The class action with which this proceeding was concerned arose from the Murrindindi Bushfire of 7 February 2009. The victims of the Murrindindi Bushfire alleged that the fire was caused by the negligence of AusNet Electricity Services Pty Ltd and others. On 6 February 2015, the class action settled and a Deed of Settlement was entered into between the parties. Subsequently, pursuant to the terms of settlement, $300 million was paid to the Murrindindi Bushfire Class Action Settlement Fund (the Fund). On 27 May 2015, the Supreme Court of Victoria (the Supreme Court) approved the Deed of Settlement and the Settlement Distribution Scheme (the SDS).
Following the deduction of the plaintiffs’ legal costs and disbursements of approximately $20 million, approximately $280 million of the Fund remained for distribution to group members (the Distribution Sum). Relevantly, the terms of the SDS did not require the applicant, when acting in his capacity as scheme administrator (the Taxpayer), to derive a return on the Distribution Sum or from the Fund. Rather, the only obligation imposed by the SDS in respect of the investment or financial management of the Distribution Sum was to deposit it in an interest-bearing bank account.
Also relevantly, as the administration of the SDS progressed, the Supreme Court approved the scheme administrator’s costs and expenses incurred in administering the Fund – and ultimately, the Supreme Court approved all costs incurred and these costs were paid out of the interest that had accrued on the Distribution Sum.
The appeal concerned the financial year ended 30 June 2016, during which the Taxpayer derived $8,355,722 in interest income by virtue of the moneys comprising the Fund having been deposited in various interest-bearing bank accounts (the Interest Income) and incurred $4,341,327 in costs and expenses (the Outgoings) comprised mainly of the scheme administrator and his staff’s costs in respect of depositing the Distribution Sum, establishing systems and internal processes to assist in the administration of the Fund and assessing and handling group members’ claims. Additionally, the Outgoings comprised fees paid to legal counsel, medical practitioners and loss assessors involved in the assessment of those claims.
The Commissioner assessed the Taxpayer on the Interest Income, but disallowed the deduction of the Outgoings. The Taxpayer appealed the decision of the Commissioner disallowing the deductions on the ground that he was entitled to deduct the Outgoings from his assessable income pursuant to s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act).
The issues for the Federal Court’s determination were:
- whether the Outgoings were:
- incurred in gaining or producing the Taxpayer’s assessable income pursuant to s 8-1(1)(a) of the 1997 Act; or
- necessarily incurred in carrying on a business for the propose of gaining or producing the Taxpayer’s assessable income pursuant to s 8-1(1)(b) of the 1997 Act; and
- whether the Outgoings were capital in nature pursuant to s 8-1(2) of the 1997 Act.
For the Taxpayer to succeed on the appeal, the answer to one or both issues (1)(a) or (b) had to be yes and the answer to issue (2) had to be no.
Issue (1)(a) – Section 8-1(1)(a)
In respect of issue (1)(a), the Taxpayer submitted that the income produced from the Fund was integrally connected with the incurring of the Outgoings for two reasons. First, he gained or produced the Interest Income by his administration of the SDS and, second, the derivation of the Interest Income arose by reason of the terms upon which he administered the Fund (including the terms of the SDS obliging him to deposit the Distribution Sum in interest-bearing accounts and to perform the task of administering the SDS).
Justice Middleton held that the Outgoings did not bear a sufficient connection with the Interest Income, or the activities that more directly gained or produced the Interest Income. His Honour found that the costs of assessing the claims of individual claimants related to the distribution of the Fund, not to the derivation of income from bank deposits.
Issue (1)(b) – Section 8-1(1)(b)
In respect of issue (1)(b), the Taxpayer made the following four principal submissions:
- it was settled law that trustees (in this case, the Taxpayer) were capable of carrying on a business;
- the Taxpayer was carrying on such a business, which could be characterised as administering the SDS;
- the Taxpayer pointed to its intention (or hope) that the costs of administering the Fund could be borne entirely by the interest that accrued on the Distribution Sum as proof of the existence of a motive to generate a profit and, thus, as an indication of the carrying on of a business; and
- the Taxpayer asserted that the business of administrating the SDS should not be separated into two categories – those which earned assessable income and those that incurred expenses, particularly in circumstances where the administration of the scheme was conducted pursuant to the same documents.
Justice Middleton held that, on the basis of a wide survey and exact scrutiny of the Taxpayer’s activities and in consideration of the factors set out by the High Court in Spriggs v Commissioner of Taxation (Cth) (2009) 239 CLR 1 at 19 , the Taxpayer’s activities did not constitute the carrying on of a business.
Justice Middleton considered each factor, as follows:
- whether the activities were systematic and organised: Middleton J found that the activities engaged in by the Taxpayer in administering the SDS were systematic and organised – as would be expected from a law firm of the size and with the resources of Maurice Blackburn. His Honour observed that this issue was not the subject of significant disagreement between the parties at the hearing of the appeal.
- the commercial character of the activities: Middleton J determined that the Taxpayer enjoyed no discretion as to which transactions to pursue and at what cost, unlike a businessperson. For example, the Taxpayer could not charge fees and disbursements against the Fund without the approval of the Supreme Court, nor could the Taxpayer derive any profit from the Fund other than by investing the Distribution Sum in interest-bearing accounts for the duration that it took to administer the SDS. In addition, his Honour considered that a distinction should be drawn between the Taxpayer’s role as a principal of Maurice Blackburn and his role as scheme administrator. In the latter role, his Honour found that the Taxpayer was not undertaking a commercial activity, rather he was administering the SDS as an officer of the Supreme Court and as part of the settled Murrindindi Bushfire proceedings. On these bases, his Honour held that the activities of the Taxpayer were not of a commercial character.
- the scale of the activities: Middleton J noted that this factor did not appear to be the subject of challenge by the Commissioner and was not doubted by the Federal Court.
- the existence of a profit-making purpose: Middleton J was not persuaded that a profit-making purpose motivated the Taxpayer’s activities in the ordinary, commercial sense of that phrase. His Honour concluded that the production of assessable income was a mere incident of the Taxpayer’s pursuit of his overarching purpose to discharge his obligations under the SDS in accordance with its terms.
Issue (2) – Section 8-1(2)(a)
In respect of issue (2), the Taxpayer argued that the occasion of the Outgoings was to be found in the carrying on of the business and that they were not of a capital nature by reason of the Outgoings being expenses of a periodical and recurrent nature.
Although not necessary for Middleton J to decide in light of his conclusions as set out above, for completeness, his Honour held that the Outgoings were of a capital nature and, thus, were not deductible. His Honour observed that the advantage sought by the Outgoings was to ensure that the moneys of the Fund were permanently distributed to group members pursuant to the SDS and once distributed, the scheme administrator’s task under the SDS was complete. Additionally, his Honour regarded the Outgoings incurred as being related to the final goal of distributing the entirety of the Distribution Sum to group members to discharge the scheme administrator’s duties under the SDS. His Honour found that, despite the Outgoings being incurred on a recurrent basis, the incurring of such Outgoings was a mere step on the path towards the ultimate destination, being the completed settlement of the litigation relating to the Murrindindi Bushfire.
The decision provides scheme administrators with valuable insight as to the tax treatment of settlement funds invested on behalf of group members, whilst reinforcing the dichotomy that exists between a scheme administrator’s duties as, on the one hand, a scheme administrator and, on the other, a legal practitioner.