Investing in real estate with a SMSF – traps & entanglement


There is more to investing in real estate together with a self managed superannuation fund (SMSF) than meets the eye. It can be fraught and illegal under SMSF rules. This blog looks at why.

Joint tenancy ownership compared to ownership by tenants-in-common

The title of this blog piece does not refer to investing jointly with a SMSF and this is deliberate. Co-ownership of land can be joint: viz. as joint tenants, where a surviving joint owner or owners take the interest of a joint owner who dies, or can be as tenant/s-in-common (TsIC) where each co-owner owns a discrete co-ownership interest in a fixed proportion of the whole outright ownership interest in the land which, in the case of an individual on his or her demise, will form a part of his or her estate just as an interest in land owned by a sole individual owner would.

Which type of ownership works where a (trustee of a) SMSF is a co-owner?

Joint tenancy is usually only appropriate for life partners. Investing in a joint tenancy can also work for joint trustees of a trust where, on the death of a trustee, it is appropriate that the property be legally owned by surviving trustee/s.

The point here is joint tenancy is inapt and inappropriate investing between a member of a SMSF and the SMSF obliged to deal on arm’s length basis under section 109 of the Superannuation Industry (Supervision) Act (C’th) 1993 (SIS Act) with all parties including the member when co-ownership of an asset is under contemplation. A SMSF needs to acquire assets at arm’s length and assets acquired need to have a discrete integrity which joint tenancy ownership doesn’t give.

So, if there is to be co-ownership between members or related parties and a SMSF investing in land, it needs to be as TsIC.

Related parties of a SMSF include:

  • relatives of the Members (spouse, children, siblings, etc.);
  • the (business) partners (Partners) of the Members;
  • the spouse and children of the Partners;
  • companies (Companies) controlled by the Members or any of the above (Associates);
  • the members of the SMSF (Members) themselves; or
  • trusts controlled by the Members, Associates and Companies.

(See Part 8 associates in Sub-division B of Part 8 of the SIS Act.)

Co-ownership of land between SMSF members and the SMSF as tenants-in-common

There is a further trap where SMSF members or other related parties and a SMSF contemplate co-ownership of land as TsIC where the land is residential property (RP):

Prohibition on acquisition of assets from superannuation fund members and related parties

With very limited exceptions, real estate with a residence cannot be business real property (BRP): see Self Managed Superannuation Funds Ruling SMSFR 2009/1 Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993.  A SMSF cannot acquire an asset from a related party of the SMSF (section 66(1) of the SIS Act) unless an exception applies such as the exception for BRP (permitted under para 66(2)(b) of the SIS Act).

A breach by a trustee of a SMSF of section 66 can result in criminal prosecution and imprisonment of the individual trustee/s or director/s of the trustee (TEsDRs), as the case may be, for up to one year (sub-section 66(4) of the SIS Act).

It follows that the trustee of a SMSF cannot, or likely cannot, lawfully acquire RP already owned by a member/related party of the SMSF unless the RP is BRP. This prohibition works in substance as schemes that have the result that RP of a member/related party of a SMSF is acquired by a SMSF, say indirectly via sale to the SMSF and then purchase back by the SMSF from an intermediary unrelated to the SMSF, are also caught by section 66 and are similarly prohibited: sub-section 66(3).

Implications for related co-owners who own RP as tenants-in-common with a SMSF

This has further implication when RP is acquired and co-owned where a SMSF is an established co-owner: let us say where the RP is purchased in an arm’s length sale on the open market.

The SMSF owns a part of the RP as a TsIC but section 66 prohibits the SMSF from buying more of the RP from the related TsIC who is now a co-owner too. That further purchase would be acquisition of an asset from a member/related party. The same anti-scheme rule in sub-section 66(3) again applies to prevent the SMSF acquiring a further interest owned by a related party as a TsIC indirectly through a scheme.

An unsatisfactory entanglement

So the entanglement of a related party in the ownership of RP effectively prevents the SMSF from ever owning the whole of a RP it invests in as TsIC with a related party. This bears on, or should have borne on, the investment decision of the SMSF trustee to invest in the RP in the first place.

Entanglement gets worse when a SMSF has individual trustees and these individual trustees are members of the SMSF with whom the SMSF co-invests in RP. Under land law in most Australian states and territories only these individuals appear on title as registered owners of the RP. Without further steps, such as registering a caveat, the trustees of the SMSF, obliged to act at arm’s length from themselves, are poorly placed to assert co-ownership of the RP by the SMSF and to comply with mandatory covenants applicable to a SMSF including:

(b)   to exercise, in relation to all matters affecting the fund, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide;

(d)   to keep the money and other assets of the fund separate from any money and assets, respectively:

  (i)   that are held by the trustee personally; or

  (ii)   that are money or assets, as the case may be, of a standard employer – sponsor, or an associate of a standard employer – sponsor, of the fund;

(e)   not to enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising the trustee’s functions and powers;

from sub-section 52B(2) of the SIS Act

Entanglement disrupting sale of the TsIC interest by a SMSF

An investment in an asset which is not discretely saleable raises further section 52B covenant difficulty. The section 52B covenants continue:

(f)   to formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to, the following:

  (i)   the risk involved in making, holding and realising, and the likely return from, the fund’s investments, having regard to its objectives and its expected cash flow requirements;

  (ii)   the composition of the fund’s investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification;

  (iii)   the liquidity of the fund’s investments, having regard to its expected cash flow requirements;

  (iv)   the ability of the fund to discharge its existing and prospective liabilities;

paragraph 52B(2)(f) of the SIS Act

Investing in a marooned asset

So does a trustee of a SMSF who invests in a asset that is marooned, because it can’t be readily sold without the co-operation of a co-owner or co-owners also selling, adequately deal with the risks referred to in paragraph 52B(2)(f)? Assumption that a related party TsIC will always co-operate with a co-owner trustee of a SMSF TsIC is incompatible with the section 109 of the SIS Act obligation of the trustee to act an arm’s length basis in its dealings including dealings with related parties.

Based on the section 52B covenants and section 109 the trustee/s of a SMSF should establish proper motive for making an investment as a co-owner in RP. To do that there likely needs to be either an exchange of:

  • tag along drag along rights; or
  • rights to require other TsICs to buy each other out of their interests;

so the SMSF can realise its investment in a TsIC investment interest in RP when it needs to meet its s52B(2)(f) covenants without being marooned in the investment.

The mandatory covenants in section 52B on trustees of SMSFs are between the trustee/s of the SMSF and the members of the SMSF. When they are the same people there are only occasional cases where a member would sue trustees for breach. The covenants are not civil penalty provisions.

Civil penalty provisions

In the SIS Act civil penalty provisions have these potential consequences for SMSFs:

  1. breach can lead to the Australian Taxation Office as SMSF regulator (ATO as R) issuing a notice of non-compliance (NONC) to a SMSF so it is no longer a complying superannuation fund where:
    1. non-complying superannuation funds pay 45% income tax on their assessable income; and
    2. the assessable income of a fund that becomes a non-complying superannuation fund under a NONC must include the value of the assets of the fund, less undeducted contributions, at the beginning of the income year when the fund becomes non-complying. This is a significant penalty as it effectively taxes the fund’s accumulated assets at the 45% rate: see Subdivision 295-E of the Income Tax Assessment Act 1997.
  2. intentional breach can result in criminal prosecution of TEsDRs: section 202 of the SIS Act;
  3. administrative penalties on TEsDRs (in less serious cases taken not to warrant the above): s166 of the SIS Act; and
  4. the ATO as R can give the TEsDRs directions to rectify (section 159 of the SIS Act) the breach or educational directions (section 160 of the SIS Act).

    Consequences 1 to 3 don’t apply to a breach that is solely or simply a breach of the section 52B mandatory covenants. Consequences 4 can happen though: the ATO as R can give TEsDRs a direction to rectify requiring sale of a marooned TsIC interest acquired in RP in breach of the covenants in paragraph 52B(2)(f).

    Sole purpose fails

    Even where the RP is let out under a lease entirely at arm’s length to an arm’s length tenant there could still be a sole purpose civil penalty provision problem under section 62 of the SIS Act where the purpose of an investment by the SMSF in RP was not so much to generate returns to the SMSF, or to assist a SMSF to fund the payment of SMSF benefits to members, but rather to finance SMSF member acquisition of an investment property. Not bothering to arrange the above rights for the SMSF amplifies the prospect that a SMSF auditor or the ATO as R will reach that conclusion about the illicit purpose of the trustee/s of the SMSF.

    Where the RP is acquired for a member or related party of the SMSF to live in then breach of the section 62 civil penalty provision will be yet more serious and clear cut.

    Entanglement of financing

    The need for a SMSF member and SMSF co-investors in RP as TsIC to co-operate extends further. The SMSF member borrowing with recourse or security over the property can amount to a charge over the property breaching SIS Regulations 13.14 and 13.15 and, where the recourse or security is called in, the SMSF might find itself co-investing with a financier eager to sell up the RP. In June 2011 the Commissioner and tax professionals considered these issues which were reported in National Tax Liason Group technical minutes. These can be difficult to locate on the somewhat dynamic Australian Taxation Office website so we have uploaded a copy here

    It follows that a mortgage can’t be given to the financier of the co-owning member/s of the SMSF over the RP co-owned by the SMSF. Giving security over the TsIC interest only of the member/s of the SMSF who borrow only may be possible but that security needs to be carefully target only the borrower’s TsIC interest so that it has no reach to impact or to give any recourse against the TsIC interest of the SMSF in the RP.

    Unit trust alternative?

    Investment of more than 5% of a superannuation fund in in-house assets under Part 8 of the SIS Act can give rise to breach of a civil penalty provision with the potential Consequences 1-4 described above: section 84 of the SIS Act.

    In 1999 the meaning of in house asset was widened to curtail significant investment by SMSFs in particular in related unit trusts. A popular strategy, to establish a unit trust to hold RP in which SMSFs and their related parties could hold units, could no longer be used without running into an in house asset problem.  A carve-out to in house asset treatment was extended in Division 13.3A–In-house assets of superannuation funds of the SIS Regulations for companies and unit trusts that:

    • are continuously non-geared, that is never have liabilities;
    • have assets that are not investments in other entities;
    • do not conduct a business; and
    • neither lend nor borrow

    so that SMSFs could invest in shares or units in them without these being in house assets.

