separately from, and in different proportions to, the income that comprised the franked distributions (see details at [20]ff). The trustee referred to this as the ‘Bifurcation Assumption’, and lodged tax returns on the basis that this was legally effective under div 207. In 2010, the Queensland Supreme Court issued ‘directions’ to the Trustee that those resolutions did give effect to the Bifurcation Assumption, and that this was legally effective under div 207.

Two of the beneficiaries (the taxpayers) filed appeals in the Federal Court under pt IVC of the Taxation Administration Act 1953 (Cth), arguing that the Bifurcation Assumption was not legally effective under div 207 (see at [34]ff). The central issue before the High Court was whether the FCAFC was bound by the directions given by the QSC and its holding that the Bifurcation Assumption was in line with div 207, and, if the FCAFC was not so bound, how div 207 should apply to the trustee’s resolutions.

The High Court (Kiefel CJ, Bell, Keane, Nettle, Gordon and Edelman JJ, and Gageler J) unanimously held that the FCAFC erred in holding that it was bound to follow the QSC ruling. The FCAFC ‘misunderstood and misapplied’ the central case on directions,

Executor Trustee & Agency Company of South Australia Ltd v Deputy Federal Commissioner of Taxes (SA) [1939] HCA 35: the High Court there held that general law rights of trustees and beneficiaries inter se (that is, rights between themselves), to the extent that they are defined by a court, are defined ‘as against the Commissioner unless the decision is set aside’ (at [54]). That case did not determine the rights against third parties, or apply tax law to those right: consequently, Executor Trustee is not authority for the proposition that the Commissioner or a court should determine the application of taxation legislation otherwise than according to law: ‘directions made under the equivalent of s 96 of the Trusts Act do not bind the Commissioner in the application of the taxation laws.’ (at [55], emphasis in original). Further, the question for the QSC concerned the management of the trust: it did not decide how the tax acts should operate, and the Commissioner was not part of those proceedings (see [57]ff).

Turning to the second issue, the joint judges rejected the taxpayers’ ‘alternative construction’ of the resolutions that the franked distributions were ‘notionally allocated’ to match the purported separate distribution of the franking credits. This construction ran against the terms of the resolutions, which did not attempt to stream or allocate franked distributions to one of the beneficiaries and the rest of the income to the other (at [66]ff). As a result, ‘there was simply no income left over that was capable of being dealt with by the Franking Credit Resolution’ (at [70]). Further, that resolution was based on the Bifurcation Agreement, which the taxpayers conceded was legally ineffective, and attempts, contrary to law, to treat franking credits as income (at [70]). Finally, the taxpayers’ construction runs against the intention of the Trustee in passing the resolutions (see [73]).

Finally, the joint judges rejected the taxpayers’ three further issues on estoppel (at [75]ff), rectification (at [78]ff) and denial of procedural fairness (at [80]ff). The joint judges allowed the appeals in relation to the 2006, 2007 and 2008 income years, and remitted the matters to the Commissioner, and dismissed the other two appeals.

Gageler J agreed with the reasoning of the plurality and joined their orders, adding observations on taxable facts and Executor Trustee. For Gageler J, taxable facts means the ‘combination of events that have occurred and legal consequences of events that have occurred on which a taxing statute fixes to impose a taxation liability or to confer a taxation benefit’, which are most often ‘independent of and antecedent to’ those tax consequences (at [84]). His Honour emphasised that Executor Trustee was concerned with identifying the ‘taxable facts’ of an ‘independent and antecedent nature’: the Supreme Court of South Australia’s construction of the will in that case, whether it was ‘”right” or “wrong”‘, had made an order on the legal entitlements of the beneficiaries among themselves: and these were ‘the taxable facts on which the taxing statute operated’: (at [93], and see at [86]ff). In this case, the QSC purported to not just make a direction to the Trustee, but also a declaration to determined the legal entitlements of the beneficiaries (at [94]). Unlike the SASC in Executor Trustee, the ‘subject matter’ of the QSC’s order ‘is not a taxable fact existing independently of and antecedently to the operation of the taxing statute’: franking credits do not exist ‘in nature or general law’ but only through the operation of div 207 (at [97]). For Gageler J, while the QSC order was wrong, the ‘cirtical point’ was that it was irrelevant to the making of assessments, and the determination of any question of fact or law under a pt IVC appeal (at [98]), and the FCA’s jurisdiction and duty was to determine for itself all contested issues of fact and law in examining this matter (at [99]).

High Court Judgment [2018] HCA 31 8 August 2018
Result One appeal allowed, one appeal partly allowed, two appeals dismissed
High Court Documents Thomas
Full Court Hearing [2018] HCATrans 62 10 April 2018
Special Leave Hearing [2017] HCATrans 206 20 October 2017
Appeal from FCAFC [2017] FCAFC 57 12 April 2017
Judgments, FCA [2015] FCA 1339 26 November 2017
[2015] FCA 968 31 August 2015
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About Martin Clark

Martin Clark is a PhD Candidate and Judge Dame Rosalyn Higgins Scholar at the London School of Economics and Political Science and Research Fellow at Melbourne Law School. He holds honours degrees in law, history and philosophy from the University of Melbourne, and an MPhil in Law from MLS. While at MLS, he worked as a researcher for several senior faculty members, was a 2012 Editor of the Melbourne Journal of International Law, tutor at MLS and various colleges, a Jessie Legatt Scholar, and attended the Center for Transnational Legal Studies Program.