FEDERAL COURT OF AUSTRALIA

Thomas v Commissioner of Taxation [2017] FCAFC 57

ORDERS

THE COURT ORDERS THAT:

1.    The appeals be allowed with costs.

2.    The parties are to submit to the Court a form of agreed orders giving effect to these reasons within 14 days or, failing agreement, competing orders.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

ORDERS

THE COURT ORDERS THAT:

1.    The appeals be dismissed with no order as to costs.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

DOWSETT J:

1    I have read the judgment of Pagone J in this matter. I agree with his Honour's reasons and the orders which he proposes.

Associate:

Dated: 12 April 2017

REASONS FOR JUDGMENT

PERRAM J:

2    I have had the advantage of reading in draft the reasons for judgment of Pagone J. I respectfully agree with his Honour’s conclusions and reasons.

3    In relation to the judicial advice proceedings before Applegarth J, it is possible to imagine many objections to the procedural course which was undertaken before his Honour. It may be doubted, for example, that the Supreme Court of Queensland could make a declaration about the proper construction of a trust resolution by means of the procedure contemplated by s 96 of the Trusts Act 1973 (Qld): cf. Macedonian Orthodox Community Church St Petka Inc v His Eminence Peter the Diocesan Bishop of Macedonian Orthodox Diocese of Australia and New Zealand [2008] HCA 42; (2008) 237 CLR 66 at 91-92 [64]-[66]. But the fact of the matter is that a declaration was made in a proceeding to which both the trustee and beneficiaries were party. As an order of a superior court of record, this declaration, however procedurally irregular, is valid and binding until set aside: Cameron v Cole [1944] HCA 5; (1944) 68 CLR 571 at 585, 590, 598 and 605; State of New South Wales v Kable [2013] HCA 26; (2013) 252 CLR 118 at 133 [32].

4    Like Pagone J, I am, with respect, sceptical about the construction of the resolutions adopted by Applegarth J, but that scepticism simply does not matter whilst the declaration remains on foot. It is what it is. That it might be attended by reasoning which may be erroneous is irrelevant whilst it exists.

5    In any event, even if this Court could in some way unpick the decision (which I do not think it can) it is difficult to see how that could justly be done without also unpicking the dismissal by Applegarth J of the rectification suit. It is impossible to imagine that this Court might embark upon a consideration of the issues which arise with that loose end left hanging.

6    I do not regard the conclusion which both Pagone J and I would draw as involving any discretionary aspect, but if it did, this matter would constitute a powerful reason for leaving the conclusions of Applegarth J undisturbed.

Associate:

Dated:    12 April 2017

REASONS FOR JUDGMENT

PAGONE J:

7    The principal issue in these appeals is whether the taxpayers are entitled to franking credits in the relevant income tax years. Other issues concerning penalty assessments also arise if the taxpayers are unsuccessful on the principal issue.

8    The appellants are Thomas Nominees Pty Ltd (“Thomas Nominees”), Mr Martin Andrew Thomas (“Mr Thomas”) and Martin Andrew Pty Ltd (“MAPL”). Thomas Nominees was the trustee of the Thomas Investment Trust (“the trust”) which was established by a trust deed dated 1 February 1979 that was amended on various dates including, relevantly, on 1 October 1992. Mr Thomas and MAPL were beneficiaries of the trust in each of the income tax years ending 30 June 2006, 2007, 2008 and 2009. Mr Thomas and his mother were the directors and equal shareholders of Thomas Nominees, and Mr Thomas was the sole director and shareholder of MAPL.

9    The trustee carried on an exchange-traded option trading business during the relevant tax years which involved dealing in exchange-traded options in shares. The options were exercisable at specified dates by one or other of the parties as provided in the option document. In each of the relevant income years the trustee received dividends which had been franked in accordance with Div 207 of Part 3-6 of the Income Tax Assessment Act 1997 (Cth) (“the 1997 Act”). The trustee derived other income during the relevant tax years, and incurred expenses in deriving that income, but the issues in these proceedings concern the entitlements to the franked credits connected with the dividends. In each of the years in question the appellants contended that, and the Commissioner contested that, the franked credits were to be taken into account in reducing the assessable income of the beneficiaries rather than that of the trustee. The Commissioner did not contend that the beneficiaries could not have become entitled to claim the benefit of the franked credits as beneficiaries of a discretionary trust or that the beneficiaries could have been made entitled to receive the benefits as they claimed, but that they had not become entitled to the benefits they claimed pursuant to the terms of Div 207 in the circumstances which occurred.

10    The terms of Div 207 of the 1997 Act, and its relationship to Div 6 of the Income Tax Assessment Act 1936 (Cth) (“the 1936 Act”), is complicated, but its overall intent is relatively clear. The provisions are designed in part to ensure that a beneficiary of a discretionary trust obtains the benefit of franking credits to the extent that the franked distributions are reflected in the beneficiary’s entitlements to the net income of the trust. The Commissioner’s submissions in the appeals, and the Commissioner’s relevant earlier published rulings, support that view. The legislative mechanism through which that object is achieved, however, is necessarily complicated because of the need for a mechanism to match (a) frankable distributions received by trustees to (b) trust income distributed to beneficiaries. A beneficiary of a discretionary trust will typically receive part of the net amount of trust income that may have included franked distributions received by a trustee of the trust estate but which will not be sufficiently traceable to, or matchable with, any franked distribution received by the trustee. An objective of Div 207 is to provide a mechanism by which the beneficiary will have attributed that proportion of the franked distributions received by the trustee that is referrable to the amount of the net income distributed to the beneficiary.

