Court rules on “present entitlement” and “disclaimer of entitlement” to trust income

The concept of “present entitlement” within the meaning of section 97 of the Income Tax Assessment Act 1936 and validity of a “disclaimer of entitlement of income” were considered by the Full Federal Court in the recent case of Lewski v Commissioner of Taxation [2017] FCAFC 145 (Lewski) that illustrates the importance of having trust law and taxation law concepts properly aligned. Lewski was an appeal from a decision of the Administrative Affairs Tribunal.

The facts of the case are complex and needed the Court to also consider whether amounts were incurred for purposes of section 8-1, the ultra vires doctrine, and the principles governing the grant of leave to appeal on grounds other than those stated in the taxation objection.

However, this article only focuses on the following questions considered by the Court:

  • whether the applicant was presently entitled to the income of the trust estate of the ACE Trust and the Arjod Trust; and
  • whether the applicant had effectively disclaimed the relevant benefits and entitlements as a beneficiary of the ACE Trust and the Arjod Trust.

 But first the facts

 The applicant was a beneficiary of two trusts – the ACE Trust and the Arjod Trust. 

 On 30 June 2006 and 2007, the applicant’s husband (Mr Lewski), as a director of the trustees of the ACE Trust and the Arjod Trust, executed a document that comprised four resolutions to:

  • confirm the definition of the ‘income of the trust fund’;
  • in the case of the ACE Trust, to distribute 100% of trust income to the applicant as a beneficiary;
  • in the case of Arjod Trust, to distribute the first $3.5 million to a bucket company and the balance to the applicant as a beneficiary; and
  • vary the definition of income so that should the Commissioner disallow any amount as a deduction, or include any amount in the assessable income of the trust, there would be a deemed distribution of 100% of such amount or amounts to a corporate beneficiary.

The applicant’s tax returns for the 2006 and 2007 income years did not include any income from trust distributions. After an audit, the Commissioner amended the applicant’s assessments for the 2006 and 2007 years to include income from the ACE Trust and the Arjod Trust after denying carry forward losses deducted by those trusts when calculating net income.

On 15 December 2015, after an unsuccessful objection, the applicant executed identical deeds of disclaimer headed “Disclaimer of Entitlement of Income” in respect of the Ace Trust and the Arjod Trust as follows:

“I hereby disclaim and reject absolutely any entitlement I have to any interest whatsoever that I may have now or in the future or have had at any time since 1 July 2006, to any income, capital or gift at all from Arjod.”

The present entitlement issues

When considering whether the applicant was presently entitled to income of the trust estate, the Court held that the resolutions (that is, the ‘distribution of trust income’ resolution and the ‘variation of income’ resolution)  were authorised by the trust deeds, the resolutions were interdependent, and “both resolutions dealt with the same subject matter – the distribution of the income of the trust for a particular year of income – with the latter resolution varying, in certain circumstances, the distribution made by the former resolution.”

Therefore, the applicant was not “presently entitled” to a share of the net income of the trust estate of the ACE Trust and the Arjod Trust.

While the Court considered that the resolutions were authorised by the trust deeds, the court also considered the present entitlement issue on the basis the resolutions were not authorised. The court reached the same conclusion. That is, the court held that:  

"…if the correct analysis is that the ‘variation of income’ resolution was invalid, whether legislative or contractual principles are applied by analogy, we do not consider severance to be available and both resolutions would fail. It follows that, on this analysis, the applicant was not “presently entitled” to a share of the net income of the trust estate of the ACE Trust for the 2006 year or the Arjod Trust for the 2007 year."

The disclaimer issues

The Court accepted that the applicant had no actual knowledge of the existence of the trusts, the distributions, or the assessments until 28 October 2015. That is, after the Commissioner had disallowed the objection and shortly before the execution of the deed of disclaimer.

The Court agreed with the decision of the Tribunal that it was open to find that the applicant had given “unfettered authority to [her husband] to handle all of her financial affairs” and that “[he] acted as her agent in relation to them” and the applicant was taken to have known of the distributions when her husband obtained knowledge of them.

When considering the validity of the “deed of disclaimer of entitlement of income”, the Court confirmed the Tribunal’s decision that the applicant had not disclaimed the relevant entitlements under both trusts as the applicant was taken to have knowledge of and accepted the entitlements before purporting to disclaim.

“Here, the applicant had handed over all of her financial affairs to Mr Lewski . It was within the scope of Mr Lewski’s authority to receive knowledge of the relevant trust distributions. We consider that Mr Lewski was under a duty to inform the applicant of the distributions as they were material transactions that affected her financial position (including her potential liability to tax). There is no question that Mr Lewski was aware of the distributions, as he either made or participated in the making of the relevant resolutions. (He was also informed of the distributions by way of the ATO position papers in December 2012 and January 2013.) Neither the applicant, nor Mr Lewski on her behalf, took any step to disclaim the distribution before 15 December 2015. In these circumstances, and taking into account the particular legal context, we consider the conclusion that the applicant was taken to have had knowledge of, and to have accepted, the gifts before 15 December 2015 to be consistent with the cases and principles discussed above.”

Because of this conclusion, the Court found it unnecessary to consider whether, as the Commissioner contended, even if there had been valid disclaimers, the disclaimers had no operation or effect for the purposes of “present entitlement” within the meaning of section 97.

Lewski raised critical issues around the importance of drafting trust documents that accord with the terms of the trust, taxation, and trust laws including that deemed knowledge may be sufficient to defeat a claim to disclaim a trust entitlement. Unfortunately, left for another day is the question of whether a valid disclaimer is effective for purposes of section 97.

For further information or advice, please contact:

Patricia Martins
Legal Project Manager
T: 03 9611 0138

Neil Brydges
Special Counsel
T: 03 9611 0176

Daniel Smedley
T: 03 9611 0105

Rob Jeremiah
T: 03 9611 0103