Guardian AIT case: Could Part IVA apply to trust distributions?

It is becoming increasingly complex for trustees of discretionary trusts to navigate the tax landscape with regard to trust fund distributions. In addition to legal and fiduciary duties, when deciding the appropriation of trust fund income or capital, a trustee must now deliberate the risk (if any) of the anti-avoidance provisions applying i.e., s100A and the general anti-avoidance provisions in Part IVA of the ITAA 1936.

In the context of Part IVA, the Full Federal Court judgement in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (Guardian) (handed down on 23 January 2023) is another reminder that in some instances, Part IVA could apply to trust distributions.

In Guardian, the Full Federal Court held that:

• s100A did not apply to trust distributions that occurred in the 2013 income year. The Commissioner did not appeal the primary judge’s finding that s.100A did not apply to the 2012- and 2014-income years; and
• Part IVA did not apply to enable the Commissioner to make a determination in respect of the 2012 income year; and
• Part IVA did apply to enable the Commissioner to make a determination in respect of the 2013 income year.

Part IVA disputes and the onus of proof

Even though it is the Commissioner who identifies the scheme(s) for Part IVA cases, like all tax disputes, a taxpayer bears the onus of proving that a Part IVA assessment is excessive. This onus is not discharged merely by showing that the Commissioner’s alternate postulate was not reasonable or contains errors. To determine whether a tax benefit would not otherwise have been available, it is necessary to identify what might reasonably have been expected to happen if the defined scheme(s) had not been entered into. The process of identifying whether a postulate is a reasonable alternative involves a factual inquiry by the Court. Unfortunately for many taxpayers, having sufficient compelling contemporaneous evidence to support the non-tax purposes or non-tax reasons for undertaking a particular transaction/arrangement/scheme can be problematical. The lack of objective evidence (or the existence of contrary evidence) was demonstrated in Guardian in relation to the appointment of the 2013 trust income to a corporate beneficiary.

The Guardian case

Broadly, the case involved three key players, Guardian AIT Pty Ltd as trustee for Australian Investment Trust (AIT), a corporate beneficiary, AIT Corporate Services Pty Ltd (AITCS) which is wholly owned by AIT, and an individual, Mr Springer.

The relevant transactions were:

• Guardian as trustee for AIT appointed income (other than income attributable to franked dividends) to AITCS for each of the years FY2012, FY2013 and FY2014;
• The income so appointed remained unpaid and thus became an unpaid present entitlement (UPE) owing to AITCS for each of the relevant years;
• The year following the appointment, AITCS drew on its UPE to discharge its liability to tax on the distribution received from AIT in the previous year;
• Prior to the lodgement of AIT tax return for the income year in which income was appointed to AITCS, the company declared a fully franked dividend to AIT in an amount equal to the balance of the remaining UPE owed to it;
• The fully franked dividend was paid to AIT before 30 June by extinguishing the existing UPE that it owed AITCS;
• AIT then distributed the fully franked dividend in the same income year to Mr Springer (and given he was a non-resident of Australia this was a final tax paid).

On 5 January 2018, the Commissioner issued alternative assessments to Mr Springer to give effect to determinations made under Part IVA. The Commissioner’s position was that if the 2012 and 2013 related schemes had not been entered into, Mr Springer would, or might reasonably be expected to have had included in his assessable income the amounts of AIT net income appointed to AITCS in each of the years under review.

Mr Springer’s position was AITCS was established for asset protection and wealth accumulation purposes. Had the defined schemes not been entered into, what would, or might reasonably be expected to happen was AITCS would have received and retained the full UPE in cash. Alternatively, AITCS would have invested the UPE with AIT in accordance with Division 7A compliant loan agreement or some combination of these.

Evidence and discharging the burden of proof

The term “asset protection” is a phrase often used by taxpayers (and practitioners) to explain and justify the purposes of a transaction(s), arrangement(s), course of action(s) etc. Whilst asset protection may be a genuine intention or reason for undertaking a course of action, in any tax disputes including Part IVA, the evidential burden is on the taxpayer. Generally, a taxpayer is found not to have satisfactorily discharged that onus where the evidence (objectively viewed) is lacking or contrary to the adopted purported position.  In other words, saying that the aim was asset protection but having no evidence to support that position is unlikely to be a successful defence.

Guardian is a case on point. The proposition that AITCS was a vehicle for wealth accumulation or asset protection was not supported by facts as any accumulation was relatively short-term. Similarly, when viewed objectively, the alternate postulates provided by Mr Springer were considered not to be readily reliable (primarily due to a lack of evidential support).

What was the evidence?

The evidence adduced by the Court showed that:

• any retained earnings AITCS had from the appointment of trust income in an income year was dissipated the following year when it declared and paid out the UPE owed to it in the previous year;
• any wealth it had acquired as a result of being appointed income were held for not more than eight months. Holding an asset of value for a period of eight months could not in their Honours’ opinion be described as an accumulation of wealth;
• had the defined schemes not been entered into or carried out, AITCS would not have received and retained in full its UPE in cash;
• Mr Springer had expressed concern about holding a significant amount of cash in AITCS bank account of which he had no control;
• had the defined schemes not been entered into or carried out, AITCS would not have invested the funds representing the UPE with AIT in accordance with a Division 7A compliant loan agreement;
• the 2013 Division 7A loan was not drafted as a substitute for the UPE to be cleared with a dividend. Rather, it was drafted as a ‘safety net’ in the event that the Commissioner characterised the UPE as a loan;
• at the time the 2013 UPE arose, Mr Springer had evidenced no desire for a loan agreement when he proposed the payment of a dividend by AITCS;
• there was an expectation that the 2013 UPE would be cleared out enabling Mr Springer to enjoy the benefit of that distribution in the form of a franked dividend paid to him in the following year (and that was what happened);
• there was significant difference between the commercial outcome of the actual scheme and the counterfactual involving AITCS investing the funds represented by the UPE owed to it with AIT. Under the alternative arrangement AITCS would retain an asset in the form of Division 7A loan investment in AIT, and the repayments of the asset would have ended in the AITCS bank account which Mr. Springer did not have control. Under the scheme Mr Springer had direct ownership and control of the right to payment of the share of net income being the dividend declared and paid by AITCS to AIT and distributed to him. The Honours considered that “ a prediction that has a different commercial outcome from the scheme entered into and carried out is not readily accepted as reliable”.

Where to from here?

When making decision regarding trust fund distributions trustees should form a habit of documenting the basis or reasoning behind a distribution. The facts forming the basis of the decision must exist at the time. This could have the advantage of a trustee turning their mind from a theoretical reason to implement an actual strategy – this could result in the necessary documentation arising out of the chosen activity itself and providing the trustee some substance to the position they have taken. As highlighted in Guardian contemporaneous records (or lack thereof) can affect the success or failure of a tax dispute.

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