Disclaimer of a beneficiary's trust entitlements

In brief - High Court in Commissioner of Taxation v Carter [2022] HCA 10 finds that a beneficiary of a trust cannot avoid income tax on an entitlement to trust income by disclaiming it after the end of the relevant income year 

The High Court's decision overturns previous decisions such as Commissioner of Taxation v Ramsden [2005] FCAFC 39, and the previous view of the Australian Taxation Office itself (see, for example, IT 2651 and ATO ID 2010/85), that income tax could be avoided by a valid disclaimer by a beneficiary after the end of the year of income.

A beneficiary may want to disclaim (or reject) an entitlement to trust income where the entitlement creates an unwanted tax liability. This is especially the case where the trust income has been set aside for the beneficiary but not actually paid to it, so the beneficiary has no funds to pay the tax liability. 

In some cases the beneficiary has no knowledge of the entitlement, or even that it is a beneficiary of the trust, until it receives a notice of assessment from the Australian Taxation Office. This can arise because the trustee has not properly exercised its powers to appoint the trust income before the end of the income year, and as a result the default beneficiaries specified in the trust deed become entitled to the trust income. That was the situation in the case before the High Court.

Meaning of "is presently entitled" under section 97(1) of the Income Tax Assessment Act

The decision involved the interpretation of section 97(1) of the Income Tax Assessment Act 1936. That section specifies the amount to be included in the assessable income of a beneficiary for an income year, where the beneficiary is not under any legal disability and is presently entitled to a share of the net income of the trust.

The taxpayer argued that "is presently entitled" means "really is presently entitled", so that for a reasonable period after the income year, later events could have the effect that the beneficiary is no longer presently entitled.

This argument was based on longstanding legal principles that an effective disclaimer operates retrospectively, and a disclaimer can occur within a reasonable time after the beneficiary becomes aware of its entitlement.

High Court's reasons for rejecting taxpayer's argument and what its decision means for disclaimers

The High Court rejected this argument because:

• liability to tax under section 97(1) depends on the right to receive an amount of distributable income, not actual receipt
• section 97(1) is directed to identifying that right immediately prior to the end of the year of income
• the beneficiary may be presently entitled immediately before the end of the income year "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"
• the other criteria for taxation in section 97(1) – that a beneficiary is not under any legal disability and is a resident – support the conclusion that a beneficiary's present entitlement is determined immediately before the end of the income year because they are circumstances which cannot be altered after the end of the income year
• other provisions in the legislation surrounding section 97(1) also operate on the basis of facts, events and legal relationships in existence at the end of the income year, which cannot be altered after the end of the income year
• the taxpayer's argument would give rise to uncertainty in the identification of the beneficiaries presently entitled to a share of the income of a trust estate, and the subsequent assessment of those beneficiaries.

The decision means that a disclaimer can only be made before the end of the income year to prevent a beneficiary becoming presently entitled to the net income of the trust. 

The decision does not consider the effectiveness of disclaimers for other purposes such as for social security entitlements, to effect a property settlement for a family break up or the status of trusts as foreign trusts for foreign investment, stamp duty and land tax purposes.