Decision Impact Statement
Raftland Pty Ltd as trustee of the Raftland Trust v Commissioner of Taxation
 HCA 21
2008 ATC 20-029
68 ATR 170
Venue: High Court
Venue Reference No: B39/2007
Judge Name: Gleeson CJ, Gummow, Kirby, Heydon and Crennan JJ
Judgment date: 22 May 2008
Appeals on foot:
Administrative Treatment (Implication on current Public Rulings and Determinations)
Present entitlement to income of a trust estate
Precis for the web page index: Whether both the apparent appointment of the trustee of a loss trust as a tertiary beneficiary and the distributions of income to that beneficiary were a sham, or otherwise ineffective in equity.
Taxpayer's appeal dismissed;
Commissioner's cross-appeal allowed
Brief Summary of Facts
Towards the end of the 1995 income year, building development companies controlled by one or more of the Heran brothers (Mr Brian Heran, Mr Martin Heran and Mr Stephen Heran) had forecast taxable profits of approximately $3 million. The Heran interests sought to acquire, and obtained, control of the E & M Unit Trust, a Thomasz family trust, which had tax losses of approximately $4 million for a "price" of $250,000.
On 30 June 1995, the Raftland Trust was settled with Raftland Pty Ltd as the trustee. Under clause 3(b) of the Raftland Trust deed, the trustee was given a discretion to pay, apply or set aside all or any part of the net income of the trust (after allowing for expenses) for the benefit of one or more of the primary, secondary and tertiary beneficiaries, or to accumulate the income. In default of the discretion being exercised the trustee was obliged to hold that income for such of the tertiary beneficiaries as were then in existence or, absent any tertiary beneficiaries, for such primary beneficiaries as were in existence (and if no primary beneficiaries were in existence for the secondary beneficiaries). Under the deed the trustee, for the time being, of the E & M Unit Trust was named as a tertiary beneficiary of the Raftland Trust and the Heran brothers were named as primary beneficiaries.
The Heran interests then took steps to channel the income of the Heran building companies to the E & M Unit Trust where it could be offset by the prior year tax losses. This involved complex agreements amongst various Heran entities and trusts, including Heran Projects Pty Ltd and the trustees of the Brian Heran Discretionary Trust, the Northbank Trust and the Heran Developments Trust.
Over three years, 1995, 1996 and 1997, some $4 million was distributed to the trustee of the Raftland Trust in this way (including, in 1996, some $57,973 sourced in rental and interest income which the trustee of Raftland Trust received from the trustee of the Brian Heran Discretionary Trust).
Of the moneys that came into the Raftland Trust in respect of the 1995 year of income, the trustee distributed $250,000 to Mr Carey in his capacity as trustee of the E & M Unit Trust and the balance also to Mr Carey, again in his capacity as trustee of the E & M Unit Trust, but by separate resolution. The trustee's resolutions were made on 30 June 1995.
With effect from 2 July 1995, Raftland Pty Ltd was appointed as trustee of the E & M Unit Trust.
On 3 July 1995, an amount of $250,000 was given to Mr Carey by way of bank cheque. The moneys for the bank cheque were provided by three Heran companies. By a written direction, Mr Carey requested that the payment be made to a firm of accountants. That firm deducted the sum of $30,000 and the balance was paid to Mr Carey who in turn paid it to his step-father, Mr Thomasz.
The income tax return for the Raftland Trust for the 1995 income year disclosed a distribution of $2,849,467. The income tax return of the E & M Unit Trust for the 1995 income year disclosed income in the same amount which was offset by prior year tax losses resulting in a net income of nil.
For the 1996 and 1997 income years, the trustee of the Raftland Trust resolved to distribute to Raftland Pty Ltd, as trustee of the E & M Unit Trust, amounts of $779,705 and $385,400. The income tax returns of E & M Unit Trust disclosed income in the same amount which was offset by prior year tax losses resulting in a net income of nil. The E & M Unit Trust's tax losses were exhausted in the 1997 income year. No further resolutions to distribute income to or by the trustee of the Raftland Trust were made.