11    The general rule in relation to franked distributions by a corporate tax entity to a member of that entity is that the member will be entitled to a tax offset equal to the franking credit on the distribution included in that member’s assessable income. Subdivision 207-B, however, modifies that general rule in cases where the franked distribution is made to a partnership or to the trustee of a trust. An objective of the subdivision is to ensure that the beneficiary of the trust income receives also the benefit of the franked distribution to the extent that the franked distribution is received through a trust. Section 207-25 of the 1997 Act provided:

207-25 What this Subdivision is about

The statutory mechanism adopted to achieve the objective of enabling trust beneficiaries to obtain the benefit of franked distributions made to trustees is found in particular in s 207-55.

12    Section 207-55(1) provided that the objects of the section are to ensure that the amount of a franked distribution made to the trustee of the trust is “allocated notionally amongst” those “who derive benefits from” that distribution, and that the allocation “corresponds with the way in which those benefits were derived”. The share of a franked distribution notionally allocated to an entity is the amount determined by application of s 207-55 and by the table contained in that section. Section 207-55 provided:

207-55    Share a franked distribution

Object of section

(1)    The object of this section is to ensure that:

(a)    the amount of a *franked distribution made to a partnership or the trustee of a trust is allocated notionally amongst entities who *derive benefits from that distribution; and

(b)    that allocation corresponds with the way in which those benefits were derived.

Note:    an entity can derive a benefit from the distribution (and therefore has a share of the distribution: see subsection (2) of this section and the example at the end of section 207-50.

(2)    An entity’s share of a *franked distribution is an amount notionally allocated to the entity as its share of the distribution, whether or not the entity actually receives any of that distribution.

(3)    That amount is equal to the entity’s share of the distribution as the focal entity in column 3 of an item of the table.

Note:    An entity’s share of the distribution is based on the share of the distribution of each preceding intermediary entity though which the distribution flows, starting from the intermediary entity to whom the distribution is made.

    This means that in some cases (see items 2 and 4), more than one item of the table will need to be applied to work out the share of the distribution of an ultimate recipient of the distribution.

[…]

(Emphasis in original.)

Section 207-55(2) provides that an entity’s share (in other words, that the beneficiary’s share) of a franked distribution “is” an amount notionally allocated as its share of the distribution whether or not the entity actually receives any of that distribution. Section 207-55(3) provides that the amount is equal to the entity’s share of the distribution “as the focal entity in column 3 of an item of the table” in the section.

13    The share of a franked distribution notionally allocated to a trust beneficiary under s 207-55(2) is, therefore, to be determined by application of the table in the section. The table contains three items describing the relationship between the entity to whom the franked distribution is made (which is referred to as the “intermediary entity”) and the entity (which is referred to as the “focal entity”) enjoying the benefit of the distribution. Item 3 in the table in s 207-55 is that which applied to the appellants in these proceedings because it is concerned with the trustee of a trust being an intermediary entity and the trustee or a beneficiary of the trust being the “focal entity”.

14    Item 3 applies where a franked distribution is made to the trustee and where the trustee or the beneficiary has, in respect of the trust, a share amount mentioned in subsection 207-50(3) or (4). The application of item 3 in the table to section 207-55 requires, therefore, consideration of whether either a trustee or a beneficiary has, in respect of the trust, a share amount mentioned in either s 207-50(3) or (4). The former effects by force of statutory operation an indirect flow of franked distributions to the beneficiaries of trusts in the circumstances identified in the subsection; the latter effects by force of statutory operation an indirect flow of franked distributions to the trustee of the trust in the circumstances identified in the subsection. It is the statutory effect of s 207-50(3) which is relevant in this appeal. That subsection provided:

Beneficiaries

(3)    A *franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

(a)    during that income year, the distribution is made to the trustee of the trust, or *flows indirectly to the trustee as a partner or beneficiary because of a previous application of subsection (2) or this subsection; and

(b)    the beneficiary has this amount for that income year (the share amount):

(i)    a share of the trust’s *net income for that income year that is covered by paragraph 97(1)(a) of the Income Tax Assessment Act 1936; or

(ii)    an individual interest in the trust’s net income for that income year that is covered by section 98A or 100 of that Act;

(whether or not the share amount becomes assessable income in the hands of the beneficiary); and

(c)    the beneficiary’s *share of the distribution under section 207-55 is a positive amount (whether or not the beneficiary actually receives any of that share).

The effect of a franked distribution flowing indirectly by force of this provision is made to depend upon a number of conditions. The first of the conditions is that found in s 207-50(3)(a) namely, that a franked distribution had been made to the trustee or had flowed indirectly to the trustee. In this case the condition in s 207-50(3)(a) was satisfied and was not in contention between the parties. The second condition is that found in s 207-50(3)(b)(i) and (ii) which are expressed as alternatives and required determining whether the beneficiaries in question had one of two specified alternative amounts, namely, either (a) an amount being a share of the trust’s net income for a year, or (b) an amount being an interest in the trust’s net income for that year covered by ss 98A(1)(a) or 100(1)(a) of the 1936 Act. The second of the alternatives did not apply in this case, so that whether the condition in s 207-50(3)(b) had been satisfied required consideration of whether a beneficiary had a share of the trust’s net income for the years in dispute which was covered by s 97(1)(a) of the 1936 Act. It will be necessary to return to consider whether the beneficiaries had a share of the trust’s net income covered by s 97(1)(a) of the 1936 Act but it may be convenient to consider first the third condition required to be satisfied by s 207-50(3)(c).

