Below is a summary of the ATO’s Decision Impact Statement on the AAT’s ruling on MH Ghali Superannuation Fund and the Commissioner of Taxation.

 

Facts:

The MH Ghali Superannuation Fund (the Super Fund) held units in the Ghali Unit Trust (the Unit Trust) and derived income as a beneficiary of the Unit Trust.

Clause 12.3.11: The Trustee shall in its absolute discretion determine which class of Unitholders shall be presently entitled to such Income of the Trust Fund as is agreed upon in accordance with the requirements of clause 12.3.1 and in default of such determination the Unitholders in the same proportions as they hold units in the Trust Fund shall notwithstanding classification be presently so entitled.

 

Issue:

Whether such income of the Super Fund was ‘special income’ (or alternatively ‘non-arm’s length’ income) and so taxable at the rate applicable to the special component of the income of a complying superannuation fund.

Note – There were two bases on which the income could be special income:

• If the income was derived ‘other than by virtue of holding a fixed entitlement to the income’ (s 273(6) of the Income Tax Assessment Act 1936 (ITAA36)).
• If a fixed entitlement to the income (or the income itself) was derived under an arrangement some or all of the parties to which were not dealing at arm’s length and the amount of income was greater than might have been expected to have been derived if the parties had been dealing at arm’s length (s 273(7) of the ITAA36).

Note – Section 273 of the ITAA 1936 has now been replaced by the ‘non-arm’s length income’ rules in s 295-550 of the ITAA 1997.

 

AAT’s Decision:

The Super Fund held a fixed entitlement to income for the purposes of s 273 (as per Schedule 2F of the ITAA 1936) and that relevantly the Super Fund held a vested and indefeasible interest.

The Super Fund did not acquire the fixed entitlement, or derive the income, pursuant to an arrangement where the parties were dealing at arm’s length, and the income was more than might have been expected had the parties been dealing at arm’s length. Accordingly, the Tribunal concluded that the relevant amounts were ‘special income’ of the Super Fund.

The capital gain was properly included in the net income of the Unit Trust in the 2006 income year.

The 25% shortfall penalty was not unjust or excessive.

 

ATO’s view

While the Commissioner of Taxation’s decision was affirmed by the Tribunal, the Tribunal’s reasoning differed from the Commissioner’s on the issue of whether the income derived by the Super Fund was by virtue of a fixed entitlement to income.

The meaning of ‘fixed entitlement’ in s 273

The Commissioner’s view is that a superannuation fund has a fixed entitlement to income ‘if the entity’s entitlement to the distribution does not depend upon the exercise of the trustee’s or any other person’s discretion.’ (TR 2006/7, paragraph 102)

The Tribunal concluded that ‘fixed entitlement’ in s 273 took its meaning from the definition in Schedule 2F to the 1936 Act.

Fixed entitlement is not defined in s 6 of the 1936 Act, and there is nothing in s 273 that suggests that the Schedule 2F definition applies. On that basis, the Commissioner maintains the view that the definition does not apply for the purposes of s 273.

In light of recent authority, it might be said that the fixed entitlement test in Schedule 2F is relatively difficult to satisfy (ref: Colonial First State Investments Ltd v FCT), and would give rise to adverse and unintended impacts on superannuation funds that hold arm’s length trust investments. Consequently a more favourable approach for superannuation funds may be to treat the fixed entitlement test as that which is set out in TR 2006/7.

The Tribunal’s application of the Schedule 2F definition

The Commissioner accepts that the interest of the Super Fund in the income of the Unit Trust could be described as ‘vested in interest’ on the basis of the default clause in Clause 12.3.11 of the Unit Trust Deed

The Tribunal appears to have focussed its enquiry on whether the beneficiary’s interest in the trust (i.e. the units themselves) was indefeasible.

In relation to the nature of a fund’s interest in the income of a trust, the Commissioner notes that there is a body of case law relating to whether the fund’s interest in a share of the income is indefeasible (Relevantly, Colonial First State Investments Ltd v FCT [2011] FCA 16 at [106], Kent v The Vessel ‘Maria Luisa’ [2003] FCAFC 93 at [71] and Dwight v FCT (1992) 23 ATR 236).

In analysing these cases, where a trustee has a discretion to distribute income amongst unitholders in whatever proportion the trustee may in its absolute discretion determine, the Commissioner does not consider that the interest of a default beneficiary in income could be described as ‘indefeasible’: whatever interest in the income of the trust a default beneficiary would have is liable to be defeated by the trustee exercising its discretion to appoint the income to others.

In conclusion, the Commissioner proposes to adhere to his existing view that the Schedule 2F definition is inapplicable for the purposes of s 273 and s 295-550 until such time that the definition is further tested in the courts or the Tribunal. Consequently, the Commissioner will continue to apply the view that a superannuation fund has a fixed entitlement to income ‘if the entity’s entitlement to the distribution does not depend upon the exercise of the trustee’s or any other person’s discretion’ (TR 2006/7).