    An exception in sub-paragraph 66(2A)(a)(iv) of the SIS Act means that investment in say a SIS Regulation 13.22C non-geared unit trust to hold RP is not only excluded from being an in-house asset under paragraph 71(1)(j), but its acquisition from a related party is not prohibited under sub-section 66(1).

    Non-geared unit trust compared to co-investing in residential property as tenants-in-common

    This is a significant advantage over investing in an interest as a TsIC in RP. So a SIS Regulation 13.22C non-geared vehicle should be seriously considered as an alternative to investing with a related party in RP as a TsIC. Still a SIS Regulation 13.22C non-geared unit trust is nevertheless a challenging structure for indirect SMSF investing in RP as:

    1. the compliance requirements, especially those that cause abrupt loss of the in house asset exclusion in SIS Regulation 13.22D are daunting (albeit the problems with investing as a TsIC in RP are covertly so and are all across the SIS Act , as this post illustrates); and
    2. units in a non-geared unit trust that don’t amount to all of the units in the trust still have the same propensity to be marooned assets of the SMSF unless the investing SMSF can compel all other unit holders to buy or drag along when the SMSF needs to realise its investment.

When can a trustee favour itself as a beneficiary of a family discretionary trust?

Give it back!

Usually but the answer is nuanced. It is often claimed that a trustee exercising a discretion [Discretion] to favour himself/herself/themselves/itself (HHTI) as a beneficiary of a family discretionary trust (FDT) is acceptable but legal authority for the claim isn’t given. Even the Australian Taxation Office distills the proposition to a sentence. They say:

The trustee may also be a beneficiary, but not the sole beneficiary unless there is more than one trustee.

Trusts, trustees and beneficiaries | Australian Taxation Office

To be fair this comment by the ATO mainly concerns the merger of trusts (considered in our blog post at Bringing trusts to a timely ending ) so maybe full accuracy shouldn’t be expected on the subsidiary point they raise about whether a trustee of a trust may be a beneficiary of the trust.

Conflict of interest

Is not the trustee exercising a Discretion to favour HHTI in a position of conflict of interest? Shouldn’t there be control over a trustee of a trust limiting when the trustee of a trust can exercise the Discretion to favour the trustee?

A primary concern for a trustee who exercises the Discretion is successful suit by a disgruntled beneficiary (DB) where the trustee distributes income or capital of the trust to HHTI instead of to the DB. Another concern is whether the trust is real or a sham: a trustee taking property held on trust for HHI is inconsistent with holding the property on trust.


Has a trustee who has done this breached a fiduciary duty?

A trustee is a fiduciary. The law imposes strict standards on a fiduciary:

It is an inflexible rule of the court of equity that a person in a fiduciary position, such as the plaintiff’s, is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule.

Lord Herschell in Bray v. Ford [1894] AC 44


It is perhaps stated most highly against trustee or director in the celebrated speech of Lord Cranworth L.C. in Aberdeen Railway v. Blaikie, where he said: “[a]nd it is a rule of universal application, that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.

Lord Upjohn in Boardman & Anor v. Phipps [1966] UKHL 2; [1967] 2 AC 46 at page 124

A trustee who exercises the Discretion to favour HHTI can be exposed to suit for breach of fiduciary duty under this line of legal authority.


Another duty of a trustee of a trust is to act impartially between beneficiaries. This duty was described in Cowan v. Scargill:

The starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust, holding the scales impartially between different classes of beneficiaries. This duty of the trustees towards their beneficiaries is paramount.

Cowan v. Scargill [1985] Ch 270 at 290-292 (Megarry VC)

Context of trustee power

One may infer from the nineteenth century case authorities cited, in particular, that these duties apply universally to all trustees. The inference is incorrect. In Bray v. Ford the exception ”unless otherwise expressly provided” is significant. Inquiry is needed into the the power given to the trustee to understand whether the rule said to be “inflexible” applies. That is, the extents of the trustee duties of fiduciaries and of impartiality to beneficiaries are at least flexibly ascertained in the context of the power given to the trustee.

In the case of a Discretion in a FDT the trustee will ordinarily be given an explicit power and duty to choose between beneficiaries. In the context of the exercise of a discretionary power in relation to a discretionary trust, there will then be no duty on the trustee to ensure impartiality; that is equal treatment of each beneficiary: Edge v. Pensions Ombudsman [1998] Ch 512, Elovalis V. Elovalis [2008] WASCA 141. In Edge v. Pensions Ombudsman, Scott V-C stated of the rule in Cowan v. Scargill:

Sir Robert Megarry was dealing with an issue regarding the exercise by pension fund trustees of an investment power. He was not dealing with the exercise of a discretionary power to choose which beneficiaries, or which classes of beneficiaries, should be the recipients of trust benefits. In relation to a discretionary power of that character it is, in my opinion, meaningless to speak of a duty on the trustees to act impartially. Trustees, when exercising a discretionary power to choose, must of course not take into account irrelevant, irrational or improper factors. But, provided they avoid doing so, they are entitled to choose and to prefer some beneficiaries over others.

Edge v. Pensions Ombudsman [1998] Ch 512 at p. 533

The limits of FDT trustee power

Adequately cast discretionary powers of a trustee such as given to the trustee of a FDT are thus unlikely to transgress fiduciary and impartiality duties contextually inapplicable to these powers. What checks on the exercise of a Discretion remain? These are explained in Karger v. Paul [1984] VR 161 where it was found that a trustee with an absolute and unfettered discretion must nevertheless exercise the discretion:

  • in good faith;
  • upon a real and genuine consideration of the interests of the beneficiaries; and
  • in accordance with the purpose for which the discretion was conferred.

In this way the obligation on the trustee not to take irrelevant, irrational or improper factors referred to in Edge v. Pensions Ombudsman is put in more positive terms in Australian courts. These benchmarks from Karger v. Paul were applied, and trustees fell short, in Owies v. JJE Nominees Pty Ltd [2022] VSCA 142 and in Wareham v. Marsella [2020] VSCA 92 (which is also considered in this blog at:

Controlling who gets death benefits from a SMSF )

Real and genuine consideration

The real and genuine consideration of the interests of the beneficiaries’ obligation of the trustee on exercising a Discretion will depend on the kind of trust, the interest of the beneficiary in the trust and the standards to be imposed on the type of trustee. For instance in Finch v. Telstra Super Pty. Ltd. [2010] HCA 36, a professional trustee of a large superannuation fund was found to have an amplified real and genuine consideration obligation extending to giving reasons in writing for the exercise or non-exercise of the discretion to pay total and permanent invalidity benefit benefits to a member of the fund.

In contrast an unpaid trustee, such as a family trustee of a FDT, is ordinarily under no obligation to provide the DB with written reasons for a decision to exercise or not exercise a Discretion. Without written reasons the DB can be left with scant evidence to challenge a trustee who instead favours another beneficiary, beneficiaries or HHTI by an exercise of a Discretion under Karger v. Paul benchmarks.

Freedom of a trustee of a FDT to favour beneficiaries including HHTI over others

Within the context and confines of those parameters a trustee of a FDT can favour one beneficiary over another. It follows that a trustee of a FDT can usually exercise a Discretion to favour HHTI to the complete exclusion of the DB so long as the Karger v. Paul parameters are observed.

But power to favour beneficiaries is exceptional

Whether or not there is an exceptional Discretion turns on the purpose for which the Discretion was conferred evident in the terms of the Discretion which is in the trust deed of the trust. An adequate expression of the Discretion in the trust deed of a FDT is expected and needed so its purpose, as an absolute and unfettered discretion to choose between beneficiaries and as to amount distributed to them, is clear.

Certainty of beneficiaries

Who the discretionary beneficiaries of a FDT also must be clear. Frequently a trust deed of a FDT will prescribe persons who are excluded from being a beneficiary of the FDT and occasionally the trustee can be so excluded because of the perceived conflict of interest or, in New South Wales, for a stamp duty reason.

A FDT for a family which includes trustee or trustees included as discretionary beneficiaries is likely to be accepted as genuine:

  • where the trustee is a merely a discretionary beneficiary among a widely cast class of family beneficiaries; and
  • and is understandable where family members of the family sought to benefit under trust terms are or could be trustees.

So a trust deed of a FDT should be checked to confirm that the trustee is a beneficiary of the trust before the trustee of a FDT exercises a Discretion to distribute to itself. It is only where the trustee qualifies as a discretionary beneficiary under the terms of the trust instrument that a distribution can be safely made to the trustee/beneficiary where the trustee is satisfied that the distribution complies with the Karger v. Paul parameters.

The drafting of the FDT deed

Ideally the trust instrument will expressly confirm that the trustee of the FDT is a beneficiary. It can be the case that the trustee is a member of a class which is included as beneficiaries under the trust instrument but the trust deed might not expressly say that a trustee can be a beneficiary. An exercise of the Discretion in the favour of the trustee is likely OK then too but the trustee runs a risk and could possibly face action asserting the trust instrument ought to be construed on a basis that the trustee is unacceptable as a beneficiary.

Fixed trust present entitlement – a land tax trap?

Trusts and land tax in NSW

To protect the integrity of land tax:

  • so no advantage is given to trust owned land that can’t be treated as owned by a taxable person viz. an individual or a company; and
  • by means now also similarly adopted in other jurisdictions, notably Victoria (trust surcharge rate applicable mainly to land acquired by a trust after 31 December 2005 Land tax and trusts | State Revenue Office Victoria );

New South Wales taxes a trust that owns NSW land not entitled to concessional tax treatment at an ample land tax rate as a special trust without threshold allowed to an outright individual or a company owner of land viz. not subject to a trust: see section 25A of the Land Tax Management Act (NSW) 1956 (LTMA).

Photo by Jon Tyson on Unsplash 

Fixed trusts

A key concession where the special trust rate will not apply is where a trust is a fixed trust:

the equitable estate in all of the land that is the subject of the trust is owned by a person or persons who are owners of the land for land tax purposes …

and the trust won’t then be a special trust: sub-sections 3A(1) and 3A(2) of the LTMA.

Where a trust is a fixed trust the trustee is not separately taxed for persons, who are owners of the equitable estate in the land:

  • are taken to be owners for land tax purposes;
  • are liable for land tax as if they were the legal owners of the land: section 25 of the LTMA; and
  • unlike the trustee of a special trust who can’t apply threshold, these land tax owners can apply their remaining threshold and thereby access or potentially access a lower land tax rate.

