No Thanks! Effective Disclaimer of a Trust Entitlement

Attempts to disclaim an entitlement to trust, income or capital have arisen in various contexts for various reasons. The contexts often include receipt of an unexpected and unwanted income tax assessment, perhaps by reason of the beneficiary being a member of a class of default beneficiaries.

Issues have arisen as to how a disclaimer must be made, when, from when it will operate, in particular, can it operate retrospectively, and what must be disclaimed for it to be effective.

The recent decision of the Full Federal Court in Carter and O’s v FCT^[1] is the latest in a line of cases where the effectiveness of disclaimers by trust beneficiaries was an issue.

The relevant principles applicable to a disclaimer were largely explained by the Full Federal Court in FCT v Ramsden^[2]. The Full Court in Carter approved the summary of those principles made by the Administrative Appeals Tribunal in its decision appealed from^[3] as follows:

1. until disclaimed, a beneficiary’s entitlement to income under a trust remains effective and attracts the operation of s 97 of the 1936 Assessment Act from the moment it arises even if the beneficiary is unaware of it;^[4]
2. an effective disclaimer of a gift or an entitlement:
   1. operates by way of avoidance, not disposition,^[5] and
   2. defeats the donor’s intention to give the relevant property to the donee, or create an interest in that property in favour of the donee, on the terms of the donor intended;^[6]
3. because of (2), a beneficiary may disclaim an entitlement on becoming aware of it, with the effect that the disclaimer operates retrospectively as if the entitlement never arose, and not as an acceptance and disposition at the time of the disclaimer;^[7]
4. there must be a complete rejection of the gift or entitlement for the disclaimer to be effective because a qualified disclaimer may be seen as or constitute a form of acceptance of or assent to the gift or entitlement,^[8] and in this regard, it becomes necessary as a matter of construction to identify what the relevant gift is;^[9]
5. a periodical (usually annual) appointment or distribution of income or capital from a discretionary trust by reason of exercise of discretionary powers to do so is a stand-alone gift, or creation of an entitlement, when the power is exercised;^[10]
6. each appointment or distribution being an independent gift or creation of an entitlement, an object of a discretionary trust is entitled to accept or reject a discretionary appointment or discretion of either income or capital, and may accept one or more and disclaim others;^[11]
7. an entitlement as a taker in default of appointment is a vested interest liable to be divested by exercise of a discretion, and is a gift or entitlement that arises by operation of the terms of the trust separate from any gift or entitlement that might arise upon exercise of a discretionary power of appointment or discretionary power to distribute;^[12]
8. an entitlement of a taker in default of appointment can also be disclaimed;^[13]
9. one gift or entitlement having the same general origin, in the sense of coming from the same trust estate, can be retained and another disclaimed, and the fact of retention of an earlier one does not automatically prevent future disclaimers of later gifts or entitlements.^[14] However, the retention of one type of gift or entitlement may have an impact on assertions as to knowledge of the relevant trust and entitlements, and whether there has been a delay in disclaiming that prevents a subsequent disclaimer operating to avoid the gift or entitlement.^[15] It follows that disclaimer of one gift or entitlement would similarly not automatically prevent a future disclaimer of a different gift or entitlement, but would have the same effect on assessment of relevant knowledge going to whether there has been delay and whether a subsequent disclaimer operates to avoid the gift or entitlement;
10. to disclaim a gift or entitlement as a taker in default of appointment, it is necessary to disclaim the entirety of the gift or entitlement, namely the gift or entitlement created by the terms of the trust, and not the annual manifestation of it arising upon a failure to appoint elsewhere. An attempt to disclaim year by year without disclaiming the gift or entitlement in a manner that disclaims it entirely and permanently is ineffective;^[16]
11. a beneficiary loses the right to disclaim the gift or entitlement if it is accepted;^[17]
12. a gift or entitlement can be accepted by overt conduct;^[18] and
13. failure to disclaim within a reasonable period of becoming aware of a gift or entitlement can, having regard to the circumstances of the case, be treated as tacit or inferred acceptance of the gift or entitlement.^[19] It is necessary to look at all of the circumstances and the time that has elapsed to see whether acceptance of the gift or entitlement should be inferred from the absence of dissent;^[20] and
14. a beneficiary of a gift is fixed with knowledge of the gift and its basis vicariously on the basis that the knowledge of an adviser, which may be the only source or repository of relevant knowledge.^[21]

The issue in Carter was that the trustees of the Whitby Trust had made resolutions to distribute the income of the trust which the ATO, on a later audit, challenged as ineffective. The result was that assessments issued as to 80% of the net income of the trust to the trustee under section 99A of the ITAA 1936 and as to 20% to the default income beneficiaries who comprised four adult and one minor sibling.