15    The third condition to be satisfied was that in s 207-50(3)(c), namely whether the beneficiary’s share of the distribution under s 207-55 was a positive amount. It is necessary to refer to the table in s 207-55 to determine whether the beneficiary’s share of the distribution under that section was a positive amount. The share of a franked distribution of a beneficiary under Item 3 in the table in s 207-55 was to be determined as follows:

[…]

The inquiry called for to determine whether the condition in s 207-50(3)(c) was satisfied was whether the beneficiary’s share of the franked distribution under s 207-55 is a positive amount. No amount of franked distribution will form part of the intermediary entity’s share if the trust does not have a positive amount of net income: see item (b) in column 2 of item 3 in s 207-55. The whole of the amount of the franked distribution will, however, be the intermediary entity’s share of the franked distribution if the trust has a positive amount of net income for the year in question: see item (a) in column 2 of item 3 in s 207-55. In this case the intermediary entity, namely the trustee, had positive amounts of income in each of the years in question. The amount being the beneficiaries’ share of the franked distribution is by reason of column 3 in item 3 so much of the franked distribution as had been worked out under column 2 of that item (namely, the whole of the franked distribution) as had been taken into account in working out the share amount referred to in (b) of column 1 in item 3 as had been mentioned in s 207-50(3).

16    It is tempting to suggest that these provisions might have been expressed more clearly but the objective to be achieved can be discerned. It is to effect by statutory operation the “flow” to the beneficiary of so much of the franked distribution as has been taken into account in working out the beneficiary’s share of the net income in the year in question. It achieves that effect by s 207-55(3) attributing to the beneficiary the amount equal to the beneficiary’s share of the franked distribution in column 3 of the table. That amount is that portion of the amount of the franked dividend worked out under column 2 (namely the trustee’s share of the franked distribution) as “is taken into account in working out that share amount”. The reference to “that share amount” in column 3 in item 3 is not to be read as a repetition of the words “so much of the amount worked out under column 2”. The “share amount” referred to in column 3 is the share amount of the individual beneficiary as contemplated by column 1 which was defined by s 207-50(3)(b) as, in this case, the beneficiary’s share of the trust’s net income for the relevant year of income. That construction accords also with the effect of the equivalent provisions in column 3 to the other items in the table in s 207-55. Thus, for example, the focal entity’s share of the franked distributions under item 2 is so much of the column 2 amount “as is attributable” to the partner having regards to the partnership agreement and other relevant circumstances. It becomes necessary, therefore, to consider for the purposes of column 3 in item 3 to s 207-55, and to return to consider for the purposes of s 207-50(3)(b), what had been the beneficiary’s share of the trust’s net income or the income years covered by s 97(1)(a) of the 1936 Act.

17    The beneficiaries’ share in this case of the trust’s net income in each of the years in question depended upon the operation of the deed and of the resolutions made pursuant to the deed. The trustee and the beneficiaries in this case also sought, and obtained, declaratory orders from the Supreme Court of Queensland concerning the entitlements of the beneficiaries in relation to the 2006-2008 years (but not the 2009 year) upon which they also relied, but it is desirable to consider first the entitlements arising independently of the declarations made by the Supreme Court of Queensland.

18    The trustee made two relevantly identical resolutions distributing the net income of the trust estate in each of the income years ending 30 June 2006, 2007, 2008 and 2009. In each year the trustee made two resolutions applying the net income of the trust. Clause 4 of the deed of trust gave the trustee an absolute and uncontrolled discretion to apply the income of the trust property. The trust deed had been amended on 1 October 1992 to enable the trustee to record separately different categories of income received into the trust property. Clause 4 was renumbered as clause 4(1) by the amendments made on 1 October 1992 and provided:

During the continuation of the Trust hereby created the Trustee shall apply the income of the Trust Property in such manner as it subject only to the provisions herein contained in its absolute and uncontrolled discretion shall think fit for the benefit maintenance education advancement in life and general well being and comfort of the Nominated Beneficiaries the Elder Beneficiaries the Younger Beneficiaries the Additional Beneficiaries the Appointed Beneficiaries and the Charitable Beneficiary equally or unequally and to the exclusion of any one or more of such beneficiaries as it shall see fit or if there is no member of any of such classes of beneficiaries as aforesaid living and the Trustee determines that the Charitable Beneficiary shall not receive any part of the income moneys available for distribution then for the benefit maintenance education advancement in life and general well being and comfort of the Alternate Beneficiaries equally or unequally and to the exclusion of any one or more of the Alternate Beneficiaries as it shall see fit and in the exercise of the duties required of it under this Clause of the Deed the Trustee shall in its absolute and uncontrolled discretion be entitled to pay the moneys representing the income applied for the benefit of a beneficiary who has not attained the age of eighteen years or who having attained the age of eighteen years is incapable to act into the funds of some other Trust created for the benefit of such beneficiary and the receipt of the Trustee of that other Trust shall effectually discharge the Trustee of this Trust from seeing to the application thereof. If during any year the Trustee has not as aforesaid paid or applied the whole of the net income of the Trust Property by the exercise of its discretion such remaining net income for that year that has not been so paid or applied shall be held by the Trustee upon trust to pay or apply the same to or for the benefit maintenance education advancement in life and general well being and comfort of the Elder Beneficiaries the Younger Beneficiaries and the Additional Beneficiaries living on the Thirtieth day of June of that year and if more than one as tenants in common in equal shares or if there is no member of any of such classes of beneficiaries living on such day as aforesaid then for the benefit maintenance education advancement in life and general well being and comfort of the Alternate Beneficiaries living on such day as aforesaid and if more than one as tenants in common in equal shares.

The amendments made in 1992 did not alter the substance of this clause other than by renumbering it as clause 4(1), but other amendments made in 1992 permitted the trustee to maintain and record different categories of income separately. The amendments also contemplated resolutions and determinations by the trustee by dealing separately with different categories of income. The following new sub-clauses were added in 1992 to clause 4:

4(2)    The Trustee may in the books of account and records of the Trust separately record each of the following categories of income received into the Trust property:

(a)    dividends which under The Income Tax Assessment Act 1936 – as amended hereinafter referred to as “the Act”:

(i)    are fully franked;

(ii)    are unfranked;

(iii)    to which a foreign tax credit attaches; or

(iv)    any other separately identifiable taxation consequence or benefit is attached or arises.

