The taxation of trusts has always been a hot topic that generates significant debate.  The debate keeps rolling as the taxpayers and the Commissioner have been granted special leave to appeal to the High Court against the Full Federal Court decision in Bamford v Commissioner of Taxation.

In Bamford, the Full Federal Court accepted the Commissioner's view and applied the proportionate approach to determine how taxable income should be divided amongst beneficiaries where it differs from trust or accounting income. 

However, the Full Court also held that the amount ultimately assessable to beneficiaries can be an amount "ascertained by the trustee according to appropriate accounting principles and the relevant trust instrument and in accordance with the ordinary concept of income..."

The Court held that if a trust deed gives the trustee the power to reclassify receipts as either capital or revenue, and the trustee exercises its discretion, this reclassification will be effective for taxation purposes.  Accordingly, the trust deed is paramount in determining the beneficiaries' assessable income.  The whole of the trust deed must be considered, rather than just the discretions contained in the income clauses.

If the High Court upholds the Full Federal Court's decision, this will support the approach that is currently adopted by many trustees and beneficiaries.

The Commissioner has issued Practice Statement PS LA 2009/7 (Practice Statement), which indicates that the ATO will continue to apply the Commissioner's views regarding how trustees and beneficiaries are taxed, despite the Full Federal Court's decision in Bamford. 

The ATO will not select cases for active compliance solely with a view to applying the views the Commissioner argued in Bamford, except where taxpayers are deliberately exploiting the operation of the tax law to avoid some or all of their tax liability.  However, the ATO will continue its ongoing compliance action in respect of trusts engaged in aggressive tax planning and to detect under reporting by beneficiaries and/or trustees.

The Practice Statement provides that the ATO will not impose penalties on trustees and beneficiaries who have lodged their income tax returns based on the Full Federal Court's views in Bamford or any alternative view that is reasonably open having regard to the other relevant authorities.  The ATO will also take these views into account when determining whether to remit any shortfall interest charge or general interest charge.  This treatment will not apply to taxpayers involved in tax avoidance schemes.

The ATO will seek agreement from relevant taxpayers to defer the issue of rulings and objection decisions, and to adjourn Administrative Appeals Tribunal and Federal Court hearings in cases that involve the issues raised in Bamford.  If a taxpayer does not agree to a deferral or adjournment, the ATO will issue a ruling or an objection decision that reflects the Commissioner's views as argued in Bamford, or will ask the court or tribunal to adjourn the matter.  If a case proceeds to hearing, the ATO will acknowledge that the court or tribunal is bound by Bamford but formally submit that the Full Federal Court's decision regarding the "income of the trust estate" is wrong and request that the court or tribunal reserve its decision until the outcome of Bamford is known.

The Bamford decision highlights just how important it is for trustees and advisors to read trust deeds carefully from start to finish!  It provides an incentive for trustees to consider whether the provisions in their trust deeds suit their requirements and, if not, whether they can be amended to suit their requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.