Income Tax: whether trust distributions can be assessed under section 6-5 of the ITAA 1997

Can amounts distributed by a managed investment trust to a unit holder of the trust (in its capacity as a unit holder) be included in the unit holder's assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) if the amounts have the quality of income in the hands of the unit holder?

Yes, such amounts paid to a unit holder are included in the unit holder's assessable income under section 6-5 of the ITAA 1997 to the extent to which they are not amounts of: • the trust's net income as calculated under section 95 of Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) (its section 95 net income); or • the trust's exempt income or non-assessable non-exempt income.

A resident general insurance company invests premiums received and other funds in order to derive a return to meet future liabilities for claims.

These investments include units in various resident managed investment trusts from which the insurance company receives periodic distributions.

These periodic distributions may result in a share of the section 95 net income of the managed investment trusts being included in the insurance company's assessable income under section 97 of the ITAA 1936.

Notwithstanding this, some of the periodic distributions to which the insurance company is entitled, or parts of those distributions, will not have been ultimately dealt with under Division 6 of the ITAA 1936 (either to the trustee of the relevant managed investment trust, to the insurance company or to any other beneficiary) because they do not form part of the section 95 net income, exempt income or non-assessable non-exempt income of the relevant managed investment trust - instead representing: • income of the managed investment trust to the extent to which it is offset by deductible building allowances in calculating the trust's section 95 net income; • unrealised gains on assets held by the trustee which the trustee recognises for accounting purposes in an asset revaluation reserve but which are not included as assessable income in calculating the trust's section 95 net income; • capital gains realised by the trustee that are not included as assessable income in calculating the trust's section 95 net income, either because they are reduced by an amount of capital losses or net capital losses applied by the trustee for tax purposes and / or they represent the 50% non-taxable component of a discounted capital gain; or • amounts recorded in a tax difference reserve that do not form part of the calculation of the trust's section 95 net income.

The net income of a trust as calculated under section 95 of the ITAA 1936 is assessed to either the trustee of the trust or its beneficiaries under Division 6 of Part III of the ITAA 1936. However, components of the relevant distributions here have not been ultimately dealt with under Division 6 in respect of either the trustee or the insurance company or any other beneficiary because they do not form part of the trust's section 95 net income, exempt income or non-assessable non-exempt income for the relevant income year (in the sense, and for the reasons, set out in the facts).

The assessable income of an Australian resident entity includes income according to ordinary concepts derived from all sources during the income year: section 6-5 of the ITAA 1997. Whether or not a particular receipt is income depends upon its quality in the hands of the recipient - see Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 14 ATD 286; (1966) 10 ATR 367 at CLR 526 per Windeyer J.

In the context of an insurance business, the investment of funds is as much a part of the business as is the collection of premiums. An acquisition of an investment with a view to obtaining a regular yield and a profit on the subsequent realisation of the investment is a normal step in carrying on the insurance business - see Colonial Mutual v. Federal Commissioner of Taxation (1946) 73 CLR 604; (1946) 3 AITR 272, 450; (1946) 8 ATD 137 at ATD 145 and The Chamber of Manufacturers Insurance Ltd v. Federal Commissioner of Taxation (1984) 2 FCR 455: (1984) 15 ATR 599; 84 ATC 4315.

Where an investment made by an insurance company produces distributions of a particular kind which are regularly received in the course of carrying on the insurance business, and are not received in respect of the realisation of the underlying investment, then the gross distributions are properly characterised as revenue receipts and as such should be included in the company's assessable income under section 6-5 of the ITAA 1997.

The fact that the distributions are from a trust does not alter that result. The scope of Division 6 was considered by the High Court in Tindal v. Federal Commissioner of Taxation (1946) 72 CLR 608; (1946) 8 ATD 152; (1946) 3 AITR 608, Federal Commissioner of Taxation v. Belford (1952) 88 CLR 589; (1952) 10 ATD 105; (1952) 5 AITR 392 ( Belford ) and Union Fidelity Trustee Co v. Federal Commissioner of Taxation (1969) 119 CLR 177; 69 ATC 4084; (1969) 1 ATR 200 ( Union Fidelity ). The majority view in Belford that Division 6 was not an exclusive code was affirmed in Union Fidelity .

In the circumstances, to the extent that the periodic distributions are represented by amounts that do not form part of the section 95 net income (see note 1), exempt income, or non-assessable non-exempt income of the relevant trust for the relevant income year, they are included in the assessable income of the insurance company under section 6-5 of the ITAA 1997 (see note 2).

Distributions included in the insurance company's assessable income under section 6-5 (such as those representing the discount component of a trust's capital gain) may also have been taken into account in calculating the company's net capital gain under section 102-5 of the ITAA 1997 by virtue of the operation of section 115-215 of the ITAA 1997 (which broadly requires the insurance company to gross up their share of a discount capital gain made by the trustee of a trust).

This conflict is not specifically resolved by section 118-20 of the ITAA 1997. That provision may reduce a capital gain made from a CGT event if, because of the event, an amount was included in assessable income by a provision of the Act outside the CGT provisions. However, section 118-20 does not apply in respect of a capital gain taken to be made by a beneficiary under section 115-215 of the ITAA 1997: see subsection 115-215(5). In any event, a capital gain made by a beneficiary under section 115-215 is not a capital gain from a CGT event.

The conflict between section 6-5 of the ITAA 1997 and the CGT provisions is nonetheless to be reconciled to give effect to the purpose and language of the provisions - see Project Blue Sky v. ABA [1998] 194 CLR 355 at paragraph 70: A legislative instrument must be construed on the prima facie basis that its provisions are intended to give effect to harmonious goals. Where conflict appears to arise from the language of particular provisions, the conflict must be alleviated, so far as possible, by adjusting the meaning of the competing provisions to achieve that result which will best give effect to the purpose and language of those provisions while maintaining the unity of all statutory provisions. Reconciling conflicting provisions will often require the court "to determine which is the leading provision and which the subordinate provision, and which must give way to the other". Only by determining the hierarchy of the provisions will it be possible in many cases to give each provision the meaning which best gives effect to its purpose and language while maintaining the unity of the statutory scheme.

Having regard to the general structure, language and purpose of the income tax law, including provisions dealing with the interactions between the CGT provisions and other regimes within the income tax system, there is a clear intent that an amount should not be included in assessable income under both section 6-5 and section 102-5 of the ITAA 1997 and, in circumstances where this would otherwise be the case, the CGT provisions should give way to section 6-5.

Accordingly, in the event of a conflict where components of the distributions are assessable to the insurance company under section 6-5 of the ITAA 1997 and are also taken into account in calculating a net capital gain under section 102-5 of the ITAA 1997, the conflict is to be resolved by reducing the relevant capital gain the insurance company is taken to have made under subsection 115-215 of the ITAA 1997 to the extent to which it has been assessed under section 6-5. Note 1 : As set out in the facts, amounts which do not form part of a managed investment trust's section 95 net income include amounts sheltered by deductible expenses (which may nonetheless be available for distribution by the trustee of the trust). Note 2 : To the extent to which the distributions comprise amounts representing the section 95 net income of the trusts, those amounts will have been dealt with under the provisions of Division 6, which prevail over the rules in section 6-5 of the ITAA 1997: refer subsection 6-25(2) of the ITAA 1997.