(b)    income, including capital gains, which under the Act:

(i)    has an Australian source;

(ii)    has an ex-Australian source;

(iii)    has a foreign tax or other credit attached; or

(iv)    is exempt or otherwise liable not to be taxed;

(v)    has or gives rise to any other separately identifiable taxation consequence or benefit.

4(3)    The Trustee may identify and separately record and maintain in the books of account and records of the Trust, income or capital having, or in respect of which there is attached, individual or unique characteristics other than as referred to in the preceding sub-clause as the Trustee by resolution shall determine.

4(4)(a)    A resolution or determination of the Trustee by which income of the Trust property is distributed or accumulated may separately deal with the whole or part of the income of a category so that the same or any part thereof may be specifically paid, applied or set aside for the benefit of any one or more of the beneficiaries exclusive of the other or others or accumulated, to the extent to which income of the Trust is permitted to be accumulated by this deed and become part of the capital of the Trust property or be held as part of the Trust property as undistributed Tax exempt income as the Trustee may in its absolute discretion determine; and

(b)    The whole or any part of the capital of a category may at the discretion of the Trustee be distributed in accordance with the provisions of Clause 3 of the Deed of Trust.

4(5)    Expenses and outgoings of the trust fund may at the discretion of the Trustee be allocated against and deducted from income or capital of any one or more categories in such manner as the Trustee may see fit.

4(6)    In the event that the Trustee shall not exercise its discretion as provided in the preceding sub-clause in respect of a financial year, outgoings and expenses of the Trust property for that year shall be allocated firstly against and deducted from income which is not income of a category and to the extent to which the same is not sufficient to absorb all such expenses and outgoings, then the part thereof which is not so absorbed shall be allocated in such manner as the Trustee may decide against income of a category or categories to which a tax credit or rebate does not attach, and thereafter against the remaining income of the Trust property.

4(7)    Income or capital of the Trust property to which a default beneficiary becomes entitled and which can be identified from the books and records of the Trust as being of a category; shall retain its separate identity when the same passes to or is received by the default beneficiary or when the default beneficiary otherwise becomes entitled thereto.

4(8)    Notwithstanding anything hereinbefore in this clause contained or implied the Trustee shall have the right to accumulate as an accretion to the Trust Property all or any part or parts of such income of the Trust Property upon which no further tax of any kind or nature is payable by the Trustee or any beneficiary hereunder and subject always to the Trustee having the power to determine at any time or times that all or any part of such accumulated tax free income shall be distributed to such beneficiary or beneficiaries and in such manner equally or unequally as the Trustee in its absolute discretion shall think fit.

The trustee made resolutions pursuant to these provisions in each of the years in question.

19    The resolutions for the 2006 year were taken by his Honour, and may be taken in the appeal, as typical of the resolutions made in each of the other years. In each year there were two resolutions made by the trustee. The first resolution in the 2006 year may for convenience of description be referred to as the “net income resolution” and was as follows:

Should the Commissioner of Taxation disallow any amount as a deduction or take any action that would have the effect of creating undistributed net income in the trust as at 30 JUNE 2006 then such net income shall be deemed to be distributed on 30 JUNE 2006 to the abovenamed beneficiaries in proportions as stated above, except where there is a remainder nomination then this amount shall be distributed to that person.

The second resolution for the 2006 year may for convenience of description be referred as “the franking credit distribution resolution” and was as follows:

Should the Commissioner of Taxation disallow any amount as a deduction or take any action that would have the effect of creating undistributed net income in the trust as at 30 JUNE 2006 then such net income shall be deemed to be distributed on 30 JUNE 2006 to the abovenamed beneficiaries in proportions as stated above, except where there is a remainder nomination then this amount shall be distributed to that person.

It may be accepted for present purposes that what was intended by these resolutions was to ensure that the benefit of the franking credits would be enjoyed by the specified beneficiaries of the discretionary trust. It can also be accepted, as the Commissioner conceded in the appeal, and as was consistent with the Commissioner’s published rulings, that such an intention was one which could have been secured by properly framed resolutions. The intended outcomes may also be assumed to have been those disclosed in the tax returns for the trust and its beneficiaries. At [39] his Honour summarised what was disclosed in the income tax returns for the trust in each of the relevant years, namely:

Fundamental to the appeal is whether the resolutions were effective to produce the intended outcome.

20    It is clear from the material in the appeal that there was considerable uncertainty about how the intended outcome was to be achieved and whether the resolutions had achieved them. The person responsible for the form of drafting of the resolution was a Ms Beth Abbott who was the accountant for Mr Thomas and for the trustee of the trust. His Honour recorded the evidence concerning her intentions in drafting the resolutions at [242]-[257]:

Ms Beth Abbott

242    As Mr Thomas said in oral evidence, “I’ve mostly left everything up to the accountants”: T, p 61, lns 15-16.

243    In Mr Thomas’s affidavit material he says that he acted extensively on the advice of Ms Abbott.

244    Ms Abbott prepared the Monthly Position Statements showing an estimated year-to-date position and a notional (“as in possible”, as she said) distribution or allocation of taxable income and a notional distribution of the franking credit benefits – the tax offsets, recognising however, that things might change as the taxable income changed, as can be seen in the comparison between the financial information set out at p 303 of the Monthly Position Statement to 31 July 2008 and p 307 of the statement to 30 September 2008.

245    Ms Abbott also prepared the tax returns and the financial accounts.

246    Ms Abbott’s method in preparing the Monthly Position Statements for Mr Thomas and the trustee was this.

247    She would identify the profit, based on the monthly (year-to-date) P & L Statement.

248    She would then make adjustments so as to calculate the s 95 net income assuming no other transactions to year end for the sake of the exercise. The adjustments involved adding back non-deductible expenses and adding the franking credits related to the dividend distributions to the trustee of the trust – the required gross-up. Non-taxable capital gains were excluded and removed from the calculation resulting in the total taxable income at that date upon the hypothesis of no further transactions to year end: T, p 72, lns 3-4.