The assessments covered the years 2001 to 2013 (the First Period) and 2014 (the Second Period). The four adult beneficiaries had executed Deeds of Disclaimer in June 2014 (the First Disclaimers) in respect of the income for the First Period, in November 2014 (the Second Disclaimers) in respect of the income for the Second Period and in September to October 2016 (the Third Disclaimers) in respect of all entitlements from the trust. The Second Disclaimers were in the same terms as the First Disclaimers, but the ATO decided the Second Disclaimers were ineffective and, as a result, the Third Disclaimers were executed.

The Full Federal Court was only concerned with the assessments with the 2014 year, it upheld the AAT’s adverse finding that the net income of the trust had not been validly appointed to the other beneficiaries and hence fell to the default beneficiaries but overturned the AAT’s decision that the default beneficiaries had not validly disclaimed their entitlement to the income for the Second Period.

Before the AAT the Commissioner had not challenged the Third Disclaimers as effective to disclaim the applicants’ interests under the Trust Deed. The Full Court considered this correct. The issue which the AAT decided against the applicants was that the entitlements to income had nevertheless been implicitly accepted by then. It inferred that by their conduct in executing the First and Second Disclaimers before executing the Third Disclaimers, the applicants had tacitly accepted the entitlements. This finding was made in the face of evidence given by all the applicants that in executing these disclaimers they intended to disclaim all entitlements to the interests, as the Third Disclaimers were effectively worded to do on their execution.

The Full Court held that in this finding the AAT had operated on an unstated erroneous premise that an ineffective disclaimer of a gift, as a matter of principle, necessarily involved a tacit acceptance of the gift, rather than determining that issue by reference to the relevant facts and circumstances.

The AAT had also asserted that the applicants delay in disclaiming in effect necessarily meant that income could not be effectively disclaimed. The Full Court, however, confirmed that the relevant issue is “whether in all the circumstances acceptance of the gift should be inferred from the absence of dissent from the donee, and the passage of time”.^[22] It rejected the existence of any principle, as apparently assumed by the AAT, that a delay in disclaiming necessarily involves a tacit acceptance of a gift.

Where there was no express acceptance of a gift, implicit or tacit acceptance is a matter of inference and presumption on the particular facts.^[23] On the facts here, the Full Court held that there was only one conclusion reasonably open, the applicants’ conduct was consistently directed to the one end of rejecting any right to any income from the trust.

The Commissioner had also contended for confirmation of the AAT decision on the grounds that the Second and Third Disclaimers did not have retrospective operation for the purposes of s97 of the ITAA 1936. This was rejected on the basis that the disclaimers operated by way of avoidance, rather than by way of disposition.^[24] Once the entitlements were held to have been disclaimed the consequence was that s97 was not engaged because it fixed liability on a beneficiary only where the beneficiary had a present entitlement to income under a trust and, while that entitlement was operative for s97 from the moment it arose, on disclaimer the general law extinguished it as initio and the Commissioner was bound to treat the beneficiaries as not entitled to the income for the purposes of s97. In holding this, the Court noted that the tax consequences of a disclaimer are determined by reference to the general laws^[25] and not by reference to legal relationships then in existence.^[26]

While it has been argued that effecting a valid trust interest disclaimer is out of the reach of the average taxpayer by reason of the demands of the onus of proof, requirements for positive, timely, unequivocal and intentional action, premised on actual knowledge of the entitlements, when the tax consequences of the entitlement is mostly not known when that knowledge is gained^[27], the Full Court judgement in Carter does recognise some circumstances where a disclaimer can be^[28] effective.

First published in the Law Society Bulletin.