Apart from the payment of $250,000, no money changed hands. The trustee of the Raftland Trust did not call upon or receive the funds to which it was entitled from the trustee of the Heran Trusts and the trustee of the E & M Unit Trust did not call upon or receive the balance monies to which it was purportedly entitled from the trustee of the Raftland Trust.
It is also of some significance to note that in the 1995 year, the Chairman of Raftland Pty Ltd reported that, apart from the $250,000 to be distributed to the trustee of the E & M Unit Trust for immediate payment, Raftland did not expect to require the funds to which it was entitled from the Brian Heran Discretionary Trust for use in its business as trustee of the Raftland Trust. Instead, Raftland subscribed for shares in a newly incorporated company called Navgate [see paragraphs 30 - 32].
The Commissioner assessed Raftland Pty Ltd as trustee of the Raftland Trust for the 1995, 1996 and 1997 income years on the net income of that trust. He also assessed penalty at the rate of 50% of the shortfall.
At first instance
On 17 February 2006, the Federal Court (Kiefel J) held that the resolutions of the trustee of the Raftland Trust to distribute to the E & M Unit Trust were a sham and should be disregarded, as should the appointment of E & M Unit Trust as a tertiary beneficiary of the Raftland Trust which was likewise part of a façade. Accordingly, the purported distributions were ineffective.
Her Honour then found that, by operation of the default provisions in clause 3(b) of the Raftland Trust deed, the primary beneficiaries, being the Heran brothers, were presently entitled to the undistributed income of the Raftland Trust. However, because these present entitlements arose out of, or in connection with, a reimbursement agreement, the Heran brothers were taken not to be presently entitled by operation of subsection 100A(1). Subsection 100A(3A) did not operate to deny the application of subsection 100A(1) because the primary beneficiaries were not trustee beneficiaries.
As a result, section 100A applied with the effect that Raftland Pty Ltd as trustee of the Raftland Trust was correctly assessed under section 99A on the income distributed to it by the Heran trusts. Kiefel J also found that in the context of a sham transaction, a conclusion of recklessness under section 226H was clearly open and there was no case for remitter of part of the penalties.
The Full Court
On 31 January 2007, the Full Court (Edmonds, Conti and Dowsett JJ) handed down its judgment. The Court disagreed with Kiefel J's finding of sham. The Court found that the effect of the Raftland Trust deed was to make the trustee of the E & M Unit Trust presently entitled to the income of the Raftland Trust. However, Edmonds J, with whom Justices Conti and Dowsett agreed, concluded that in respect of all but $57,973 of that income, which His Honour found was sourced in rental and interest income, the trustee's present entitlement arose out of, or in connection with, a reimbursement agreement: subsection 100A(1). Since the E & M Unit Trust was a trustee beneficiary, subsection 100A(3A) therefore had to be considered.
The Court found that subsection 100A(3A) did not operate to deny the application of s100A(1) as the unitholders of the E & M Unit Trust were not presently entitled to the income of the E & M Unit Trust. There were several reasons given by the Court as to why this was so.
The primary reason given was that there was no trust law income of the E & M Unit Trust available for distribution to unit holders - by way of payment, application or setting aside - because the income of the trust was required to make good prior year losses that had been incurred by the trustee in carrying on a business of buying and selling real property. Edmonds J said that the general rule is that losses in one year must, in the absence of any contrary direction in the trust instrument, be made up out of profits of subsequent years and not out of capital - see Upton v Brown - and that there could be no profits properly distributable in cash until all past losses were paid.
Therefore, Raftland Pty Ltd in its capacity as trustee of the Raftland Trust had been correctly assessed under section 99A on the income distributed to it by the abovementioned trusts, save for the $57,973 in the 1996 income year which could not be said to have been 'sourced' in the reimbursement agreement.
