A trustee invariably makes gains or losses when selling trust investments — for example shares, units or real estate. In the ATO's view, the fact that an investment has been made by an entity in its capacity as trustee does not necessarily mean that any gain or loss from that investment will be on capital account.
The ATO's draft TD states that to determine whether a gain or loss is on income or capital account:
- first the trustee must consider whether tax law treats the gain or loss as either on revenue or capital account (for example, the capital gains tax provisions of the Income Tax Assessment Act 1997 (ITAA1997) in relation to managed investment trusts);
- if not, then the trustee must conduct its own characterisation.
The characterisation process necessarily involves a "wide survey and an exact scrutiny of all relevant factors to determine whether the trustee's activities constitute a business or profit making scheme". That is, the nature of the trust and the terms and content of the trustee's do not by themselves determine the answer. In fact, the character of the gain or loss must be determined having regard to all of the relevant facts and circumstances.
Are trustees capable of making gains from selling trust investments on revenue account?
The ATO considers that if a trust deed authorises the trustee to engage in business or undertake a profit making activity with the view to generating profits from which distributions can be made, then the profits are likely to be income according to ordinary concepts and therefore on revenue account.
This is in contrast to two High Court decisions, discussed in the Draft TD, namely Charles v Federal Commissioner of Taxation (Charles) and London Australia Investment Co Ltd v Federal Commissioner of Taxation (London Australia).
Those cases suggested that a trustee is incapable of making gains on revenue account because the trustee has a fiduciary duty to preserve the assets comprising the trust fund for the beneficiaries. The ATO takes the view that the finding in Charles was based:
"largely on the unchallenged evidence from the manager of the trust that at no time were securities acquired for the express purpose of re-sale at a profit and that sales were normally made when the managers anticipated a fall in the value of shares".
Consistent with those decisions, however, the ATO considers that gains may be on capital account if:
- the trustee is directed to ensure that the value of the trust assets are preserved for the long term in order to provide an income stream; and
- the assets were not acquired with the intention of making a profit.
Relevant factors to consider
The Draft TD notes that in characterising whether the gain or loss has been made on revenue or capital account, the following factors need to be considered:
- the nature of the trustee's powers and obligations;
- the nature and scale of the trustee's investment and other activities;
- the investment style employed in respect of the trust assets;
- the nature of the trust assets;
- whether there are different classes of beneficiaries with competing interests;
- the length of time individual investments are held;
- the regularity in sale activity involving the trust assets;
- the average annual turnover of the trust assets;
- the percentage of total income which the gains represent; and
- the nature of any connection between the trustee and other parties to the dealings.
The Draft TD suggests the factors shown in the table below may indicate that a gain or loss made from an investment will be on revenue or capital account. The relevance of these factors depends on the nature and scale of the operation and would need to be considered together. A single factor on its own may have little or no relevance.
More likely to be on Revenue Account if . . .
More likely to be on Capital Account if . . .
The trust deed authorises the trustee to engage in business or to undertake a profit making activity with the view to generate profit from which distributions to investors can be made.
The trustee is authorised or directed to ensure that the value of the assets under their control, including any increments, are preserved for the long term.
Carrying on a business of investment.
A disposal amounts to no more than a change of investment.
A transaction entered into with the intention of making a profit or gain.
The absence of an investment style which envisages an exit point.
A one-off or isolated transaction where the investment was acquired in a business operation or commercial transaction for the purpose of profit-making.
A low average annual turnover of shares (stocks).
A high average annual turnover of shares (stocks).
A high proportion of stocks sold have been held for a significant number of years.
A high proportion of shares (stocks) sold have been held for short period of time.
A low level of sales transactions compared to the number of stocks in the portfolio.
High level of sales transactions.
A lack of regularity in the particular sale activity.
Profits on sale normally constitute a small percentage of total income
Significant percentage of 'aged' stocks remain in the portfolio.
The Draft TD provides a number of examples of circumstances of when a gain or loss on an investment will be on a revenue or capital account.
Example 1 — Investments for an incapacitated person
- The Draft TD discusses the decision of the Full Federal Court in FC of T v Radnor Pty Ltd  (Radnor). The case involved a taxpayer company which, although not a trustee, was used as the vehicle for the investment of the funds of three trusts established to provide lifetime support for an incapacitated person.
- In that case, Hill J was determining whether an activity is properly to be characterised as a business activity, and therefore whether any profits are income. In doing so, the judge said it is relevant, although not conclusive, that the activity is undertaken by a taxpayer in the position of a trustee who is obliged to ensure that the value of the assets under its control are preserved for the benefit of the beneficiaries.
- The Court considered the provisions of the trust deed and that the taxpayer's entire investment philosophy was to preserve the trusts assets to ensure funds were available for the incapacitated person. The Court found that this fact was fundamental to the conclusion that the taxpayer was not carrying on a business and the gains were on capital account.
Example 2 — Trust with objective of regular distributions
- Unit trust established to produce profits from buying, holding and disposing of securities for the purpose of making regular distributions to unit holders.
- Trustee's investment policy is to target securities which display above-average earnings growth potential. On average the turnover of stock exceeds 10% of the market value of the portfolio.
- Trustee has broad powers to vary investments and a discretion to distribute any part of the trust fund at any time.
- The purpose of which the trust was established, the investment policy and with the manner and extent of the trading activities undertaken by the trustee supports the conclusion that the gains and losses on disposal of securities are on revenue account.
Example 3 — Testamentary trust preserving capital
- Testamentary trust established for the benefit of the deceased incapacitated spouse.
- The trust has no explicit portfolio management style. The annual portfolio turnover is approximately 10% of the market value of the portfolio.
- Under the deceased's will, the trustee is directed to hold and invest the estate and apply the income for the deceased's spouse's benefit during her lifetime. The capital passing on the spouse's death to other members of the family.
- It appears that the trustee's duty is to preserve the capital so as to produce an income stream to maintain the spouse over time, therefore the gains and losses on disposal of shares are on capital account.
A more detailed discussion of these and related issues is contained in Taxation Ruling TR 2005/23 Income tax: listed investment companies and in TR 92/3 Income tax: whether profits on isolated transactions are income.
Further consultation and likely implementation timing
The date for comments and feedback on the Draft TD has passed. Although the Draft TD does not outline any timeline for the further steps after the consultation process, it does state that when the final Determination is issued, it is proposed to apply both before and after its date of issue.
More Information from Maddocks
For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Tax and Revenue or General Commercial Teams.
More Information from Cleardocs
For more information:
- about the Cleardocs:
- see a Guide by Maddocks dealing with:
- a comparison table of key benefits and things to be wary of in each type of trust, here; and
- a comparison table of the key features of each type of trust here.
- about Bamford's case, see here
 (1954) 90 CLR 598
 (1977) 138 CLR 106
 Orr v Wendt & Ors  WASCA 199
 Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693
 London Australia
 Milton Corporation Ltd v. FC of T 85 ATC 4243
 AGC (Investments) Limited v. FC of T (1992) 23 ATR 287
 91 ATC 4689