Usually, as this term of art is understood in trust law, a fixed trust will be a fixed trust under section 3A of the LTMA. It doesn’t follow that a unit trust will usually be a fixed trust.

When can a unit trust be a fixed trust?

Whether or not a unit trust is a (section 3A) fixed trust will vary case by case as some unit trusts meet the above formulation of a fixed trust in sub-section 3A(2) and some, likely most, do not.

The demarcation was authoritatively considered by the High Court in CPT Custodian Pty Ltd v Commissioner of State Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53. CPT Custodian Pty Ltd was a Victorian land tax case where unit holders of a unit trust where found not to have an equitable estate in the property of the trust. It followed that the unit holders could not be treated as having a fixed interest in the property of the trust and so they could not be treated as owners of the land of the trust for Victorian land tax purposes.

CPT Custodian Pty Ltd distinguished the earlier decision of the High Court in Charles v. Federal Commissioner of Taxation (1954) HCA 16 where, unlike in CPT Custodian, unit holders were conferred equitable proprietary interests in the property of the unit trust in the proportions in which they held units under the terms of the trust deed of the relevant trust in Charles, the Second Provident Unit Trust.

The LTMA approach

If what is a fixed trust under the LTMA ended with the sub-section 3A(2) formulation as enunciated in CPT Custodian Pty Ltd then a fixed trust under the LTMA would be conceptually clear and land tax integrity aims would be achieved. But sub-section 3A(2) and CPT Custodian Pty Ltd are either:

  • somehow not enough assurance of the integrity of the distinction to the legislator; or
  • unintelligible to or incapable of ready application by Revenue NSW officers;

and so the LTMA proffers additional relevant criteria viz. guidelines for what is a fixed trust viz. when the “relevant” criteria are met, a trust will be taken to be a fixed trust with owners taken to have the required equitable estate in the land of the trust: section 3A(3A) of the LTMA.

Safe harbour?

In other words the relevant criteria are a safe harbour viz. where the relevant criteria are satisfied by a trust then it will be notionally unnecessary to separately apply the principles enunciated in CPT Custodian to ascertain whether the equitable estate in the subject land under the trust is wholly owned by a person or persons who are owners of the land for land tax purposes.

The relevant criteria are:

(a) the trust deed specifically provides that the beneficiaries of the trust–

        (i) are presently entitled to the income of the trust, subject only to payment of proper expenses by and of the trustee relating to the administration of the trust, and

        (ii) are presently entitled to the capital of the trust, and may require the trustee to wind up the trust and distribute the trust property or the net proceeds of the trust property,

    (b) the entitlements referred to in paragraph (a) cannot be removed, restricted or otherwise affected by the exercise of any discretion, or by a failure to exercise any discretion, conferred on a person by the trust deed,

    (c) if the trust is a unit trust–

        (i) there must be only one class of units issued, and

        (ii) the proportion of trust capital to which a unit holder is entitled on a winding up or surrender of units must be fixed and must be the same as the proportion of income of the trust to which the unit holder is entitled.

section 3A(3B) of the LTMA (emphasis added)

But what safety is there in the safe harbour?

So if you are establishing a unit trust to hold NSW land that is to be treated as a fixed trust, or you are the lawyer acting for prospective NSW land owners setting up a unit trust what do you do? Should you simply include the relevant criteria so a Revenue NSW officer can give the trust a sign off on the safe harbour for a fixed trust under section 3A(3A) so the trustee won’t be taxed on the land on a special trust basis?

Discretions and classes of units

Section 3A(3A)’s relevant criteria concerning discretions shouldn’t present a difficulty. A unit trust that meets the  principles in CPT Custodian and is comparable to the Second Provident Unit Trust in Charles doesn’t give discretions to any person to distribute, redirect or accumulate income or to distribute or redirect capital to beneficiaries other to the unit holder who holds the so fixed proportion of the equitable estate of the trust. Similarly there would be no point to more than one class of units, as prescribed by the relevant criteria, when designing a trust with fixed proportions of the equitable estate in property of the trust referable to each unit as in Charles.

However present entitlements proposed by Section 3A(3A)’s relevant criteria for a fixed trust are a different matter:

Present entitlements are inapt

Present entitlement as a measure in the relevant criteria is drawn from sub-section 97(1) of the Income Tax Assessment Act (C’th) 1936 (C’th ITAA 36) which speaks of “a beneficiary of a trust estate” who is “presently entitled to a share of the income of the trust estate” and is understood to have a corresponding meaning in the relevant criteria.

Under Division 6 of Part III of the C’th ITAA 36 (Division 6) a beneficiary is presently entitled if, and only if:

  • the beneficiary has an interest in the income which is both vested in interest and vested in possession; and
  • the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

[Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199, at pp 215-216, 219-220; Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444, at pp 450-452; Harmer v. Federal Commissioner of Taxation [1991] HCA 51 at para. 8 and Commissioner of Taxation v. Bamford & Ors, Bamford & Ors v. Commissioner of Taxation [2010] HCA 10 at para. 37.]

Present entitlement is an evaluative state at a particular point of time which is applied under Division 6 to retrospectively determine income tax liability at the end of either an income year or some other period of a trust in practice. In that context present entitlement is not used as a means to define estates or interests in trusts in succession prospectively by a preparer of a trust deed. It is instead used as a determinant of tax liability turning on whether a person is presently entitled to income of a trust. Despite that the relevant criteria in sub-section 3A(3B) agitate specific trust deed provisions that beneficiaries of a trust “are presently entitled” to income and capital of a fixed trust to attract the safe harbour.

Temporal fail

This doesn’t work as even a fixed trust with fixed correlation between the income and capital of the unit holders as holders of the equitable estate in the property of the trust can’t always achieve present entitlement in a time continuum, and certainly not at the outset of the trust when a trust deed of a trust may likely be drafted to potentially include the relevant criteria and executed, and the trust is yet to acquire property to which the beneficiaries may become presently entitled to income and capital but not “are” yet.

The relevant criteria oblige that beneficiaries are presently entitled seemingly to all income and capital of the trust through its existence. Beneficiaries can’t be presently entitled to income and capital in property of a trust that the trust is yet to acquire or to income of future periods or to capital on dates in the future of the trust. Beneficiaries are not presently entitled to income and capital from property that is yet to be property of the trust and a provision to the contrary in a trust deed to the effect that they are makes no sense.

Senseless provisions in a trust deeds unhinge the effectiveness of their other provisions and the trust itself.

Present entitlement when a unit holder dies?

Further Division 6 contains failsafes that apply where no beneficiary is presently entitled viz. sections 99 and 99A. Section 99 dealing with deceased estate cases is of particular significance as it could be that a unit holder in a unit trust with provisions in its trust deed to comply with the relevant criteria and to gain the safe harbour dies. From the moments after death until full administration of the deceased estate of the deceased unit holder, if that occurs, there is no owner of an equitable estate in the property of the trust reflecting the interest of the deceased who is presently entitled to the income of the property such as the fixed trust interest in the deceased estate: see Taxation Ruling IT 2622 Income tax: present entitlement during the stages of administration of deceased estates.

Until a legal personal representative obtains probate or letters of administration no equitable owner has standing to require the trustee of the fixed trust to require the trustee to transfer the property reflecting the interest of the deceased over to them.

But that is contrary to and in breach of a trust deed that obliges continual present entitlement, viz. that beneficiaries remain “are” presently entitled to the income and capital in land in succession.

Present entitlement when a unit holder is an infant or lacks legal capacity?

It could be that units in a unitised fixed trust that has adopted the relevant criteria come be to owned by an infant or a beneficiary subject to a disability who cannot be presently entitled to income or capital of the trust. In Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444, at pp 450-452 Kitto. J was able to deal with how section 98 can apply to these beneficiaries at para. 11 as follows:

Notwithstanding a passage in the joint judgment of Latham C.J. and Williams J. (Federal Commissioner of Taxation v. Whiting (1943) 68 CLR, at pp 214-215 ) which I must own I do not altogether understand in view of the recognition by s. 98 that a beneficiary may be “presently entitled” to income notwithstanding that by reason of a legal disability he has no right to obtain immediate payment, the tenor of the judgments is, I think, that “presently entitled” refers to an interest in possession in an amount of income that is legally ready for distribution so that the beneficiary would have a right to obtain payment of it if he were not under a disability.

(at p452)

but sub-section 3A(3B)(a) of the LTMA, unlike section 98 in Division 6, is neither qualified nor focused on application to a beneficiary under a legal disability who has no right to immediate payment of the amount such that the beneficiary can be considered presently entitled to income and capital of the trust so there is no reason why present entitlement of an infant unit holder, who can’t demand payment of trust income to him or her, for instance, should be inferred under sub-section 3A(3B)(a) of the LTMA based on Taylor.

Companies that “are” presently entitled – more likely to work

Unlike individuals, companies have perpetual succession and so, when they are beneficiaries of a fixed trust they can likely sustain continual present entitlement to the income and capital of a trust.

Is the inference thus to be drawn that a trust deed of a trust that includes the “are” presently entitled conditions to meet the relevant criteria and attract the safe harbour precludes individuals from becoming beneficiaries because an individual cannot necessarily sustain continual present entitlement such that they always are presently entitled because they may die, lose or never have legal capacity?

Lawyer’s quandary

How is a drafter of a deed for a fixed trust to deal with sub-section 3A(3A)’s relevant criteria in sub-section 3A(3B) then? I can’t follow what legitimate concern it is of the NSW legislature in a taxation statute or Revenue NSW to dictate trust terms to lawyers tasked with defining fixed interests in estates in succession but clearly blind adoption of the relevant criteria gives a tempting assurance to a drafter of a trust deed that a trust will be a fixed trust not land taxed as a special trust.

But inclusion of the relevant criteria which shouldn’t be strictly necessary has unintended consequences. A lawyer drafting a trust deed for a client is obliged to ensure that the drafting of a trust:

  • does not have adverse implications for the client such as precluding individuals who can be taxable owners for land tax from being unit holders; and
  • needs be wary of including trust deed terms that make no sense for which the lawyer, and not the legislator, is professionally responsible to the client.