The taxpayer sought leave to the High Court to appeal against the decision of the Full Court. The Commissioner lodged a notice of contention in relation to the Full Court's rejection of sham, and also sought leave to cross-appeal in relation to the exclusion of the $57,973 from the taxpayer's assessment in the 1996 income year.
Issues decided by the Court
On 22 May 2008, the High Court (Gleeson CJ, Gummow, Kirby, Heydon and Crennan JJ) dismissed the taxpayer's appeal and allowed the Commissioner's cross-appeal. As a result, the High Court upheld the assessments issued by the Commissioner to Raftland Pty Ltd as trustee of the Raftland Trust.
The issues considered by the High Court were:
- whether the trustee of the E & M Unit Trust was presently entitled to the income of the Raftland Trust;
- the application of section 100A;
- whether the Full Federal Court was correct in excluding the amount of $57,973 from the application of section 100A; and
- the amount of penalties.
The joint judgement of Gleeson CJ, Gummow and Crennan JJ
Entitlement to the income of the Raftland Trust
In a joint judgment, Gleeson CJ, Gummow and Crennan JJ upheld Kiefel J's finding that the entitlement under the Raftland Trust deed was not intended by the settlor, or the trustee, or the "tertiary beneficiary", to have substantive, as opposed to apparent, legal effect [see paragraph 58]. In so finding, their Honours cited, with apparent approval, her Honour's conclusion that the provisions of the Raftland Trust deed which purported to create an entitlement in the E & M Unit Trust as tertiary beneficiary, and the resolutions which purported to reflect that entitlement, were a facade and were contrary to the intentions of the Herans and Mr and Mrs Thomasz [see paragraph 53].
Their Honours found that the evidence showed that the "business people" looked upon the transaction as the purchase, for a price of $250,000, by the Heran interests from the Thomasz interests, of control of a trust with accumulated tax losses [see paragraph 50]. They further found that it would have been inconsistent with this 'sale' of 'control' for the Thomasz interests subsequently to seek an accounting from Raftland for the purported distributions [see paragraph 50] or otherwise to assert any rights [see paragraph 53]. They had no entitlement to the income [see paragraph 53].
The application of section 100A
Gleeson CJ, Gummow and Crennan JJ upheld Kiefel J's conclusion that subsection 100A(1) applied and that, under the default provisions of clause 3(b) of the Raftland Trust deed, the primary beneficiaries were presently entitled to the trust income with the consequence that subsection 100A(3A) did not operate to deny the application of subsection 100A(1) because the primary beneficiaries were not trustee beneficiaries [see paragraphs 53 and 63].
Their Honours cited, with apparent approval, Kiefel J's conclusion that subsection 100A(1) applied to deny the present entitlement of the primary beneficiaries to the income of the Raftland Trust because those entitlements had come about by reason of the invalidity of the appointments to the E & M Unit Trust which, in turn, had been made pursuant to a reimbursement agreement which provided benefits to the Brian Heran Discretionary Trust and Heran Projects. Her Honour had said that the Brian Heran Discretionary Trust benefited so long as it was not called upon to pay income to the trustee of the Raftland Trust and Heran Projects benefited so long as it was not called upon to repay its loan from the Brian Heran Discretionary Trust [see paragraphs 60 - 61].
As a result of the application of section 100A, Raftland Pty Ltd as trustee of the Raftland Trust was correctly assessed on the distributions that had been made to it.
As their Honours upheld Kiefel J's conclusions in respect of the entitlement of the trustee of the E & M Unit Trust to the income of the Raftland Trust, it was strictly unnecessary for their Honours to examine the Full Court's conclusion that, for each of the three years, the E & M Unit Trust had no net income for trust purposes because of the losses of previous years. Nevertheless, as the Full Court had based this conclusion on an application of the general rule in Upton v Brown, and this involved a question of general principle, their Honours said that it should not be allowed to pass without comment.
