Commissioner of Taxation v Martin Andrew Thomas and Others [2018] HCA 31: Distribution of Franking Credits

In Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Thomas and Others [2018] HCA 31 (8 August 2018), the High Court of Australia has unanimously allowed two appeals (one of them in part) and dismissed two appeals from the Full Court of the Federal Court of Australia [see Thomas v Commissioner of Taxation [2017] FCAFC 57 (12 April 2017)].  

Background to the Decision

In reaching its decision the High Court held that the Full Court of the Federal Court had erred in concluding that "directions" that had been given by the Supreme Court of Queensland [see Thomas Nominees Pty Ltd v Thomas and Ors [2010] QSC 417 (11 November 2010)] pursuant to section 96 of the Trusts Act 1973 (Qld), determined conclusively, against the Federal Commissioner of Taxation, the application of Division 207 in Pt 3-6 of the Income Tax Assessment Act 1997 (Cth) (the ITAA 1997) to certain “franked distributions”.

Division 207 of the ITAA 1997 sets out the effects, for tax, of beneficiaries of a trust having received income which includes franked distributions.  In certain income years, the trustee of a trust ("the Trustee") received franked distributions within the meaning of Division 207 of the ITAA 1997.  The Trustee passed resolutions that sought to distribute franking credits between beneficiaries separately from, and in different proportions to, the income comprising the franked distributions.  The intention of the resolutions was to maximise refundable tax offsets and "stream" the income between beneficiaries to attract the most favourable marginal tax rates.  

In the appeals, the assumption that franking credits could be so distributed was referred to as the "Bifurcation Assumption" - the term for a process in which something splits in two, for example, a stream divides into two smaller streams.

The income tax returns for the Trustee and beneficiaries were prepared and lodged on the basis that the Bifurcation Assumption was legally effective under Division 207 of the ITAA 1997.  Those returns produced deemed assessments. When the Commissioner gave notice of an audit, the Trustee applied for and obtained "directions" from the Supreme Court of Queensland that the resolutions gave effect to the Bifurcation Assumption, which was correct in law [see Thomas Nominees Pty Ltd v Thomas and Ors [2010] QSC 417 (11 November 2010)].  The Commissioner completed his audit and issued Notices of Amended Assessment. 

In the Federal Court

Two beneficiaries filed appeals [see Thomas v Commissioner of Taxation [2015] FCA 968 and Thomas v Commissioner of Taxation [2015] FCA 1339] and pursuant to Part IVC of the Taxation Administration Act 1953 (Cth), contended that the decision in Executor Trustee and Agency Co of South Australia Ltd v Deputy Federal Commissioner of Taxes (SA) (1939) 62 CLR 545; [1939] HCA 35 required that the "directions" conclusively determined the rights between the parties, even if the result was wrong in law.

The primary judge dismissed the appeals, holding that the Bifurcation Assumption was flawed in law, and the decision in Executor Trustee did not require the Commissioner of Taxation to give effect to the "directions".  On appeal, the Full Court of the Federal Court held, that applying the decision in Executor Trustee, "directions" determined conclusively against the Commissioner of Taxation the application of Division 207 of the ITAA1997 to the franked distributions

On Appeal to the High Court.  

By grant of special leave on 20 October 2017, the Commissioner of Taxation appealed to the High Court.  The High Court found that the Trustee and two beneficiaries accepted that the “Bifurcation Assumption” was legally ineffective under Division 207 of the ITAA 1997. Further, the High Court held that the "directions" did not determine, against the Commissioner of Taxation, the application of Division 207 of theITAA 1997.  

Note: The full citation for this case is:

The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Thomas; The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Pty Ltd; The Commissioner of Taxation of the Commonwealth of Australia v Thomas Nominees Pty Ltd; The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Thomas  [2018] HCA 31 (8 August 2018)

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The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Thomas; The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Pty Ltd; The Commissioner of Taxation of the Commonwealth of Australia v Thomas Nominees Pty Ltd; The Commissioner of Taxation of the Commonwealth of Australia v Martin Andrew Thomas [2018] HCA 31 (8 August 2018) and supporting summaries and materials.