The recent New South Wales Supreme Court case of Smeaton Grange Holdings Pty Ltd v Chief Commissioner of State Revenue [2016] NSWSC 1594 highlights how discretionary trusts can be caught up in payroll tax groups – even where those trusts are not carrying on a business. The decision also highlights a possible solution.
The technical issue is that under all state payroll tax legislations, potential beneficiaries of a discretionary trust are deemed to have a controlling interest in that trust.
This means that if a discretionary object of a trust also has a controlling interest in an entity that runs a business, then the trust and that business entity will be grouped for payroll tax purposes.
The effect of this grouping is that:
- all grouped entities' taxable wages are included in working out whether:
-
- each entity is required to be registered; and
- the amount of payroll tax to be paid by the group; and
- allmembers of the group are jointly and severally liable for the payroll tax obligations of the group – regardless of whether the entity actually pays wages.
It was the second issue that resulted in the litigation in Smeaton Grange.
The group in Smeaton Grange
In Smeaton Grange, an operating entity had outstanding payroll tax. In an attempt to collect this, the NSW Office of State Revenue issued assessments to the trustees of two trusts it considered members of the payroll tax group. The Commissioner concluded that the trusts were grouped because Michael Gerace was a discretionary object of those trusts.
- One of the trusts was Michael's brother's family trust, and Michael fell within the eligible class of beneficiaries because he was the sibling of a primary beneficiary (his brother).
- The other trust was his parents' family trust and, even though the deed had been lost, the parties accepted that Michael and his brother were likely to be beneficiaries of that trust.
Under the deeming provisions, Michael was deemed to have a controlling interest in both trusts. He also had an actual controlling interest in the operating entity as its sole shareholder and director.
What happened next?
In response to these assessments, Michael disclaimed any interest that he had in both trusts with effect from the date of settlement of those trusts.
The potential effect of this disclaimer was that:
- Michael was never a discretionary object – and therefore never deemed to have a controlling interest in his parents' trust and his brother's trust; and
- the trusts were never grouped with the operating company and therefore never had joint and several liability.
The decision
The Court decided that the disclaimer was effective and that it did operate retrospectively. The reason for this was that Michael had never considered whether he should agree to be a discretionary object of the trusts and had therefore never accepted his rights as a discretionary object of the trusts.
He was able to disclaim his rights as a discretionary object and, when he did, it was as if the rights never existed.
In dealing with the retrospective issue, the Court held that Michael's rights as a discretionary object were disclaimed ab initio. In other words, under the general law the disclaimer's effect was that Michael was taken never to have been a discretionary object of the trusts.
In our view, the decision may have been different if Michael had turned his mind to whether he wanted to be a discretionary object of, or had ever received a distribution from, either trust.
Silver bullet for grouping issues?
This case highlights the alarming breadth of the payroll tax grouping provisions, particularly in the way that they capture discretionary trusts, even where those trusts are not involved in the business generating the taxable wages.
White J in Smeaton Grange put it this way:
Moreover, persons may be discretionary objects of discretionary trusts without their knowledge. There may be many discretionary trust deeds under which the whole world other than specifically excluded individuals are potential discretionary objects. The grouping provisions could operate oppressively if the general law principles in relation to disclaimer did not have their full operation.
(emphasis added)
The case also confirms that disclaiming discretionary rights can, in some circumstances, be an effective strategy in correcting inadvertent grouping issues (although there will be potential tax and duty issues that would need to be considered).
The decision in Federal Commissioner of Taxation v Ramsden [2005] FCAFC 39 demonstrated what is required for a disclaimer to be effective.
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