In relation to Upton v Brown, their Honours said that the principle of losses being made good out of the subsequent profits rather than out of capital is a particular application of the general requirement that a trustee who has two or more beneficiaries is under a duty to deal with each of them impartially. Their Honours concluded that while there may be a rationale for applying the general rule in Upton v Brown in a case where the testator or settlor has created successive interests, with an interest in income followed by an interest in capital, that rationale did not exist in a case such as the E & M Unit Trust where there was only one class of unit holder [see paragraph 69].
Whether the Full Court was correct in excluding the amount of $57,973 from the application of section 100A
Gleeson CJ, Gummow and Crennan JJ overturned the Full Court's finding in relation to the exclusion of the amount of $57,973 from the operation of subsection 100A(1) [see paragraph 63]. Their Honours concluded that if the reimbursement agreement had not been entered into, the amount of $57,973 would not have been distributed to the Raftland Trust [see paragraph 77].
In so finding their Honours cited, with apparent approval, Kiefel J's observation that, following Commissioner of Taxation v Prestige Motors Pty Ltd (1998) 82 FCR 195 and Idlecroft Pty Ltd v Commissioner of Taxation (2005) 144 FCR 501, a "reimbursement agreement" does not have to be legally enforceable and it is not necessary that the beneficiary be a party to it [see paragraph 61].
Gleeson CJ, Gummow and Crennan JJ upheld Kiefel J's decision as to recklessness and her finding that there was no case for remitter of part of the penalties [see paragraph 72].
The judgement of Kirby J
His Honour agreed with the conclusions of Gleeson CJ, Gummow and Crennan JJ and in particular the conclusion that the entitlement of the trustee of the E & M Unit Trust under the Raftland Trust deed was not intended by the settlor or the trustee or the "tertiary beneficiary" to have substantive, as opposed to apparent legal effect [see paragraph 85].
His Honour examined the utility and content of sham in legal analysis. In doing this, his Honour said that the particular utility of sham analysis, especially in revenue cases, is that it permits courts to send a clear signal that they will not be deceived into giving effect to unreal transactions just because such transactions are expressed in instruments that, to a greater or lesser extent, observe legal forms and give effect to apparent legal objectives [see paragraph 140].
The judgement of Heydon J
His Honour agreed with the conclusions of Gleeson CJ, Gummow and Crennan JJ save for the issue discussed below [see paragraph 181].
His Honour considered that the central question of whether the Tertiary Beneficiary was presently entitled to the income of the Raftland Trust was answered by hypothesising whether, had the trustee of the E & M Unit Trust sued the Trustee of the Raftland Trust for the income of that trust, that claim would have been 'vindicated .. by curial action' [see paragraph 172].
His Honour did not consider that, on the facts of this case, the question could be answered by reference to 'sham'. His Honour said that this was because the trial judge had not made a finding that the transaction was 'aimed at deceiving third parties' [see paragraph 173].
Nevertheless, his Honour did conclude that the trustee of the Raftland Trust could have resisted a claim to the income made by the trustee of the E & M Unit Trust on the basis that clause 3(b) of the Raftland Trust deed was a mere piece of machinery obtained by the Heran interests from the Thomasz interests, subsidiary to and for the purposes of the verbal and only real agreement, in circumstances which would have made the use of it for any purpose inconsistent with that agreement, dishonest and fraudulent [see paragraph 177]. Accordingly, if the Thomasz interests acting through the Trustee of the E & M Unit Trust could not use clause 3(b) of the Raftland Trust deed to enforce a present entitlement to the income of the Raftland Trust, it followed that such an entitlement had never arisen [see paragraphs 174 and 178].
It followed that both the nomination of the trustee of the E & M Unit Trust as a tertiary beneficiary of the Raftland Trust and the resolutions of the trustee of the Raftland Trust to distribute income to the trustee of the E & M Unit Trust should be disregarded [see paragraph 180].
