On the basis of tax

Court considers issue of whether settlement administration costs can be deducted, for tax purposes, from interest earned on the settlement sum.

This judgment concerned the question whether costs incurred by the Court-appointed administrator of a class action settlement distribution scheme could, for income tax purposes, be deducted from any interest earned on the settlement sum, so as to reduce the amount of income tax otherwise payable on that interest income. Under s 8-1 of the Income Tax Assessment Act 1997 (Cth), the answer to that ultimate question depended, in turn, on whether the settlement administration costs were:

  • incurred in gaining or producing the interest income (First Limb); or
  • necessarily incurred in carrying on a business for the purpose of gaining or producing the interest income (Second Limb); and
  • not capital, or of a capital nature (Negative Limb).

At first instance, the primary judge (Middleton J) held that the settlement administration costs failed each of those three limbs (Watson as trustee for the Murrindindi Bushfire Class Action Settlement Fund v Commissioner of Taxation [2019] FCA 228). The Full Court unanimously agreed with that conclusion.

In relation to the First Limb, the Court held that the degree of connection between the incurring of the settlement administration costs and the earning of the interest income was too loose to constitute those costs being “incurred in gaining or producing that income”, observing (at [33]-[35]):

Here, the occasion of the administration costs did not lie in what the taxpayer did to produce the interest income earned on the bank deposits, but in giving effect to the terms of the Distribution Scheme for the distribution of the money paid under the settlement scheme to eligible claimants. The costs were incurred by the taxpayer in performing his duty to distribute the settlement sum to eligible claimants in accordance with the terms of the Distribution Scheme. The occasion of the outgoings is to be found in the appellant’s task, as an appointee of the Court, in the assessment of claims and distribution of the settlement funds. Those activities were not productive of interest income and they were not incurred “in” gaining or producing interest income. Those expenses had a loose, but ultimately insufficient, connection with the derivation of interest income …

… Any connection between the occasion of the expenditure and the earning of interest on the bank deposits was insufficient and too indirect to qualify the costs as deductions under [the First Limb].

In relation to the Second Limb, the Court held (at [37]-[38]) that the fact that the appellant was acting as a trustee, and was subject to the supervision of the Supreme Court which had appointed him, was relevant but not determinative as to whether or not he was ‘carrying on a business’. The Court then held (at [39]-[41]) that the primary judge was correct to find that the appellant was not ‘carrying on a business’:

First, it is important to bear in mind the purpose for which the Distribution Scheme was established, namely to provide the procedure for the distribution of the money paid by the defendants under the settlement of the class action. The activities conducted by the taxpayer pursuant to the Distribution Scheme were conducted by him in implementing and administering the Distribution Scheme. Such activities lacked the character of activities conducted as a business. The fact that some of those activities were commercial in nature, such as engaging staff and third party contractors, and the investment of the Fund, does not imbue the activities with a business character when looked at overall. Nor does the fact that Mr Watson had considerable experience in the administration of settlement schemes of this kind lead to a different answer. Mr Watson had earlier been appointed as scheme administrator of the materially identical Kilmore East/Kinglake Bushfire Settlement Distribution Scheme and had previously managed or supervised more than 20 other settlement distribution schemes administered by Maurice Blackburn. It can be accepted that he turned his experience to account in discharging his functions and responsibilities under the Distribution Scheme, but he was doing so in the context of administering the Distribution Scheme in accordance with its terms. As the primary judge observed … it is “important not to confuse Mr Watson’s role as a principal of Maurice Blackburn and Mr Watson’s other role as scheme administrator”.

Secondly, the primary judge was correct to conclude that the investment activities conducted by the taxpayer did not stamp the activities of the taxpayer taken as a whole as the conduct of a business. Undoubtedly the purpose of the investment was to accrue sufficient interest out of which to pay the administration costs, but even if done systematically and skilfully, it does not follow that, without something more, the activity can properly be described as a business… Considered as a whole, the taxpayer’s investment activities were therefore an incident of the performance of his duties under the Distribution Scheme.

Thirdly, the scale of activities does not have the consequence that the activities are properly to be characterised as the carrying on of a business. The scale and nature of the activities undertaken by the taxpayer was a function of the number of group members and the complex nature of the process required to assess the various claims. It does not lead to a conclusion that a business was being carried on.

Finally, in relation to the Negative Limb, the Court held (at [44]-[48]) that, properly analysed, the settlement administration costs were in any event capital or of a capital nature.

Watson as trustee for the Murrindindi Bushfire Class Action Settlement Fund v Commissioner of Taxation [2020] FCAFC 92

Federal Court of Australia, Kenny, Davies and Thawley JJ, 27 May 2020

Appellant’s Solicitors: PricewaterhouseCoopers;          

Respondent’s Solicitors: Australian Government Solicitor;

Appellant’s Funder: N/A

Austlii link: http://www.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/FCAFC/2020/92.html?context=1;query=Watson%20as%20trustee%20for%20the%20Murrindindi%20Bushfire%20;mask_path


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