Trust distribution of capital gain held to be "special income" derived by SMSF – SCCASP Holdings as trustee for the H&R Super Fund v FCT

The Federal Court has held that a resolution to distribute a $14m capital gain from a family trust was "special income" derived by a self-managed superannuation fund (SMSF) under former section 273(6) of the Income Tax Assessment Act 1936 (ITAA36) (taxable at 47%), notwithstanding that the amount was not actually received by the SMSF: SCCASP Holdings as trustee for the H&R Super Fund v FCT^[1].

The Facts

The taxpayer (SCCASP Holdings) is the corporate trustee of the H&R Super Fund, an SMSF with husband and wife directors who are the only members of the fund. The husband and wife are also directors of a trustee company for a family trust which carried on the Super Cheap Auto business.

In July 2000, the trustee company transferred the Super Cheap Auto business to a wholly owned company and elected to obtain CGT rollover relief under the Income Tax Assessment Act 1997 (ITAA97)^[2]. As part of the restructure, shares in the company were issued to the family trust which later transferred the shares to a group holding company, and the family trust elected rollover relief^[3].

On 30 June 2004:

• the family trust sold some (but not all) of its shares in the group holding company before it was listed on the ASX in July 2004;
• the trustee of the family trust resolved that 100% of the income of the trust for the 2004 income year would be distributed to the taxpayer as trustee of the SMSF; and
• the trustee company resolved that: "The income hereby paid and applied for the benefit of the aforesaid beneficiary [SCCASP Holdings] be entered into the books of the Trust as having been so distributed and the same be held by the Trustee until paid over absolutely on behalf of the beneficiary in accordance with the terms of the Trust Deed".

The SMSF's income tax return for the 2004 income year:

• recorded an amount of $4,759,424 as a special component of the SMSF's taxable income;
• recorded a net capital gain of $9,331,187 (being the result of an initial capital gain of $14,001,129, less prior year net losses of $4,349 and less a 33.33% CGT discount) which was included as the standard component of the SMSF's taxable income; and
• claimed an amount of $1,768,588 as exempt current pension income (ECPI), which had the effect of reducing the fund's taxable income.

On 6 May 2009, the Commissioner amended the SMSF's assessment to treat the $9.3m net capital gain as "special income" of the fund (which is taxable at 47% instead of 15%). This increased the tax payable by the SMSF by $3,114,512. The Commissioner disallowed the taxpayer's objection against the amended assessment, and the taxpayer appealed to the Federal Court arguing that the amended assessment was excessive.

Taxpayer's arguments

The taxpayer sought to distinguish the finding in Allen v FCT^[4] where the Full Federal Court had ruled that "income derived" in section 273(7) refers to both statutory income (for example, net capital gains) and income according to ordinary concepts.

The taxpayer claimed that:

• unlike in Allen's case, no decision had been made by the trustee of the family trust to actually pay or apply any amount of capital, so it could not be said to be "derived" by the SMSF under section 273;
• although the net capital gain was included in the assessable income of the SMSF^[5] in order to be "special income" for the purposes of section 273(6), the income had to be "derived" by it as trustee of the SMSF; and
• the income could not be "derived" by it in the sense referred to in section 273 if it had not been received by the SMSF or applied or dealt with in any way on behalf of it in its capacity as trustee of the SMSF (or in accordance with directions given by it in that capacity). The taxpayer contended that there had neither been any such receipt nor any such application, dealing with or directions such that the amount of the net capital gain was still held by the trustee of the family trust.

Commissioner's argument

The Commissioner argued that seeking to limit the ratio of Allen to the finding that "income derived" in section 273 is limited to that part of the income included in assessable income that was actually or constructively received (or the subject of a trust distribution) would ignore the proper application of section 97(1)(a) relied upon by the Full Court. That is, the Commissioner contended that the ITAA36 looks at the section 97(1)(a) amount and treats that amount as being derived, not the amount of the income of the trust estate to which the beneficiary is presently entitled.

Decision

In upholding the amended assessment, the Federal Court said:

• it was bound by Allen to conclude that "income" in section 273 means assessable income and therefore includes both ordinary and statutory income (for example, net capital gains); and
• accordingly, it was bound to hold that the $9.3m net capital gain was, for the purposes of section 273(6), "income derived" by the SMSF in the 2004 income year.

"Income derived" The Court considered that "derived", for the purposes of "income derived" in section 273(6), must accommodate how a particular type of assessable income (which can form part of the net income of the trust estate) is included in the assessable income of a beneficiary pursuant to section 97 of the ITAA36. That being so, the Court said "derived" extends to include "attributed to" or "imputed to".

The Court considered that the effect of section 97 is that the assessable income of a beneficiary of a trust estate includes so much of that share of the net income of the trust estate as is attributable to a beneficiary. That is so whether or not that share has been received, applied or dealt with by or on behalf of that beneficiary. It is enough that the beneficiary is presently entitled to that share, the Court said. In this respect, the Court considered that it would make no sense to construe the word "derived" in section 273 in a way that included some types of assessable income but excluded others.

Net capital gain, statutory income and assessable income The Court noted that the reference to section 6-10 in FCT v Bamford^[6] evidences the recognition by the High Court that statutory income forms part of assessable income. In turn, the reference to section 102-5 evidences recognition by the High Court that one such form of statutory income is the net capital gain which section 102-5 includes in assessable income. The Court said it is any such net capital gain which is included in the net income of the trust estate within the meaning of section 95(1) of the ITAA36. According to the Court, this is in harmony with the observation in Bamford that, "Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the notion of present entitlement has served its purpose, and the beneficiary is to be taxed on that share (or proportion) of the taxable income of the trust estate".

Net capital gain as "special income" As a result, the Court upheld the amended assessment to include the $9.3m net capital gain as "special income" of the SMSF (and reduced the SMSF's exempt current pension income by $856,882), thereby increasing the tax payable by the SMSF by $3,114,512.

Thomson Reuters comment

For the 2007-08 and later income years, the special income rules in former section 273 of the ITAA36 have been rewritten into sections 295-550 of the ITAA97 and special income has been renamed "non-arm's length income". Non-arm's length income is taxed at the rate of 45%.

Source: This article was first published in Thomson Reuters' Weekly Tax Bulletin. To subscribe to Weekly Tax Bulletin, or for more information, please:

• see http://www.thomsonreuters.com.au/catalogue/productdetails.asp?id=1429 ; or
• contact Thomson Reuters on 1300 304 195 or at LTA.Service@thomsonreuters.com

More information from Cleardocs

You can read:

• articles on a wide range of trusts topics, here.
• articles on a wide range of SMSF topics, here.

Order SMSF related document packages

• Set up an SMSF
• Update an SMSF deed
• Set up an SMSF pension
• Arrange SMSF borrowing documents:
  • for when the lender is a bank
  • for when the lender is a related party
• Set up an SMSF corporate trustee
• SMSF Death Benefit Nomination – binding or non binding
• SMSF Death Benefit Agreement – binding and permanent

[1] [2012] FCA 1052 (Federal Court, Logan J, 26 September 2012, to be reported in ATR).

[2] Subdivision 122-A.

[3] Subdivision 124-G.

[4] [2011] FCAFC 118; (2011) 195 FCR 416.

[5] sections 6-10(2) and (3), 10-5 and 115-215 of the ITAA97 (and sections 95 and 97(1) of the ITAA36).

[6] (2010) 75 ATR 1.