Lessons learned from Carter – planning for effective trust distributions and disclaimers
Carter v Commissioner of Taxation  FCAFC 150 (Carter) involves a long running dispute with the Commissioner of Taxation.
This particular iteration of the dispute deals with disclaimers of trusts interest by default beneficiaries. These default beneficiaries were assessed with additional income as a result of amended assessments increasing the taxable income of the trust.
Because the beneficiaries never received any income in fact, but only as an operation of default provisions, they attempted to disclaim the trust interests, so as to escape the tax consequences that followed.
The facts of the case were as follows:
(a) the taxpayers were default beneficiaries of a discretionary trust. Clause 3.7 of the trust deed read:
‘If… the Trustee has made no effective determination pursuant to the preceding provisions of this clause in respect to any part of the income of that Accounting Period immediately prior to the end of the last day of that Accounting Period, then the Trustee shall hold that income in trust successively for the persons who are living or existing on the last day of that Accounting Period and who are successively described in clauses 4.1 to 4.5.’
(b) the trustee resolutions made for the trust in the 2011 – 2014 income years were deemed invalid by the ATO;
(c) because of this, the ATO then sought to issue amended assessments to the default individual beneficiaries of the trust (the taxpayers); and
(d) the taxpayers then sought through a series of Deeds of Disclaimers to disclaim their interests for the years 2011 – 2014.
While the ATO accepted disclaimers for the years 2011 – 2013 (first disclaimer), the 2014 disclaimer (second disclaimer) was not accepted by the Commissioner (despite it being on identical terms to the earlier disclaimer the Commissioner stated that his acceptance of the earlier disclaimer was wrong).
The second disclaimer (and for that matter, the first disclaimer) only purported to disclaim the default distribution made in each specific year. Based on ample case law, this was ineffective to disclaim the gift contained in clause 3.7 of the trust. To effectively disclaim this gift, the beneficiaries needed to disclaim default distributions in all years in a timely manner, without acting in a way that was inconsistent with that disclaimer.
To correct this mistake, the beneficiaries executed a third disclaimer which purported to disclaim the gift in a manner that adequately satisfied the authorities.
The Commissioner then challenged the third disclaimer, arguing that the operation of the Income Tax Assessment Act had already disposed of the issue of present entitlement to the taxable income of the trust at 30 June 2014 (the year in question).
That is, the disclaimer essentially could not have a retrospective operation.
The Commissioner relied, in part, on a NSW Court of Appeal decision involving grouping for payroll tax purposes Smeaton Grange Holdings v Chief Commissioner of State Revenue  NSWSC 1954, which concluded that for grouping purposes, the beneficiaries of a trust were those in existence of each payroll tax period (i.e. monthly), and a later disclaimer did not change that position.
The Full Federal Court unanimously allowed the taxpayers’ appeal and confined Smeaton Grange to the statutory regime concerning payroll tax grouping.
The Commissioner feels aggrieved by this decision and has sought special leave to appeal to the HCA – no doubt intending to highlight the seeming discrepancy between two courts of appeal on the validity of retrospective disclaimers.
Whichever way the High Court decides to proceed, this case like others before it, highlights the need to identify default beneficiaries carefully. If a trustee receives an amended assessment in a year where the trustee believed it had no taxable income, the likelihood is that default beneficiaries will wear tax that they did not expect. As this can often occur when they also received no income, the results can be particularly galling.
For further information on any of the issues raised in the alert, please contact a member of our tax team below.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.