Of further concern is that, despite the primary notion of the definition of fixed trust in section 3A(2), my recent experience is that Revenue NSW is obliging trustees to meet section 3A(3A)’s relevant criteria as if it is on those criteria, rather than the actual definition of fixed trust in section 3A(2), on which a fixed trust characterisation under the LTMA will turn. Without express inclusion of the are presently entitled stipulations of beneficiary interests in the trust deed of the trust Revenue NSW is treating a fixed trust that meets the CPT Custodian principles and so makes out as a fixed trust under section 3A(2) as a special trust. Officers at Revenue NSW don’t appear to follow or recognise that sub-sections 3A(3A) and (3B) are a safe harbor for the fixed trust notion specifically defined in sub-section 3A(2) of the LTMA.

Land tax assessments arising due to this approach by Revenue NSW should be challenged and disputed.

Has the AAT in Bendel reset the treatment of UPEs from trusts as Division 7A deemed dividends?


The Commissioner of Taxation’s longstanding practice as to when an unpaid present entitlement (UPE) of a private company beneficiary of a trust will give rise to a deemed dividend under Division 7A of the Income Tax Assessment  Act 1936 has been dismantled by the Administrative Appeals Tribunal (AAT) in Bendel v. Commissioner of Taxation [2023] AATA 3074.

The Commissioner’s practice

That practice was set out by the Commissioner in Taxation Ruling TR 2010/3 and Practice Statement Law Administration PS LA 2010/4 and is now adjusted by Taxation Determination TD 2022/11 (the Practice).

Unfortunately the AAT decision in Bendel doesn’t directly deal with or critique the Practice, which has been foundational to the administration of Division 7A and trusts, and has dealt with the prospect of a trust UPE loophole in Division 7A, since 2010. It is clear that the AAT has diverged from the Practice by its approach to the Division 7A provisions in Bendel.


The AAT in Bendel found that, despite the Commissioner’s position in the Practice and as a party in Bendel that a sub-trust arises where a trustee holds a UPE to income for a beneficiary of a family discretionary trust (FDT), no new or separate trust arises as a matter of law: On the authority of the High Court in Fischer v. Nemeske Pty. Ltd. [2016] HCA 11 which the AAT found “more to the point”, the AAT observed:

  • it is difficult to see any reason in principle why such an unconditional and irrevocable allocation of trust property must take the form of an alteration of the beneficial ownership of one or more specific trust assets;
  • there was no suggestion that the trustee’s exercise of the power to apply trust property involved a resettlement of trust property so as to result in the creation of a new trust;
  • further, the exercise of that power effected an alteration of beneficial entitlements in property which the trustee continued to hold on trust under the terms of the existing settlement was orthodox as a matter of principle. It was also unremarkable as a matter of practice…; and
  • An absolute beneficial entitlement to some part of a fund of property that is held on trust need not be reflected in an absolute beneficial entitlement to the whole or some part of any specific asset within that fund. That must be so whether the absolute beneficial entitlement to some part of a fund of property that is held on trust is defined by the terms of the trust settlement itself, or whether such absolute beneficial entitlement to some part of a fund of property that is held on trust is defined by an exercise of a power conferred on a trustee under the terms of a trust settlement.

[Italicised are extracts from the judgment of Gagelar J. of the High Court in Fischer v. Nemeske Pty. Ltd. [2016] HCA 11  at paras 95 to 99 included in the AAT decision.]

It follows that a UPE remains an entitlement of the beneficiary under the terms of the head or main trust.

But what of explicitly declared sub-trusts in the trust deed?

The AAT in Bendel did not consider the impact of the terms of the trust deed of the FDT on that reasoning. The deed explicitly sought to establish sub-trusts for UPEs arising under the FDT which counters the AAT finding, on the authority of Fischer v. Nemeske Pty. Ltd., that the UPE remains an entitlement under the main FDT. In my estimation these terms “settling” a UPE sub-trust could have been ineffectual in any case due to them having been:

  • internally inconsistent: on the one hand a sub-trust was stated to be held for a beneficiary “absolutely” but on the other the trustee was given wide discretion to resort to and deal with the assets of the sub-trust and, in practice and in the accounts, the property of UPE sub-trusts, if they existed, was intermingled with the property of the main trust and so separate sub-trusts were thus perhaps a sham or without legal effect? and
  • insufficiently clear to establish or “re-settle” sub-trusts or to alter beneficial interests as explained in Fischer v. Nemeske Pty. Ltd.: the sub-trust provisions of the deed had “no work to do” just like the Second Declaration of Trust in Benidorm Pty Ltd v. Chief Commissioner of State Revenue [2020] NSWSC 471.

Is a UPE an extended loan?

A UPE under a trust is not and is divergent from a loan in the ordinary sense. That is not disputed. Unfortunately, surprisingly and more controversially the AAT does not appear to directly deal with the question of whether a UPE from a trust is what was referred to in TR 2010/3 as a “section three loan” or a loan within the extended meaning of loan under sub-section 109D(3) of the ITAA 1936 (extended loan) although submissions of the parties on the questions of whether or not a UPE is either:

  • a financial accommodation; or
  • an in substance loan;

were received and outlined in the Bendel decision but received scant consideration in the decision.

It isn’t apparent that the AAT accepted the taxpayer’s contentions to the effect that a financial accommodation and an in substance loan are a subset of director/creditor type or loan-like relationships and are inapplicable to a trust entitlement and so concurred that a passive UPE owed to a beneficiary cannot be either a financial accommodation or an in substance loan that triggers an extended loan as considered by the Commissioner in paragraphs 19 to 26 of TR 2010/3. Rather the AAT gave a matrix in paragraph 101 of the decision (see below) to seemingly justify not giving a concluded view on these contentions.

Dictionary definitions and restrictive views

Maybe the AAT had financial accommodation front of mind when the taxpayer’s counsel referred to dictionary definitions being considered out of statutory context and legislative history as: a foundation for error where the outcome is contrary to statutory context and legislative history (SCLH)?

I am not so sure the SCLH, when considered in the context of twelve or more years of the Practice where the Commissioner has clearly relied on his wide view of financial accommodation in sub-section 109D(3) such that it can encompass an omission to pay out a UPE within the standard time frame allowed under paragraph 109D(1)(b), demands the restrictive view of when a UPE can be an extended loan the AAT has apparently taken in Bendel.

What should follow from legislative flaws in Division 7A concerning UPEs perceived by the AAT?

If I understand the AAT decision in Bendel correctly, the AAT have inferred from the SCLH, of which the AAT is critical, that the parliamentary intent on introducing section 109UB and, later, its replacement Subdivision EA, or that the effect of those provisions by dent of design fault, was that they are to apply to UPEs from trusts to the exclusion of the core provision governing what is a loan in section 109D.

If section 109UB, section 109XA et al. in the SCLH are so deficient, why would the AAT give them paramountcy over the core provisions which the Commissioner has been able to satisfactorily administer with the Practice over a long period? Couldn’t the AAT have inferred that the legislature, and the Commissioner prior to his adoption of the Practice, had acted on an unnecessary and untested assumption that a UPE from a trust could not be or would not be an extended loan under sub-section 109D(3)?

Does the Practice really tax two people over the one UPE?

A further departure of the decision of the AAT from the Practice is that applying section 109D:

raises the spectre of taxing two people in respect of precisely the same underlying circumstance, namely the same UPE

see paragraph 98 of the AAT decision in Bendel

In my view it is open to the Commissioner and reasonable, given the legislative policy of Division 7A, to treat the distribution from the FDT to a corporate beneficiary and the UPE arising in favour of the beneficiary as a distinct and earlier in time transaction from the failure to satisfy the UPE by payment within the standard time frame allowed under paragraph 109D(1)(b).

This is just as much taxing two people in respect of the same income as a private company earning income subject to company tax and a shareholder of the company thereupon receiving that already company taxed income as an unfranked dividend which is thereupon taxable to the shareholder. It is to this outcome that Division 7A, as an anti-avoidance regime underpinning the integrity of the company tax system, seems rightly directed.

Interpretation approaches to the provisions

It occurs to me that, that being so:

  • the shortcomings of the Division 7A legislation insofar as it addressed UPEs from trusts set out in the decision;
  • the restrictive reading of it by the AAT in the context of the SCLH;
  • an interpretation based on generalia specialibus non derogant so that section 109UB and Subdivision EA, despite what the AAT says was its flawed passage into law, overrides the general provision: section 109D; and
  • a possible further contention by the taxpayer that a financial accommodation, an in substance loan or both are part of a ejusdem generis list that should be confined to financial accommodations or in substance loans within or comparable to advances of money, provisions of credit and the like viz. strictly debtor creditor financial activity;

are approaches and considerations likely to be or should be subordinated to the need to “ascertain the legislative intention from the terms of the instrument viewed as a whole”: Cooper Brookes (Wollongong) Pty Ltd v. Federal Commissioner of Taxation [1981] HCA 26 understanding that the Acts Interpretation Act (C’th) 1901 provides:

In the interpretation of a provision of an Act a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

section 15AA of the Acts Interpretation Act (C’th) 1901

and applies to taxing Acts as well as other Acts and that the purpose of Division 7A is directed to maintaining the integrity of the Australian system of taxation of private companies.