249    The next step was to notionally allocate the s 95 net income between MAPL and Mr Thomas to ensure that Mr Thomas did not receive an amount that would cause him to be paying more than 30c in the dollar as an average tax rate.

250    After having notionally allocated the s 95 net income, Ms Abbott would notionally allocate the franking credit offsets (benefits) between the two beneficiaries based on an amount sufficient to meet (and no more) MAPL’s income tax liability based on the notional s 95 net income distribution with the balance allocated to Mr Thomas. Thus, the “only intention” in allocating a particular amount of offsetting franking credit benefits was to meet the tax otherwise payable by MAPL and no more. The remaining franking credits would then be allocated to Mr Thomas and applied against his tax payable. The assumption was that he would then be entitled to a refund of the surplus or unused franking credit benefits beyond offsetting the tax payable by him.

251    Ms Abbott accepted that these steps reflected her philosophy in preparing the documents throughout the relevant tax years: T, p 73, ln 8.

252     Ms Abbott also accepted that the same philosophy was applied to the determination of the actual resolutions passed each year for the trust: T, p 73, lns 10-11.

253    Having accepted that this was the method or philosophy adopted for each income year, Ms Abbott accepted that the s 95 net income was distributed by means of one resolution but further observed that “it was put into two” resolutions (although she said she might have misunderstood the proposition put to her): T, p 73, lns 13-15. Ms Abbott accepted that one resolution addressed a distribution of s 95 net income and the “other” concerned an allocation of franking credit benefits: T, p 73, lns 17-21. However, momentarily later, at T, p 73, lns 31-40, Ms Abbott observed seemingly by clarification in her mind, that the “other” resolution operated to distribute the franking credits. Mr Looney QC put to Ms Abbott that the subject matter of the resolution was the allocation of the benefits (that is, the potential offset entitlements) and Ms Abbott responded by describing the subject matter of the resolution, in her mind, as the distribution of the franking credit amounts to the beneficiaries: T, p 73, lns 31-45. Mr Looney QC then put to Ms Abbott that her reference to franking credit amounts is to be understood as the franking credit benefits – the “entitlement to claim the offset”: T, p 74, lns 1-2. Ms Abbott responded: “Technically. But that’s probably not what – the terminology I would use, no. Franking credit benefit – I don’t know”: T, p 74, lns 4-6.

254    I mention this exchange because it suggests that at least up until that moment in Ms Abbott’s cross-examination (and the putting to her, as a frame of reference, that the intention of the resolution at the time of making it was to distribute entitlements called franking credit benefits), Ms Abbott thought that she was framing a resolution which was allocating franking credit amounts and that as a matter of taxonomy or terminology she did not consider (at the time) the resolution as allocating franking credit benefits, so described.

255    Ms Abbott accepted, however, that the franking credits resolution did not seek to do anything with the franking credit income, that is, the amount of the gross-up (T, p 74, lns 17-20; lns 37-38) and observed that the purpose of the resolution was “to indicate who those benefits [“referable to the franking credits that came with the dividend”] were to go to”: T, p 74, lns 22-24. It thus seems that although Ms Abbott was not thinking about these things at the time by reference to the term franking credit benefits, the substance and subject matter of her thinking involved the allocation of a benefit in the form of an offset.

256    Nor was there any intention to deal with the original dividends paid to the trust in passing the franking credits resolution: T, p 74, lns 33-35.

257    Ms Abbott seemed to accept that the dividend income and the amount of the franking credit gross-up were included in (“captured in”) the s 95 net income resolutions: T, p 74, lns 40-47.

(Emphasis in original.)

Similar evidence had been given to Applegarth J in the proceedings in the Supreme Court of Queensland which had been commenced by the trustee against Mr Thomas and MAPL under the Trusts Act 1973 (Qld) for the proper construction of the trust deed and the resolutions: see Thomas Nominees Pty Ltd v Thomas (2010) [2010] QSC 417; 80 ATR 828 at [21]-[28]. In that proceeding Applegarth J made declaratory orders concerning, as between the trustee and beneficiaries, the proper construction of the resolutions which had been made for the income years in these proceedings which will be considered below.

21    The net income distribution resolution in the 2006 year purported on its terms to distribute the whole of the net income of the trust estate to MAPL except for $21,600 which was distributed to Mr Thomas. There was thus, accordingly, no further net income of the trust estate in that year available for distribution by the franking credit distribution resolution despite the fact that its terms also purported to apply “the net income of the trust estate”. The person drafting the resolutions seemed, however, to believe that a trustee could distribute separately the credits attaching to the income of a trust estate from the distribution of the income itself. That belief may have been caused by the terms of the amendments which had been made in 1992 to the trust deed which, amongst other matters, contemplated the keeping of separate accounts in the trust for income with different qualities. Whatever the belief, and whatever may be their effect, the two resolutions combined show what their drafter intended: namely, that one beneficiary (Mr Thomas) was to receive the benefit of the bulk of the franking credits (but only $21,600 of the net income of the trust fund) and that the other beneficiary (MAPL) was to receive the benefit of a smaller amount of franking credits (but the balance of the net income of the trust fund). The resolutions themselves do not reveal whether the two resolutions independently achieved the same outcome; that is the resolutions above do not reveal whether a distribution of $21,600 of the net income of the trust estate for the 2006 year by the net income distribution resolution was a distribution to Mr Thomas of the “share amount” of the trust income for the 2006 year which, for the purposes of Div 207, would result in Mr Thomas having the benefit of franking credits to the extent of the $2,416,217.92 in the franking credit distribution resolution for that year.