Tax Office view of Decision
This decision confirms and reinforces the Commissioner's ability to challenge trust loss trafficking arrangements by ascertaining the true intentions of the parties. As such, the case demonstrates that it will not always be necessary to look to complex anti-avoidance rules to defeat tax avoidance arrangements.
With respect to the sham issue, the Commissioner understands the decision of the Court to be as follows:
- Sham is just one of various situations in which a court may take an agreement or other instrument, such as a settlement on trust, as not disclosing, or disclosing fully, the legal rights and entitlements for which it provides on its face (ie. by way of exception to the parol evidence rule) [see Gleeson CJ and Gummow and Crennan JJ at paragraphs 33-34 and Kirby J at 142-143];
- Another case is where the document is 'a mere piece of machinery' for serving some purpose other than that of constituting the whole of the arrangement; in such a case the existence of the writing does not preclude the reception of other evidence as to the terms of the broader arrangement or contract (see Hoyt's Pty Ltd v Spencer (1919) 27 CLR 133 at 144; Hawke v Edwards (1947) 48 SR (NSW) 21 at 23 and Jervis v Berridge (1873) LR 8 Ch 351 at 359) [see Gleeson CJ, Gummow and Crennan JJ at paragraphs 33-34 and Heydon J at 177];
- Although it appears to be generally understood that the term 'sham' is an expression which refers to steps which take the form of a legally effective transaction but which the parties intend should not have its apparent, or any, legal consequences (see Equuscorp (2004) 218 CLR 471 at 486 ) [see Kirby J at paragraph 131 and 145], there is ambiguity and uncertainty surrounding its meaning and application [see Gleeson CJ, Gummow and Crennan JJ at paragraph 35 but compare Kirby J at paragraphs 134 and 136];
- The real question in a tax case will usually be whether a transaction is intended to have its apparent consequences rather than whether it is properly described as a 'sham'. The conclusion that a transaction is not intended to have its apparent effect may appear from an examination of the whole of the relevant circumstances, and these are not confined to the terms of the instrument but include all objective facts [see Gleeson CJ, Gummow and Crennan JJ at paragraph 36 and Kirby J at paragraph 136] - a court may also examine the parties' explanations as to their dealings [see Kirby J at paragraph 147] and evidence describing their subsequent conduct [see Gleeson CJ, Gummow and Crennan JJ at paragraph 49 and Kirby J at paragraph 147];
- A key to a finding of sham in this sense will often be the demonstration, by evidence or available inference, of a disparity between the transaction evidenced in the documentation (and related conduct of the parties) and the reality disclosed elsewhere in the evidence [see Gleeson CJ, Gummow and Crennan JJ at paragraph 33 and Kirby J at paragraph 145];
- Where the question is whether an express trust apparently created was wholly or partly a pretence, the relevant intention will be that of the person alleged to have created it (on the facts of this case that was the Heran brothers because the settlor and her employer, Mr Tobin, had no intention independent of the Herans) [see Gleeson CJ, Gummow and Crennan JJ at paragraphs 44, 47, 48, and 57];
- A part of an instrument may be a pretence [see Gleeson CJ, Gummow and Crennan JJ at paragraph 47];
- Just because a tax objective will not be achieved unless a transaction has a particular effect, it does not follow that the transaction will therefore have that effect. As the facts in Raftland illustrate, taxpayers may pursue mutually inconsistent objectives. Where this is the case it will always be necessary to consider whether the parties' other intentions would be defeated if the fiscal objectives were given effect to [see Gleeson CJ, Gummow and Crennan JJ at paragraph 56]; and
- While it is not necessarily a fraud to cast a transaction in a form suggesting it has an effect it is not intended to have (ie. where the parties had no intention to deceive other persons), it is a fraud for the parties to a transaction to represent to another person (eg. the Commissioner) that the transaction has an effect that they know it was not intended to have (in the present case Chief Justice Gleeson and Justices Gummow and Crennan were of the view that there was something less than fraud on the facts in Raftland ) [see paragraphs 35-36].