I think it unlikely that a court would be confused by or would miss the purpose of the provisions due to the AAT’s questionable matrix set out as follows:

Having regard to:

    (a)          the policy of Division 7A to tax those who in substance enjoy the benefit of corporate profits without bearing taxation that would arise had the company paid dividends in the usual way;

    (b)          statutory construction principles that call for

        (i)          regard to statutory context and legislative history; and

        (ii)         potentially competing provisions to be construed in a manner which ‘gives effect to harmonious goals’;

    (c)          there being no tiebreaker provision which mandates which of two competing assessing provisions would apply if an unpaid present entitlement constituted a loan within the meaning of s 109D(3);

    (d)          the s 109RB discretion not being designed to allow relieving discretions to be exercise outside the s 109RD(1)(b) gateways of honest mistakes and inadvertent omissions and thus not a discretion that would relieve inappropriate double taxing;

    (e)          Subdivision EA being a specific, and therefore lead, provision containing an express set of rules that can be regarded as a particular path has been chosen to deal with the taxation effect of unpaid present entitlements in favour of corporate beneficiaries in prescribed circumstances;

    (f)          the lack of clarity as to the nature of an unpaid present entitlement and the separate trust concept often broached in conjunction with the unpaid present entitlement topic;

    (g)          the expressed explanation accompanying s 109UB, the predecessor of Subdivision EA, to the effect:

        (iii)        that an unpaid present entitlement in favour of a corporate beneficiary and a contemporaneous loan by the trustee to a shareholder in the corporate beneficiary (or associate) is in substance a loan by the company to the shareholder; and

        (iv)         that an amount to which a company is entitled ‘held on a secondary trust for the benefit of the company’ is regarded as unpaid and within the ambit of s 109UB;

    (h)          the operation of Subdivision EA which taxes the shareholder in the foregoing circumstances as if the company had lent money directly to that shareholder which falls squarely within the Division 7A policy framework;

    (i)          there being no provision in either of the Assessment Acts that anyone points to that expressly allows assessment of two people arising out of the same circumstance with one of those people potentially not enjoying any benefit of the corporate profits that are the underlying cause of the assessment,

the necessary conclusion is that a loan within the meaning of s 109D(3) does not reach so far as to embrace the rights in equity created when entitlements to trust income (or capital) are created but not satisfied and remain unpaid. The balance of an outstanding or unpaid entitlement of a corporate beneficiary of a trust, whether held on a separate trust or otherwise, is not a loan to the trustee of that trust.

para 101 of the AAT decision in Bendel

Towards a purposive construction of the provisions

In adopting a purposive construction of these provisions of Division 7A I would be surprised if a court would replicate the AAT’s disdain for parliament’s efforts to plug the UPE loophole with section 109UB and, later, its replacement Subdivision EA. If I read the AAT decision correctly, these provisions and the manner of their introduction prejudice the Commissioner and the Revenue such that the language of sub-section 109D(3), as a generality, can no longer be applied to UPEs from trusts.

Ironically if the AAT decision is correct, and what is an extended loan is constrained by it, then the legislative clarity from the government the AAT appears to urge and seek in Bendel can no longer be achieved by the repeal of Subdivision EA.

In any case one can expect the government to amend the UPE rules in Division 7A to reverse Bendel should the Bendel decision originated by the AAT persist as authority.

It is clear from Fischer v. Nemeske Pty. Ltd. that a UPE from a trust is different to a loan but the differences between a trust and a loan conflate in that case too. Gagelar J. states:

In challenging the Court of Appeal’s holding concerning the effect in law of the Trustee going on to record a liability to Mr and Mrs Nemes in the sum of $3,904,300 in the Trust’s balance sheet, the appellants do not dispute that a trustee who admits to having an unconditional obligation to pay a specified amount of money to a beneficiary can thereby become liable to an action at law for the recovery of that amount as money had and received to the benefit of the beneficiary, so as to overlay the equitable relationship of trustee and beneficiary with the legal relationship of debtor and creditor.  That has been settled since at least the middle of the nineteenth century[107].

at para 105 of Fischer v. Nemeske Pty. Ltd.

It can be inferred that a trustee of a FDT given an unconditional obligation to pay money to a beneficiary under a UPE has been given a financial accommodation, an in substance loan or both under sub-section 109D(3). A loan and a UPE give rise to clearly comparable liabilities which is precisely the mischief to which section 109D is directed.

Further, an in substance loan is a particularly apt characterisation of the UPE in Bendel where the taxpayer, the FDT and the company beneficiary are related parties as they will be in most of these cases. Where they are related it is clearly commercially open to the trustee of the FDT and related parties to achieve the same liability as understood from para 105 of Fischer v. Nemeske Pty. Ltd. and the same financial goal by either a loan or by a UPE which, in substance, offers the related parties the same thing.

Can the CGT main residence exemption be used to save tax on a profitable property development?


In my August 2022 blog:

The capital gains tax main residence exemption, affordable housing and caps – The capital gains tax main residence exemption, affordable housing and caps

I considered the generous, unlimited and regressive CGT main residence (MR) exemption under Australian income tax and pondered the extent to which the CGT MR exemption has contributed to housing unaffordability. As I said in that post, for those who occupy and turnover homes they own in Australia, the CGT MR exemption delivers uncapped tax free uplifts in wealth as prices rise.

But the line can be overstepped.

A’s residential building project

Let us take A who has significantly benefitted from tax free CGT uplifts on previous sales of A’s former homes:

  1. A acquires real estate which can be subdivided and on which two homes can be built.
  2. A’s idea with this acquisition is to move in to one of the homes (Lot 1) once it is built and occupiable.
  3. But A doesn’t plan to live in Lot 1 long term. A’s plans are to sell Lot 1 and Lot 2 with completed dwellings for a hoped for profit.
  4. Will the CGT MR exemption enable A to enjoy profits from the project tax free?

The Commissioner of Taxation can treat the above development for sale as an adventure in the nature of trade to sell the land and buildings for profit. The occupation by A of Lot 1 as A’s home is incidental to the project. This differs from another case where, say, B uses real estate, on which B’s existing home is located, for a development where B subdivides, builds and sells where there was clearly an initial time pre-project where the real estate was only used by B as B’s home.

Proceeds or profits from sales and ordinary income

Where a project is a development for sale at a profit, such as in A’s case for the whole time and, in B’s case, for the phase of development to sale, the proceeds or profits can be treated as ordinary income by the Commissioner based on cases and tax principles referred to in:

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income

in which profits or gains in the ordinary course of business and from profit-making undertakings or schemes are considered.

Where proceeds or profits from sales are ordinary income arising either in the ordinary course of business or in a profit-making venture and also produce (otherwise taxable) capital gains then, due to section 118-20 of the Income Tax Assessment Act 1997, the proceeds or profits are treated as ordinary income and capital gains are not taxed. That is CGT does not apply and CGT principles, concessions and exemptions don’t apply to gains or losses made on income account.

So in A’s case, where the proceeds or profits from the sales of Units 1 and 2 are ordinary income:

  • no CGT MR exemption can be applied to reduce tax on Unit 1 as there is no taxable capital gain; and
  • further, no 50% CGT discount can be applied to reduce the extent to which proceeds or profits on sales are included in A’s assessable income as ordinary income

even though A is a resident individual generally entitled to such capital gain concessions.

Commissioner on the lookout

A’s plans to sell are not necessarily:

  • going to be obvious to; or
  • reported to;

the Commissioner particularly in the early stages of the A’s project. However that should change once Lot 1 and Lot 2 do sell. That is because:

  • the Commissioner is on the lookout for residential real estate developments that are an adventure in the nature of trade and are an enterprise under goods and services tax (GST) rules:

Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number

  • and it is Australian Business Number and GST information gathering by the Commissioner that may well reveal that A’s project is to develop and sell. The project can then be a review or audit target where proceeds and profits have not been returned by A as ordinary income.

New residential premises and GST taxable supplies

The sales of Units 1 and 2 are taxable supplies of new residential premises for GST where the sales happen within five years of when Units 1 and 2 are built and occupied as residences.

Generally the sale of a someone’s home is not treated as a taxable supply however that reassurance, considered at paragraph 11 of:

Goods and Services Tax Ruling GSTR 2003/3 Goods and services tax: when is a sale of real property a sale of new residential premises?

does not apply if the sale occurs as part of a profit making undertaking of scheme viz. where the supply is in the course of an enterprise and is not a mere realisation of the owner’s home: see paragraph 263 of MT 2006/1 et al.

Project trading stock or taxation of project profit?

What of B? How would B be taxed on income account when B’s earlier use of real estate was exclusively as B’s private home? When B sells B will be dealing with two events treated like sales for tax over an earlier and a later period. CGT and the CGT MR exemption can apply up to when B’s property is put to B’s development for sale project. But at that point B can be taken to have put the property to use as trading stock and section 70-30 of the ITAA 1997 applies to treat B as having sold the property and as having re-acquired the property as trading stock even though B continues to own the property [possibilitity 1].


Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as ‘trading stock’?

the Commissioner states:

Land is treated as trading stock for income tax purposes if:

•    it is held for the purpose of resale; and

•   a business activity which involves dealing in land has commenced.

Even where the development for sale is not considered to be a “business activity”, but is nonetheless an isolated transaction within the ambit of TR 92/3; B’s profits, not B’s sale proceeds, can comprise the assessable income of B from the the development [possibility 2]. Those profits are based on the value of the property as a cost at the time the property is ventured to the development based on the High Court decision in F.C. of T. v. Whitfords Beach Pty. Ltd. (1982) HCA 8; 150 CLR 355.

The use as a home phase and the project development to sale phase are treated separately for tax either with possibility 1 and possibility 2.

GST, enterprise and creditable acquisitions

As A’s (or B’s) project leads to taxable supplies of new residential premises it will follow that A’s project is an enterprise requiring A to be registered for GST: see MT 2006/1. When that is understood by A, A may then register for the GST on a timely basis positioning A to more easily claim project expenses as creditable acquisitions and obtain GST credit or refunds.

That opportunity gets complicated where the new dwellings on Lots 1 and 2 may come to be used by A once built – say privately as A’s main residence, or say where held and used to earn rent, rather than sold, in which cases creditable acquisition claims on activity statements may need to be adjusted under GST rules due to A’s change in creditable purpose.

C the builder

Let us now consider C who, like A, has significantly benefitted from tax free uplifts, questionably, on previous sales of C’s former homes using the CGT MR exemption. But C is or has become a professional builder and C’s buy, build/renovate and sell for a profit can be understood and characterised as C’s business activity/profit making venturing after C’s real estate owning history is fully understood. The frequency and amount of those previous tax free uplifts taken with claims of the CGT MR exemption is a part of that history.

The cases and tax principles referred to TR 92/3 mean that C can still be taxed on income account, and cannot access the CGT MR exemption on this next project, even where C uses a dwelling built/renovated by C as C’s home during times when the dwellings C builds or renovates become occupiable.

Cases raising the income/capital dichotomy and these complications do not necessarily have the same tax outcomes and will turn on their own whole factual story.

The useful family trust election and income “injection”


In 1998 the trust tax loss measures in Schedule 2F of the Income Tax Assessment Act (ITAA) 1936 (Schedule 2F) were finally enacted to curb the unscrupulous trade in trust tax losses.