22    The application of Div 207, however, depended upon determining the share amount of each beneficiary of the trust’s net income for the income year covered by s 97(1)(a) of the 1936 Act. That amount for each of the beneficiaries would appear to be the amount distributed by the net income distribution resolution and not by the franking credit distribution resolution. The latter could not distribute to either beneficiary any amount or share of the trust’s income covered by s 97(1)(a) of the 1936 Act if it had been distributed by the net income distribution resolution. One reading of the two resolutions is that the net income distribution distributed the net income of the trust estate in the year in question and that the franking credit distribution resolution purported to distribute the franking credits separately as if they were separate items of income or property which did not automatically “flow” to the beneficiaries by force of Div 207 from the terms of the net income. Whatever effect the franking credit distribution resolution may have had for the purposes of the trust between the beneficiaries amongst themselves and as between them and the trustee, the resolution, on one reading of its terms, did not distribute to any beneficiary any amount or share needed to have been distributed for the effect of Div 207 to have “flow” to them the amount of franking credits stated in the second resolution. The franking credits available in the 2006 year to each of Mr Thomas and MAPL, on that view, for example, would be that proportion of the total franking credits received as corresponds to their respective proportions of the amounts distributed to them by the net income distribution.

23    It becomes necessary to consider, however, whether the operation of Div 207 was affected by the orders made by Applegarth J in the Supreme Court of Queensland in November 2010. The Commissioner had notified the trustee in May 2009 of an intention to commence an audit for the tax years ended 30 June 2005 to 30 June 2009. Correspondence on behalf of the trustee to the Commissioner in November 2009 raised the possibility of errors having been made in the tax returns for the relevant years. On 24 August 2010 the trustee commenced proceedings in the Supreme Court of Queensland seeking directions under s 96 of the Trusts Act 1973 (Qld) as to the proper construction of the trust deed and of the two sets of resolutions passed in the 2006, 2007 and 2008 years of income. Mr Thomas and MAPL, as beneficiaries of trusts, were the respondents in the application but they supported the trustee’s application and there was no controverter in the proceeding. The Commissioner was notified of the proceeding but informed the applicant’s solicitor that it was not considered appropriate for the Commissioner to be a party to the application: Thomas Nominees Pty Ltd v Thomas [2010] QSC 417; (2010) 80 ATR 828, [11].

24    The application was heard on 29 September 2010 by Applegarth J who gave reasons for his proposed orders on 11 November 2010. His Honour’s published reasons expressed conclusions about the issue of construction but the formal direction on that day was for the parties to that application to be heard concerning the form of orders to be made in light of his Honour’s published reasons and conclusions. Senior counsel informed the Court in this appeal that what next occurred was that senior counsel for the trustee in that application prepared and filed short minutes of orders which his Honour formally made on 12 November 2010 as follows:

1.    The court directs the applicant under s 96 of the Trusts Act 1973 (Qld), and declares, that:

(a)    on the proper construction of the Income Tax Assessment Act 1997 (Cth), franking credits in respect of a franked distribution made to the trustee of a trust confer a financial advantage which falls to be dealt with by the trustee of the trust; and

(b)    on the proper construction of the trust deed for the Thomas Investment Trust and of the resolutions of the directors of the applicant for the years ended 30 June 2005 to 2008, those resolutions were effective to:

(i)    allocate to the following beneficiaries in the following amounts the benefits pertaining to the franking credits; and

(ii)    entitle those beneficiaries to those benefits in the proportions which those amounts bear, each to the other:

Date of Resolution    Martin A Thomas    Martin Andrew Pty Ltd

30 June 2005        $282,631.49        $17,860.51

30 June 2006        $2,416,217.92        $228,900.38

30 June 2007        $4,765,353.11        $548,488.89

30 June 2008        $1,030,838.70        $42,780.30

(iii)    confer on each of those beneficiaries respectively a vested and indefeasible interest in possession in a share of the distributable income that is consistent with the above allocation to those beneficiaries of the benefits pertaining to the franking credits;

(iv)    distribute all the distributable income of the Trust in each year among the above beneficiaries in accordance with those resolutions.

2.    The court orders that the application for equitable rectification of those resolutions be dismissed.

One of the orders which had been sought in the application heard by Applegarth J had been for equitable rectification of the resolutions, but the application for rectification was, by order 2, dismissed by his Honour. Counsel for the taxpayers in these appeals under Part IVC of the Taxation Administration Act 1953 (Cth) (“the Administration Act”) informed the Court that senior counsel for the trustee in the Supreme Court application (who also appeared as senior counsel in these appeals) had informed Applegarth J that the draft orders to be submitted to him would include the order dismissing the application for rectification of the resolutions.

25    His Honour’s dismissal of the application for rectification is significant because his Honour’s orders did not operate to alter the resolutions made by the trustee. His Honour’s declaration may, however, nonetheless bind the Commissioner (as the Commissioner correctly conceded) to the extent that his Honour’s orders conclusively determined the rights of the beneficiaries and the trustee. In Executor Trustee and Agency Co of South Australia v Deputy Federal Commissioner of Taxes (South Australia) [1939] HCA 35; (1939) 62 CLR 545 Latham CJ said at 562-3:

The Commissioner of Taxation who takes moneys from a taxpayer as a contribution to the revenue cannot be described as a privy in estate to the taxpayer where rights have been determined in a proceeding to which the commissioner was not a party. But when, in duly constituted proceedings before a competent court, the rights of a cestui que trust against a trustee and the corresponding duty of the trustee towards the cestui que trust have been defined, there is no means whereby those rights can be otherwise defined, because each party is conclusively bound by the order of the court. If the right in question is a right of the cestui que trust to receive money, such as income, from the trustee, the order necessarily and in the nature of the case finally determines, so far as it goes, the nature and extent of the right of the cestui que trust. When the revenue authorities come to impose a tax in relation to such rights, they must, in my opinion, take them as they in fact actually exist between the parties. Thus, although the commissioner cannot be said to be “bound” by the order of the Supreme Court as res judicaia or in any other way, he has no option but to assess the trustee or the cestuis que trust upon the basis of their duties and rights as declared by the order.