With respect to the application of prior year losses made by a trustee of a trust, the Commissioner understands the decision of the Court to be as follows:
- The general principle in Upton v Brown that business losses of one year must, in the absence of a contrary direction in the trust instrument, be made good out of the profits of subsequent years and not out of capital, does not apply to a trust if there is only one person capable of benefiting under the trust, or if all the beneficiaries have the same interests in, or rights to be considered in respect of, the income and capital of the trust (ie. a single class of beneficiaries or objects). The general principle does not apply in cases such as these because there is no relevant sense in which a decision by a trustee to charge a loss to income or capital can disadvantage one beneficiary over another.
- That is not to say, however, that in a case to which the principle in Upton v Brown does not apply, an intention that profits of subsequent years should be applied to make good losses of an earlier year could not be disclosed by the trust instrument itself, either expressly or by implication.
Implications for current Public Rulings & Determinations
Implications for general administration
The Commissioner will continue to challenge trust loss trafficking arrangements by seeking to ascertain the true intentions of the parties, by applying section 100A (where applicable) and/or by applying other general anti-avoidance and integrity provisions of the taxation law.
With respect to prior year business losses, the question of whether a trustee is under an obligation or has a power to make good lost capital of an earlier year out of income of a later year will depend on:
- whether the trust deed explicitly or implicitly permits or requires the trustee to make good the lost capital; and
- if not, whether the rule in Upton v Brown applies.
In a trust to which the rule in Upton v Brown does not apply and where the trust instrument, expressly or by implication, does not provide the trustee with an obligation or a power to make good lost capital of an earlier year out of income of a later year, the loss will rest where it falls and constitute a permanent diminution of the capital of the trust.
Implications on Law Administration Practice Statements
We invite you to advise us if you feel this decision has consequences we have not identified, or if a precedential decision such as a Public Ruling or an ATO ID requires reconsideration or amendment. Please forward your comments to the contact officer by the due date.
| Date Issued:
||24 October 2008
| Due Date:
|| 19 December 2008
| Contact officer:
| Email address:
||(02) 621 61242
||(02) 621 61247
||Attention: Kate Roff
Australian Taxation Offie
GPO Box 997
Belconnen ACT 2616
Income Tax Assessment Act 1936 (Cth)
Scott v. Commissioner of Taxation (No 2)
(1966) 40 ALJR 265
(1966) 14 ATD 333
(1966) 10 AITR 290
Equuscorp Pty Ltd v. Glengallan Investments Pty Ltd
(2004) 218 CLR 471
 HCA 55
(2004) 211 ALR 101
57 ATR 556
Upton v. Brown
(1884) 26 CH D 588
Sharrment Pty Ltd v. Official Trustee in Bankruptcy
(1988) 18 FCR 449
(1988) 82 ALR 530
Hawke v. Edwards
(1947) 48 SR (NSW) 21
(1947) 64 WN (NSW) 211
Hoyt's Pty Ltd v. Spencer
(1919) 27 CLR 133
(1919) 20 SR (NSW) 430
(1919) 26 ALR 21
Jervis v. Berridge
(1873) LR 8 Ch App 351
A G. Securities v. Vaughan
 1 AC 417
 3 All ER 1058
 3 WLR 1205
Commissioner of Taxation v. Prestige Motors Pty Ltd
(1998) 82 FCR 195
(1998) 38 ATR 568
(1998) 153 ALR 19
(1998) 98 ATC 4241
Idlecroft Pty Ltd v. Commissioner of Taxation
(2005) 144 FCR 501
(2005) 60 ATR 224
 FCAFC 141
(2005) 2005 ATC 4647