Income injection test

An essential and not so well understood retardant of the trade in these measures is the income injection test (IIT). Neither the term income injection nor the words inject or injection are in Schedule 2F. Nevertheless the test is there in Division 270 of Schedule 2F under the heading Schemes to take advantage of deductions.

The ITAAs and Schedule 2F, in particular, have much jargon which is in italics in this post.

Unlike some other tests in Schedule 2F, such as the stake test and the control test, which are both applicable to non-fixed trusts, transgression of the IIT doesn’t disqualify a trust from using all of its tax losses including carry forward prior year tax losses. A trust that fails the IIT is precluded from offsetting otherwise tax deductible tax losses against (taxable) assessable income (only) to the extent of scheme assessable income.

Scheme assessable income is what is “injected”.

How the IIT works

As an anti-avoidance provision designed for wide reach, the IIT in Division 270 of Schedule 2F is so expressed. Scheme, as is usual in anti-avoidance laws in the ITAAs, is widely defined and an outsider or outsider to the trust, is pervasive under the IIT. In the case of a trust that isn’t a Schedule 2F family trust (a 2FFT) an outsider to the trust is a (any) person other than the trustee of the trust or a person with a fixed entitlement to income or capital of the trust: see section 270-25(2) of Schedule 2F.

Scheme assessable income arises where (in any order):

  • the trust earns assessable income;
  • an outsider to the trust directly or indirectly provides a benefit (also widely cast – can be money, property or anything else of benefit set out in section 270-20  – which may be but need not be the scheme assessable income) to the trustee of the trust, a beneficiary of the trust or an associate of either of them; and
  • the trustee of the trust, a beneficiary of the trust or either of them provides a benefit to the outsider to the trust or an associate wholly or partly, but not incidentally, because the deduction is allowable to the trust.

Context of the IIT

With this broad formula the IIT in the tax trust loss measures of Schedule 2F can be contrasted to the business continuity test that applies to company tax losses under Division 165 of the ITAA 1997. An injection by, viz. a benefit from, an outsider to the trust or an associate that can produce income in the trust, against which unrelated tax losses might otherwise have been deducted, gives rise to scheme assessable income against which tax losses cannot be deducted.

When the IIT applies – outsiders

So let us say:

  1. a private company with profits and a family discretionary trust (FDT) with tax losses but no current income producing activity of its own are controlled by a family;
  2. the FDT owns shares in the company; and
  3. the company pays dividends to the FDT.

A clear distinction between a FDT and a 2FFT needs to be understood. Schedule 2F refers to a “family trust”, i.e. a 2FFT, as a trust that has made a family trust election (FTE). A 2FFT in comparison can be a FDT, a fixed trust or a unit trust that has lodged a FTE which is in force. A FDT can be called a family trust in common parlance but a FDT will be a non-fixed trust under Schedule 2F; that is, not a Schedule 2F “family trust” until it lodges a FTE to become a 2FFT.

At least initially (see below), the company in my example is an outsider to the trust. There the benefit to the trust of the dividends is the scheme assessable income. The benefit to the company and its associates viz. the family, is that income tax isn’t payable on the dividends to the extent tax losses of the trust can be deducted against assessable income of the trust and the parties can’t disprove that this tax advantage of declaring dividends to the FDT shareholder was more than incidental.

How a family trust election can modify how the income injection test is applied

To avoid losses to the extent of so imputed scheme assessable income being denied to the trust under the IIT:

  • the trustee of the trust can make a FTE and become a 2FFT, and;
  • the company can make an interposed entity election (IEE).

The FTE would need to cover the period, in the case of carry forward tax losses of the trust, from when the losses were incurred by the FDT/2FFT to when they are sought to be deducted against assessable income (for tax) by the FDT/2FFT.

Companies and trusts that have a FTE or an IEE in place are excluded from being outsiders to the trust. The IIT is then an IIT of modified operation which can still be failed but the IIT will now only fail where benefits flow from and to a now reduced, less pervasive, range of outsiders to the trust. but is not failed when the flow is between 2FFTs. interposed entities and individual family members that are taken to be a part of the family group under Schedule 2F: see sub-section 270-25(1) of Schedule 2F.

Downside of a family trust election

Where a company, trust of partnership (Entity) meets the family control test viz. the Entity is controlled by the family group viz. a family, and is so eligible to become a part of a family group by way of a FTE or an IEE then the prospect of family trust distributions tax (FTDT), which is distinct from trust income tax and only applies to 2FFTs, needs to be considered.

Once an Entity lodges a FTE or an IEE then distributions by the Entity outside of the family group of the individual specified in the FTE or IEE, as the case may be, are caught by FTDT at the highest marginal income tax rate.

A FTE or an IEE is a de facto limitation by way of tax penalty on beneficiaries to whom income and capital of a 2FFT can be distributed.

Upside of a family trust election

A FTE can be lodged by a trust with commencement from when or before its prior year trust losses were incurred so the modified IIT can apply from that time to prevent scheme assessable income arising. That is so, so long as the commencement date of the trust as a 2FFT is no earlier than 1 July 2004. This is sometimes known or understood as “backdating” but that, like the use of the term “family trust” itself in Schedule 2F, is a misnomer and selecting a past commencement date for a 2FFT is lawful and allowed under Schedule 2F.

So long as a 2FFT can keep its distributions within the family group and so avoid FTDT, lodging a FTE or an IEE will be dually beneficial to the parties and the beneficiaries of the 2FFT to whom the franked dividends are on-distributed in my example once tax losses of the 2FFT are exhausted and the 2FFT has (positive) trust income as:

  • current and prior year losses can be offset by the trustee of the 2FFT against the dividends which are assessable income when received by the 2FFT where a FTE is in effect over the required periods and an IEE is in effect for the company so the company is within the family group; and
  • the 2FFT can meet the holding period rule and beneficiaries of the 2FFT to whom the franked dividends received by the 2FFT are distributed, after losses have been so offset, can then use franking credits on the dividends: see section 207-145(1)(a) of the ITAA 1997 and under the heading THE HOLDING PERIOD RULES REGULATING ACCESS TO FRANKING CREDITS at Family trusts – concessions | Australian Taxation Office

Reasons to be a 2FFT

The Australian Taxation Office at Family trusts – concessions lists five main “reasons” (actually imperatives for accessing tax concessions) why a trustee of a trust may want to make a FTE and become a 2FFT:

  • accessing trust tax losses to deduct them against trust assessable income;
  • to trace eligibility for company losses through a trust;
  • access of beneficiaries of a trust to franking credits under the holding period rules;
  • relief from the trustee beneficiary reporting rules; and
  • access to the small business restructure rollover in Sub-division 328-G of the ITAA 1997.

Schedule 2F doesn’t apply to deny capital losses that can be offset against capital gains under section 102-5 of the ITAA 1997.

Individual trustees of a SMSF – useful or a hindrance to SMSF decision making?

In 2008 I wrote an article published in SMSF magazineSeparatedDot

Having individuals as trustees of SMSFs – companies versus individuals as trustees of SMSFs 

which mainly looked at when having individuals as trustees of a SMSF can prove a false economy.

A recent Full Federal Court case authoratively sets out reality checks for SMSFs with individual trustees: Frigger v Trenfield (No 3) [2023] FCAFC 49 concerned an accountant, Mrs. Frigger and her husband, Mr. Frigger, who had been made bankrupt.

The bankrupts took action against their official receiver to require the official receiver to treat assets, which had been sequestrated by the official receiver, as the property of their superannuation fund, the Frigger Superannuation Fund (FSF). The aim of the bankrupts was to bring these assets within sub-paragraph 116(2)(d)(iii)(A) of the Bankruptcy Act (C’th) 1966 as assets not divisible amongst the creditors of undischarged bankrupts.

SMSF assets need to be owned by the trustees

Regulation 4.09A(2) of the Superannuation Industry (Supervision) [“SIS”] Regulations contains the following prescribed standard:

A trustee of a regulated superannuation fund that is a self managed superannuation fund must keep the money and other assets of the fund separate from any money and assets, respectively:

(a) that are held by the trustee personally; or

(b) that are money or assets, as the case may be, of a standard employer-sponsor, or an associated of a standard employer-sponsor, of the fund

Despite the above Regulation 4.09A(2), the comparable covenant in paragraph 52(2)(g) of the SIS Act 1993 and trust law principles that forbid trustees from mixing their own property with property held on trust, the bankrupts ran bank accounts and held assets, including rental earning real estate, in their own names which the bankrupts claimed were assets of the FSF in Frigger v Trenfield (No 3). These assets had not been put into the names of all trustees being Mr and Mrs Frigger, their children Mr Michael Frigger and Ms Jessica Frigger jointly either expeditiously or at all.

In my article I looked at the work needed and likely cost to keep assets in the name of the trustees on changes of trustee of a SMSF. The FSF, where there were numerous changes of trustee and numerous assets including real estate, was a chronic case of the imperative to keep fund assets in the name of the trustees and the significant effort and costs required my article considered. The bankrupts and the other trustees of the FSF didn’t act on the imperative made plain below in this post.

Further accounts, tax and SMSF returns and other records relied on by the bankrupts to show that the assets were owned by the FSF, and so attracted sub-paragraph 116(2)(d)(iii)(A) protection from sequestration, were found by the Full Federal Court to be deficient and insufficient to convince the Full Federal Court that the assets were assets of the FSF.