Dixon J (with whom Evatt J agreed) said at 569-570:

Even if these two orders had not been made and the construction of the will were altogether open, I should not place upon it the interpretation for which the appellant contends. The orders, however, fix the rights of the beneficiaries in relation to the income of the land upon which the tax is levied, and, in my opinion, they control the situation.

There is no question of res judicata or issue-estoppel. But the rights in question being measured by the nature and extent of the interests which are taken in the land as at 30th June 1938, we must look at all operative instruments which define those interests. The orders define the interests of the six beneficiaries. It is true that they do not purport to give new interests and that in law they operate only as declarations determining, as between trustee and beneficiary, the interests otherwise existing, that is, arising under the will. But it is none the less true that the beneficiaries can, after the making of the orders, have no interest in the land inconsistent with the orders.

McTiernan J at 572 said:

It was said that, as the commissioner was not a party to the proceedings, the orders were not binding in this appeal. It is true that none of the questions decided in those proceedings is binding on the commissioner as if it were a res judicata. But the will and the orders made by the Supreme Court determine the interests which according to the law of South Australia the annuitants have in the income from the land. I agree that the interests were liable to taxation upon the basis that they were correctly declared by the orders.

It is respectfully correct to say, as was observed by Greenwood J at [425]-[445], that the Commissioner is not bound by the construction of Div 207 adopted by Applegarth J, but for present purposes the relevant question is whether his Honour’s orders relevantly determined conclusively the rights of the beneficiaries as against the trustee in such a way that Div 207 would operate as the taxpayers contended.

26    The issue before Applegarth J was whether the trustee had distributed to the beneficiaries franking credits upon the footing that the franking credits were trust property able to be distributed separately pursuant to the terms of the trust. At [40] his Honour identified the issue as put to him in the proceedings as follows:

The issue in this matter is whether the franking credits which formed part of the trust property in each relevant year were distributed to the beneficiaries in accordance with the resolutions that recorded them being applied, being resolutions that dealt specifically with the franking credits. The issue is whether the resolution that was intended to distribute franking credits was effective to pass them to the beneficiary recorded in the resolution that dealt with franking credits, or whether, as the ATO apparently suggests, franking credits were allocated in accordance with the other resolution. The ATO’s suggestion is at odds with the terms of the resolutions which were executed contemporaneously, and does not accord with the clear intent of the trustee. That said, I apprehend that the essential issue in respect of which the trustee seeks direction pursuant to s 96 of the Trusts Act 1873 (Cth) is whether the Deed permits a differential allocation of franking credits so as to achieve the outcome intended by the trustee’s resolutions. If it does not, the trustee seeks rectification of the resolutions.

(Emphasis added.)

At [50] Applegarth J concluded that the resolutions purported to allocate the franking credits differentially according to the terms of the trust.

27    Applegarth J’s declaration in 1(b)(iii) is, perhaps surprisingly, that the resolutions which the trustee had made in the years ended 30 June 2005 to 30 June 2008 had conferred upon each of the beneficiaries a vested and indefeasible interest in the distributable income consistent with the intended flow of franking credits. That had been the intention of the trustee when making the relevant resolutions in respect of each of the four years and his Honour was persuaded that the resolutions required that they be read in that way. The application before his Honour required the Court to make sense of what may, perhaps not unfairly, be described as confused resolutions. The resolutions purported to do something and an ultimate intention could fairly be discerned however ineptly the two resolutions may have been drawn. However the rights of the beneficiaries flowing as against the Commissioner from Div 207 of the 1997 Act depended wholly upon the effect of the rights created as between the trustee and the beneficiary by whatever the resolutions may have achieved. The rights to be created by the trustee as against the Commissioner were a matter wholly within the control of the trustee and it was in the jurisdiction of the Supreme Court to make declarations concerning the proper construction of what the trustee had done pursuant to a domestic trust. The Commissioner was not obliged to participate in that proceeding, and may not be bound by the construction of Div 207, but the Commissioner is bound by a declaration concerning the effect of the resolutions if the declaration conclusively determines that a beneficiary has a share of the trust’s net income for a year of income that is covered by s 97(1)(a) of the 1936 Act. His Honour’s declaration in paragraph 1(b)(iii) is to that effect and determined conclusively as against the Commissioner the beneficiary’s share of the trust’s net income for the years covered by his Honour’s orders. It follows that the appeal should be allowed in respect of those years and that the objection decision for those years should be remitted to the Commissioner for reassessment. It follows also that it is unnecessary to consider the Commissioner’s notice of cross-appeal although it is perhaps desirable to say that if the taxpayer’s appeal had been dismissed it would have been necessary to consider whether Greenwood J nonetheless erred in not determining that each of the beneficiaries were entitled to so much of the franking credits as was referrable to the share of the trust income distributed by the first of the resolutions.