How trust property must be held. protected and made good by individual trustees of a SMSF

In the course of the lengthy joint judgement in Frigger v Trenfield (No 3) the Full Federal Court (Allsop CJ, Anderson And Feutrill JJ) elaborated on how individuals, who are co-trustees of a trust such as a SMSF must reach decisions and hold, protect and, if need be, make good the property of the trust. This elaboration is an aide-memoir for individual trustees of a SMSF:

  1. Decisions of co-trustees must be unanimous: Luke v South Kensington Hotel Co (1879) LR 11 Ch D 121 at 125. In the case of In the Estate of William Just (deceased) (No 1) (1973) 7 SASR 508 (Estate of Just), where money had been paid into a bank account held in the name of one of two co-trustees, Jacobs J said (at 513–514):
… In the case of co-trustees of a private trust, the office is a joint one. Where the administration of the trust is vested in co-trustees, they all form, as it were, but one collective trustee and therefore must execute the duties of the office in their joint capacity. Sometimes, one of several trustees is spoken of as the active trustee, but the court knows of no such distinction: all who accept the office are in the eyes of the law active trustees. If anyone refuses or is incapable to join, it is not competent for the other to proceed without him, and if for any reason they are unable to appoint a new trustee in his place, the administration of the trust must devolve upon the court. Though a trustee joining in a receipt may be safe in permitting his co-trustee to receive in the first instance, yet he will not be justified in allowing the money to remain in his hands longer than reasonably necessary. The proper course is to pay trust money into a joint bank account in the names of both or all the trustees. …
  1. In general, a trustee must discharge the duties and exercise the powers of trustee personally. Where there are co-trustees, in the absence of unanimous agreement, actions taken independently of the other co-trustees lack authority and do not bind all trustees: see, e.g., Lee v Sankey (1872) LR 15 Eq 204 at 211; Astbury v Astbury [1898] 2 Ch 111 at 115–116; Pelham v Pelham & Braybrook [1955] SASR 53 at 57. A co-trustee is not and cannot be bound by a decision of the majority and each co-trustee must turn his or her mind to the exercise of the applicable power and decide on the action to be taken: see, e.g., Cock v Smith (1909) 9 CLR 773 at 800; Re Billington [1949] St R 102 at 111, 115.
  2. As the authors of Ford and Lee: The Law of Trusts (looseleaf at 13 February 2020, Thomson Reuters) (Ford and Lee) observe (at [9.11090]): “A consequence of the unanimity rule is that trust business cannot be transacted except at a meeting at which all the trustees, or their delegates, are present; and that where the trustees cannot agree about a course of action the status quo prevails.” In the case of a regulated superannuation fund, if the superannuation entity has a group of individual trustees, the trustees must keep, and retain for at least 10 years, minutes of all meetings of the trustees at which matters affecting the entity were considered: s 103(1) SIS Act.
  3. It may also be possible for co-trustees to ratify an action taken by another trustee without prior agreement: Meeseena v Carr (1870) LR 9 Eq 260 at 262–263; Hansard v Hansard [2015] 2 NZLR 158 (Hansard v Hansard) at [47] citing Thomas Lewin and others, Lewin on Trusts (18th Ed, Sweet & Maxwell 2018) at [29-209]. However, for ratification to be effective, the ratifying co-trustee(s) must know of the essential detail of the act or decision in question. It must be more than passive acquiescence to a decision made by another trustee. The act of ratification must show that the co-trustee(s) considered the exercise of power as trustee and consented to the action taken. Thus, “[s]ubsequent approval of financial statements [by all trustees] may therefore not be sufficient to amount to ratification of actions taken without the unanimous approval of trustees”: Hansard v Hansard at [51]. Something more than mere approval of financial statements would be necessary to demonstrate the required ‘act of ratification’.
  4. Property of the trust must be held jointly and it is a breach of the trustees’ duties not to ‘get in’ the trust property and hold the legal (or where applicable equitable) title to that property jointly or otherwise hold the property under joint control: Lewis v Nobbs (1878) 8 Ch D 591 (Lewis v Nobbs) at 594; Guazzi v Pateson (1918) 18 SR (NSW) 275 at 282. As Hall VC explained in Lewis v Nobbs, the rationale for the duty is to ensure that trust property is not dealt with improperly by one of the co-trustees or without the agreement of all co-trustees.
  5. Clause 140 of the FSF Trust Deed required the trustees of the FSF to ensure that money received by the fund was, amongst other things, deposited to the credit of the fund in an account kept with a bank chosen by the trustees. That is, chosen by the co-trustees by unanimous agreement.
  6. While there may be circumstances in which property is conveyed to, or acquired, by one of a number of co-trustees as trust property with the consent of the other trustees, it remains the duty of all trustees to ensure that title to the property is ultimately convey (sic.) to and held by all co-trustees jointly within a reasonable time thereafter: Estate of Just at 513–514. Any inconvenience that might result from the changing composition of the co-trustees from time to time does not absolve the trustees of that duty: see, e.g., Trustees of the Kean Memorial Trust Fund v Attorney-General (SA) [2003] SASC 227; 86 SASR 449 at [94].
  7. Further, in the absence of an express provision permitting mixing, it is also a duty of a trustee to keep personal and trust property separated: Associated Alloys at 605 [34]. A trustee has a positive duty “to distinguish the piece of property he … acquires from other similar things which he may obtain for himself or in which he may be interested”: Van Rassel v Kroon (1953) 87 CLR 298 at 302–303 (Dixon CJ); Heydon and Leeming, Jacob’s Law of Trusts in Australia (8th ed, LexisNexis, 2016) at [17-02]. It is also trite that a trustee cannot unilaterally repudiate the trust and appropriate the trust property: Ford and Lee (looseleaf as at 14 May 2021) at [17.4530].
  8. A co-trustee is obliged, as part of the duty to get in trust property, to bring proprietary claims against another trustee who, in breach of trust, has misappropriated or mixed trust property with his or her own property. Likewise, a trustee who has participated in such a breach of trust has an obligation, notwithstanding his or her own wrongdoing, to make good the trust property and, if necessary, to institute proceedings against other trustees who participated in the wrongdoing to make good the loss: Young v Murphy [1996] 1 VR 279 at 282–284, (per Brooking J), 300 (per Phillips J), 319 (per Batt J).
  9. The above principles have significance in this appeal because the evidence before the primary judge was to the effect that Mrs Frigger alone held the legal title to the funds in the BW1 and BOQ2 accounts, Mr Frigger alone held the legal title to the funds in the BOQ1 account and Mr and Mrs Frigger jointly held the legal title to the securities in the Main Portfolio. Also, Mrs Frigger held the legal title to the Como and Bayswater properties. Therefore, the legal title to the disputed assets was not held by the co-trustees of the FSF jointly immediately before the sequestration orders were made or by the sole trustee of the FSF (H & A Frigger) immediately after the sequestration orders were made. There was no evidence before the primary judge that any of the individual co-trustees had taken any steps at any time to ‘get in’ the trust property and have funds held in a bank account in the joint names of the four individual trustees (or HAF), to transfer the securities in the Main Account into a CHESS holding account held in the joint names of the four individual trustees (or HAF), or to transfer the Como and Bayswater properties into the joint names of the four individual trustees (or HAF).

So the bankrupts fell short of the exacting requirements on individual trustees.

Majority individual trustee decisions and the unanimity rule?

The above passage from Frigger v Trenfield (No 3) does not countenance a SMSF trust deed that allows individual trustees to reach decisions by a majority of the individual trustees.

It is questionable whether a SMSF trust deed allowing for majority trustee decisions, not in conformity with the unanimity rule, satisfies paragraph 17A(1)(b) of the SIS Act. There is the prospect that a superannuation fund governed by such an (attempted) SMSF trust deed may not be (qualify as) a SMSF. That may be so unless a deeming clause in the trust deed overrides the decisions by majority clauses in the trust deed in which case individual trustees are obliged to comply with the unanimity rule nonetheless so that the superannuation fund can be regulated as a SMSF.  

No scope for equivocal individual ownership of SMSF assets

Clearly there can be no presumption that the Australian Taxation Office, a tribunal or a court will accept that an asset not in the name of a SMSF is an asset of the SMSF. The bankrupts may have hoped that, by having individual trustees, the FSF was usefully positioned to assert ownership by the SMSF of multiple properties in the names of one or more trustees but not all of them.  But the above principles set out in Frigger v Trenfield (No 3) mean that individual trustees of a SMSF, in particular, need to produce valid minutes of meetings of trustees and documents that establish and explain why an asset, and particularly an asset not in the name of all of the trustees, is an asset of a SMSF before an asset will be inferred to be an asset of a SMSF with individual trustees.

Advantages of a corporate trustee

A corporate trustee, especially a corporate trustee that acts in no other capacity, is better placed to assert ownership of any asset in the name of the corporate trustee and won’t be at the same risk of mixing trust property as a practical matter. Although corporate trustees need to keep records of their decisions, corporate trustee can have streamlined decision making procedures which need not require meetings of directors and their minuting where individual trustees can’t streamline their decision making.


Frigger v Trenfield (No 3) is a stark reminder that ownership of assets of a superannuation fund by the trustees needs to be unequivocal should a member of the fund go bankrupt. There are numerous breaches of standards beyond Regulation 4.09A(2) and bankruptcy troubles that can arise where assets of a SMSF are not kept separate from assets that are not successfully.

Correcting a mistake in a prior year return – income tax and GST dovetail

correction fluid

Request an amendment or object?

As we have noted on this blog including in our post:

Is an objection needed to amend a tax assessment?

it will often be better for a taxpayer to object against an assessment of income tax (AOIT) the taxpayer doesn’t accept rather than request an amendment of the AOIT by the Commissioner of Taxation. That can be for a number of reasons for that including:

  • where the taxpayer seeks to be or needs to be assertive that the AOIT needs to be fixed; or
  • where time for amendment of the AOIT may be running against the taxpayer.

Dealing with simple mistakes

However were the taxpayer has simply made a mistake on an income tax return (ITR) where:

  • an objection isn’t worth the trouble; and
  • the mistake doesn’t present a real risk of overpaid tax to the taxpayer;

then requesting an amendment of an AOIT based on the ITR will be a simple solution and, in the case of a GST where a BAS or BASs have returned the error, won’t even be necessary.

Example – fees overstated in a prior year

Let us say a company registered for GST earned fees from an activity in the 2020 income year, and as a result of a dispute with the payer, the company had to refund those fees back to payer in the 2022 income year.

Income tax

The fees were returned as assessable income in the 2020 income tax return of the company.

The company can either:

If the company is a small business entity the company should act promptly to ensure it is within the two year period of review (time limit allowed) for amendments of AOITs.

Goods and services tax

For GST it’s different.

The fees were returned as taxable supplies in BASs of the company in 2020.

The company can correct taxable supplies overstated, on an earlier BAS or BASs, on its upcoming BAS as a credit error so long as the upcoming BAS is within the four period of review of the BAS with the overstated taxable supplies: GSTE 2013/1 Goods and Services Tax: Correcting GST Errors Determination 2013

To be eligible to correct credit errors in this way, rather than by having the prior period BAS amended:

•  the error must be within the four year BAS period of review, as stated;

•  the error has not been corrected in another BAS; and

•  the tax period in which the error was made is not subject to ATO compliance activity.

Part IVA – is a discretionary trust owned bucket company a sitting duck?


The Full Federal Court in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 has dismissed the Commissioner’s appeal against decisions at [2021] FCA 1619 of the primary judge, Logan. J, not to impose the reimbursement agreement assessments on the trustee of the AIT under section 100A of the Income Tax Assessment Act (ITAA) 1936.

But the Full Federal Court has unanimously taken a radically different construction of the facts in the case to Logan J. to find that Part IVA of the ITAA 1936 was correctly applied to the Guardian AIT facts to support the Commissioner’s Part IVA determination, run as an alternative to section 100A, made in respect of the 2013 income year.

Reimbursement agreements – a blunt tool?

On this blog we have queried whether the section 100A reimbursement agreement regime is a tool useful to the Commissioner that gives the Commissioner scope to attack trust distributions that are no part of a trust stripping arrangement involving parties external to the trust: 100A trust reimbursement agreement not the tool to fix the bucket company dividend washing machine . We have also blogged about bucket companies lately, see: Can a family discretionary trust distribute income to its corporate trustee?

Without going into the detail in this blog post, the Full Federal Court in Guardian AIT has rather confirmed our thoughts about the utility of section 100A. We don’t see that the decision vindicates or gives legal support or backing to the Commissioner’s products and section 100A-based approaches in Taxation Ruling TR 2022/4 and Practical Compliance Guideline PCG 2022/2. Oddly the Commissioner finalised TR 2022/4 and PCG 2022/2 before Guardian AIT ran its course.

In the meantime there is another section 100A case on foot: BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112, which is also on appeal to the Full Federal Court and there is also the prospect of appeal in Guardian AIT to the High Court.

Part IVA sharpened up?

But Part IVA is a different matter. The Full Federal Court in Guardian AIT has warned how susceptible certain types of discretionary trust strategies, particularly discretionary trust strategies involving trust distributions to bucket company beneficiaries, may be to Part IVA.

This leads me to the key point of difference on the facts in the case between the Full Federal Court and Logan J. mentioned at the outset. Logan J. accepted Mr Springer’s contention that his company, AIT Corporate Services Pty Ltd (AITCS), was set up to accumulate assets for asset protection. Although the Full Federal Court accepted this as a tenable explanation in the 2012 income year, despite AITCS clearing out its asset, the distribution receipt from the AIT back to the AIT as a dividend; repeating the process to clear out the 2013 trust distribution back to the AIT in the 2013 year demonstrated AITCS wasn’t:

  • holding or protecting anything for asset protections reasons; or
  • more particularly planning to hold or protect assets accumulated or to be accumulated in the company.

AITCS was plainly being used as a bucket company to receive a trust distribution in the 2013 income year which allowed AITCS to distribute a franked dividend back to the AIT which could then be distributed tax advantageously by the AIT to Mr Springer, a non-resident.

The apparent counterfactual

The Full Federal Court had no difficulty accepting the Commissioner’s Part IVA counterfactual contended in the appeal. That counterfactual was that the AIT would have distributed 2013 year AIT income to Mr Springer directly which “might reasonably be expected to have been included” in 2013 income taxable to the trustee under Division 6 of Part III of the ITAA 1936. That distribution could have been made to Mr Springer without the circularity of the “washing machine” distribution going to AITCS, then back to the AIT as franked dividend and then, finally, going to Mr Springer as NANE income being a form of income not taxable to the trustee nor to Mr Springer under Division 6.

Circularity and the form of the scheme

The Full Federal Court noted the circularity of the scheme which the Commissioner could and did take into account under paragraph 177D(2)(b) of Part IVA in considering the form of the scheme.

Commercial rationale or explanation of the scheme?

The difficulty under the Full Federal Court Part IVA analysis for the AIT was that the only difference in effect between the scheme and the counterfactual was that, under the scheme, the income distribution to the non-resident beneficiary Mr Springer was tax free NANE income. Under the counterfactual though, tax on the trustee of AIT at the highest marginal rate under Division 6 might reasonably have been expected. The same commercial outcome viz. income in Mr Springer’s hands within eight months of the end of the 2013 year of income confirmed that the only difference in what happened between the scheme, and reasonably expected to happen under the counterfactual, was the tax effect: a tax benefit the Commissioner could posit under Part IVA.

section 177CB – tax gives no explanation

The Full Federal Court noted that, following amendment to Part IVA which introduced section 177CB and sub-section 177CB(4) in particular, the tax impact of the scheme viz. the “operation of the Act”, or, more pointedly, the lower tax cost choice, is now expressly excluded as something that might reasonably be expected viz. the tax impact is now precluded by legislation from being a basis for a Part IVA counterfactual. Shortly stated that means the better tax outcome can no longer be a reasonable justification for choosing to implement a scheme caught under Part IVA.


Once the façade of an asset protection asset accumulating role for AITCS was identified by the Full Federal Court then AITCS was left exposed as a bucket company with a role in a tax scheme to re-purpose a trust distribution as a franked dividend to the tax advantage of Mr Springer in the 2013 year. In the context of potential Part IVA counterfactuals the Commissioner can raise, the AITCS bucket company can be viewed as unfortunately placed as both:

  • AITCS was a beneficiary of the AIT viz. the bucket company characteristic; and
  • shares in AITCS were owned by the AIT which facilitated the payment of trust income distributed to AITCS as dividends back to the trust;

enabling the loop or circularity which allowed the AIT to route income via AITCS as a franked dividend back to itself. But a clear or obvious alternative for the trustee of AIT would have been to distribute trust income to a different prominent beneficiary with a history of receiving distributions from the trust, such as Mr Springer. Distribution to Mr Springer was an even more obvious and irrefutable counterfactual when the distribution reflecting the income ultimately ended up with that beneficiary after going around in the circle.

Part IVA risks beyond non-residents?

Why would Part IVA in these situations be confined to where the ultimate beneficiary is a non-resident even though the AITCS scheme was particularly advantageous to AIT given high rates that apply on Division 6 taxation of non-residents? There can also a tax advantage and potential tax benefit too where a resident beneficiary receives discretionary trust income in the form of a franked dividend instead or as ordinary trust income. There is no reason why Part IVA couldn’t be similarly applied to a comparable circular scheme to use a bucket company loop to transform ordinary trust income into more lightly taxed franked dividend income.

Are bucket companies sitting ducks for Part IVA?

As a matter of policy the Commissioner has not used Part IVA to challenge direct distributions by family discretionary trusts to bucket companies to my knowledge. Guardian AIT shows that Part IVA can give the Commissioner a basis or tool to attack distributions to bucket companies which can be shown to have no purpose or reason, objectively determined, other than to save tax.

Where  discretionary trust ownership of shares in the bucket company facilitates opportunity for franking or other tax saving by going around in a circle, the trustee may be a sitting duck for the Commissioner’s Part IVA counterfactual positing what the trustee may have done had the distribution been made to the intended beneficiary to receive trust income the first time around.

Integrity measures covering income tax deductions for payments, including salary, to relatives

Involved “associate” issues come up frequently on this blog. For instance:

In this piece I am looking at some core associate rules concerning income tax deductions: how the Income Tax Assessment Acts (ITAA) can restrict income tax deductions for payments, including salary and wages, where the person in receipt is a relative or associate.

Example – mischief to which s26-35 of the ITAA 1997 is directed

Let us say X owns a business which employs X’s son Y and daughter-in-law Z. The business is profitable and X pays tax on income from the business at a high marginal rate. Y and Z only have assessable income from their salary from working in the business and both pay income tax at a lower rate than X. To give Y and Z a helping hand and so X, Y and Z pay less income tax overall X pays Y and Z overly generous salaries taking into account the age, experience, extent and profitability of the work that Y and Z do in the business.

How s26-35 applies

Section 26-35, which operates together with section 65 of the ITAA 1936, to cover off on payments to individuals including payments routed through partnerships, trusts and companies, reduces the deduction for salary and wages X is allowed to the amount the Commissioner of Taxation (Commissioner) considers reasonable based on the nature of the duties performed by, the hours worked by and the total remuneration of the relative. The excess is not deductible.

The section is not punitive: sub-section 26-35(4) operates to treat the non-deductible part of the payment the relative receives as non-taxable (NANE income) to the relative. So in the example assessments of income of X, Y and Z are all in the frame for adjustment by the Commissioner so the reduction in the tax deduction for salary and wages to X can be effected.

Income tax return requirements

The onerous part of section 26-35 is that X must keep sufficient records to substantiate that the payments to relatives claimed as deductions are reasonable. As usual a taxpayer needs to self assess and the burden of proving a payment, such as of salary, is reasonable is on the taxpayer: see our blog The burden of proof in a tax objection

In support of a claim of a reasonable deduction for a payment paid to relative a taxpayer such as X must also return the total of all payments made to associates in their income tax return. This is a flag to the Commissioner that deductions have been claimed for payments to relatives and, for a safe harbour to support the total associate payments deducted, the Commissioner states that a taxpayer needs to keep:

  • full name of relative or other related entity
  • relationship
  • age, if under 18 years of age
  • nature of duties performed
  • hours worked
  • total remuneration
  • salaries or wages claimed as deductions
  • other amounts paid – for example, retiring gratuities, bonuses and commissions.

for the Commissioner’s inspection. In the 2022 income tax return X might complete this item is:

P16 Payments to associated persons

with amounts comprising total associate payments deducted returned at item G item P15, These records need to be kept even if, in the view of the taxpayer and his or her advisers, the payments made by the taxpayer to relatives are reasonable and say even align with award entitlements.


The regime catches payments to partnerships where a partner is a relative however a payment by a partnership to a partner (of the same partnership) who is a relative of another partner (of that partnership) is not caught: proviso in sub-section 26-35(3). Hence the above records are not required in the context of deductible payments made to say a wife partner by a husband and wife partnership. (Not of partnership [agreement] “salary” which is not deductible in any case.)

A payment of a deductible superannuation contribution by X as an employer for Y or Z is also not necessarily caught by this regime where the payment is not to a relative either directly or indirectly via a company, trust or partnership within the section 26-35 of the ITAA 1997 and section 65 of the ITAA 1936 regime. The relative is less likely to become entangled in this regime where the relative is not an individual trustee of the superannuation fund contributed to by X.