28    The taxpayers appeal also the decision in this Court in respect of the 2009 year which was not covered by orders of Applegarth J. The resolutions passed in respect of the 2009 year were to the same effect as those which had been passed for the years considered by Applegarth J in the Supreme Court proceeding. Trust resolutions, therefore, proceeded upon the same misunderstanding of the proper operation of Div 207; that is, upon the misunderstanding that franking credits could be distributed separately. The intention of the person drafting the resolution, however, was consistent with the intention found by Applegarth J. The trustee intended to pass resolutions which would trigger the operation of Div 207 so that Mr Thomas would receive the greater benefit of the franking credits in the 2009 year although he would receive a lower proportion of net income than MAPL. It is difficult to embrace the conclusions of Applegarth J and to see the combined effect of the two resolutions as, in effect, contradicting part of the otherwise clear terms of the net income distribution resolution for 2009 (which is expressed to distribute that upon which Div 207, and in particular s 207-50(3)(b)(i) is to operate). The franking credit distribution resolution is explicable only by a fundamental confusion in the mind of the person drafting the resolution to achieve an outcome which could not be achieved by the resolutions upon their terms. Applegarth J, however, was persuaded that the terms of the two resolutions taken together in the previous years should be read to give effect to what can be accepted as having been the intentions of Mr Thomas and Ms Abbott upon the basis of their belief about the operation of Div 207 and the terms of the trust. His Honour said at [19]-[27]:

19    Mr Thomas’ and Ms Abbott’s states of mind in relation to the resolutions the subject of this application, and in particular the taxation outcome that they intended to achieve, are relevant facts. As Bowen LJ stated in Edgington v Fitzmaurice, “the state of a man’s mind is as much a fact as the state of his digestion.”

20    Mr Thomas and Ms Abbott each believed that by reason of the operation of the tax legislation:

(a)    The trustee was required each income year to calculate the amount liable to taxation in accordance s 95 of the Income Tax Assessment Act 1936 (Cth) (the ITAA 1936), being assessable income less allowable deductions. This amount is referred to as “the s 95 net income”.

(b)    The amount of the dividends and other income was assessable income.

(c)    The amount of the franking credits was assessable income.

(d)    The trustee’s expenses were allowable deductions.

(e)    In relation to s 95 net incomes, all of it must be distributed by the trustee among the beneficiaries lest the trustee be liable to tax at the highest marginal tax rate under s 99A of the ITAA 1936.

(f)    In relation to franking credits, they can be allocated by the trustee among the beneficiaries and, in that case, 2 statutory advantages are conferred on the beneficiary to whom a franking credit is allocated:

(i)    a rebate of tax otherwise payable by that beneficiary, and

(ii)    in the case of an individual (that is, Mr Thomas) but not a company (that is, Martin Andrew Pty Ltd), a cash entitlement as against the Commissioner of Taxation in relation to the excess not used for (i).

21    In each of the income years, before formal distribution resolutions were made, Ms Abbott and Mr Thomas discussed what distributions should be made, having regard in particular to the amount of s 95 net income and the statutory advantages conferred by the franking credits on those beneficiaries entitled to them under Div 207 of the ITAA 1997.

22    The 2 principal taxation factors referred to above – the desirability of distributing all the s 95 net income and the statutory advantages of allocating franking credits among individual and corporate beneficiaries effectively – were known to and informed the discussions between Mr Thomas and Ms Abbott.

23    The over-riding factor in Mr Thomas’ and Ms Abbott’s view was to ensure that the full benefits of the franking credits were obtained, especially that Mr Thomas as an individual beneficiary would be allocated the franking credits to allow him to claim cash from the Commissioner of Taxation. Mr Thomas ordered his affairs based on the anticipated franking credits that he would receive from the Commissioner.

24    Mr Thomas gave Ms Abbott instructions to draft resolutions that would be effective to: (i) distribute all of the s 95 net income each year so that the trustee would not be liable to tax under s 99A; and (ii) confer on himself and on Martin Andrew Pty Ltd the maximum advantages related to the franking credits, being: (a) to reduce the tax otherwise payable by himself and by Martin Andrew Pty Ltd to nil; and (b) to confer on himself the statutory right to cash as against the Commissioner of Taxation in relation to the excess not used in (a).

25    For each of the income years Ms Abbott calculated the expected s 95 net income for the year and determined the amount of franking credits available for allocation. The franking credits available for distribution far exceeded the s 95 net income in each income year.

26    Ms Abbott then chose to draft dual resolutions for simultaneous execution (rather than one resolution) based on Mr Thomas’ wishes. The first resolution purported to deal with the franking credits and other special tax income (namely, a foreign tax credit). In terms, it distributed the vast bulk of the franking credits to Mr Thomas and distributed to Martin Andrew Pty Ltd only so much as was required to pay the tax payable by that company. The second resolution purported to deal with all the trust income that did not relate to franking credits or other special tax income. It distributed a cash amount to Mr Thomas and the balance to Martin Andrew Pty Ltd.

27    For each of the income years Mr Thomas as director of the trustee made formal resolutions in the terms as drafted by Ms Abbott, believing that they were effective to achieve his intentions.

Although his Honour dismissed the application for rectification, at [53] he expressed the view that he would have ordered rectification of the resolutions if he had reached a different conclusion about the proper construction of the resolutions in respect of the 2005 to 2008 years.

29    A similar conclusion to the order made by Applegarth J should be reached in respect of the 2009 resolutions albeit with reluctance. It would, indeed, perhaps be impossible to embrace his Honour’s construction of the resolutions had they been made after those drafting them had become aware of their inherent problems. The resolutions for the 2009 year were made, however, on 31 August 2009 and were plainly made upon the same misguided misunderstanding of how Division 207 operated. The terms of the two resolutions taken together only make sense if construed as conferring upon Mr Thomas, as a share of the trust’s net income covered by s 97(1)(a) of the 1936 Act in the 2009 year, so much of the trust’s net income for that year as would see him receive the benefit of franking credits in the amount stated in the franking credit distribution resolution notwithstanding that the amount of income purportedly distributed to him in the 2009 year was $16,000 and to MAPL $157,143. This conclusion fits uneasily with the words of the resolutions but is consistent with the intention of the trustee reflected in the mind of the person drafting the resolutions. Accordingly the appeal in the 2009 year should also be allowed and the decisions remitted to the Commissioner for reassessment, although the formal orders in those years may be affected by the fact that the Commissioner had assessed under s 99A of the 1936 Act.

30    It becomes unnecessary to consider the questions concerning penalties.

31    The appeal should be allowed with the parties directed to submit a form of order in each of the proceedings to give effect to these reasons.