Editors --- "Income test: life interest under will: losses and offse" [2005] SocSecRpr 3; (2005) 7 Social Security Reporter, Article 3

• FOGARTY and SECRETARY TO THE DfaCS
• The issues
• Submissions
• Construction of the will
• Formal decision

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Income test: life interest under will: losses and offset

FOGARTY and SECRETARY TO THE DfaCS

Decided: 2nd September 2005 by R.G. Kenny

At the time of his death in March 2003 Mr Fogarty owned a farming property. Built on the farm are four houses. Fogarty, his widow, lived in one of the houses. Her son lived in another of the houses and the remaining two houses were rented. Mr Fogarty appointed his three children as trustees of his estate. The will contained the following clauses:

“I GIVE AND DEVISE ANDBEQUEATH all the rest and residue of my estate of whatkindsoever and wheresoever situate unto my trustees upon the following trusts, namely:

(a) As to any real estate owned by me to permit my wife ROSINA MARY FOGARTY to have the use and occupation thereof or the income therefrom during her lifetime ...

In June 2004, a decision was made to reduce Fogarty’s rate of age pension, after taking into account, as income, the rental payments from the two rented houses on the farm.

The issues

The principal issues addressed by the AAT were whether the rent paid in relation to two houses comprised income as that term is defined in the Social Security Act 1991 (the Act)and, if so, whether business losses from a farming operation could be set off against the income.

The definition of income in s.8(1) of the Act provides that income of a person includes an income amount “earned, derived or received by the person for the person’s own use or benefit”.

Section 1072 of the Act relevantly provides that a reference in the Act to a person’s ordinary income for a period is a reference to “the person’s gross ordinary income from all sources for the period calculated without any reduction...”

Submissions

It was submitted that Mr Fogarty’s intention had always been to provide Fogarty with a secure home on the farm for as long as she wanted without any concerns, financial or otherwise, associated with running a farm. His intentions did not include Fogarty receiving the income from the property if she lived there. The trustees were registered as the legal owners of the farm and since then had managed the business activities of farming and the rental of the houses. Fogarty was not involved with any of the farm activities and this included both the farming business and the rental business.

It was argued that the words of the will were plain and clear on their face and should be given their plain meaning. Fogarty had the choice of either the use and occupation of the property or the income therefrom. As she had chosen to remain on the property, she had no legal entitlement whatsoever under the will to any income from the farm while she lived there.

An alternative submission was that, if there was an entitlement to income from the farm business activities, this was limited to the amount of net income derived by the trust, allowing for any other necessary payments or distributions by the trustees. It was also submitted that the farming business and the renting of the houses were effectively two limbs of a total business enterprise. Fogarty referred to taxation returns that demonstrated the farming business should be utilised to set off against profits of the rental business.

The Department submitted that, because of the terms of the will, Fogarty held a life interest in the estate of her husband which allowed her the use and occupation of the property. Fogarty’s children were bare trustees who held the legal title of the land in order to permit her to use it and occupy it during her lifetime. The term “use and occupation” was a technical term which created the life interest in the property and the right to income. The will did not give the trustees the power to operate the farming or rental property businesses nor the power to determine how the income from these businesses is to be applied. Whilst it may have suited the family for the farm to be operated by Fogarty’s children, it was, nevertheless, not provided for in the will.

In those circumstances the rental payments from the two tenanted houses on the farm and any other income from the property constituted income to which Fogarty had a present legal entitlement and which satisfied the definition of income in s.8(1) of the Act. Even if Fogarty did not actually receive the money this did not mean that it had not been derived by her for the purposes of the Act. If Fogarty allowed the income from the property to go to the trust rather than to herself then it was a disposal of income caught by s.1106 of the Act. It was also submitted that farm losses could not be set off against the assessable income from the rental properties.

Construction of the will

The AAT noted that there are limited circumstances in which a court, charged with the responsibility of construing a will, may rely upon extrinsic evidence where the words and terms in the will do not provide clarity as to the testator’s intentions. However, the rules applicable to a court of construction did not necessarily apply to the deliberations of an administrative tribunal. In any event, the Tribunal was satisfied that the terms of the will were not ambiguous.

Clause (a) of the will provided alternatives, namely that Fogarty had the option of the use and occupation of the real estate during her lifetime or, alternatively, the option not to dose but to take the income from it during her lifetime. The AAT noted that in some cases, the bestowal of a right to occupy premises or land had been held to be a personal right only and not one which established a life interest. This was so where the will specifically provided for a person to reside there (Re Hoppe [1961] VicRp 64; [1961] VR 381 at387 and Equity Trustees Executors and Agency Co Ltd v Buckhurst [[1907] VicLawRp 49; 1907] VLR 252 at 257). Such a personal right could arise where the testator utilised the formula “use and occupation” and this would be where other parts of the will demonstrated that the testator’s intention was to create a mere personal right (Re Anderson [1920] 1 Ch175 at 181). Many of the cases where personal right was found related to particular premises in which the beneficiary was able to reside. Where, however, on a reading of the will as a whole, there was nothing to limit the grant in that way, the words “use and occupation” established a life interest (Rabbeth v Squire (1859) 4 De G and J 406; [1859] EngR 682; 45 ER 157 at 158 and National Trustees, Executors and Agency Co. Ltd v Keast [1897] VicLawRp 77; (1896) 22 VLR 447 at450-51).

The AAT looked at other terms of Fogarty’s will which made it clear that a life interest was being created, in particular, if all or any part of the farm property was sold, the proceeds were to be utilised for the acquisition of a home for Fogarty.

Was Fogarty entitled to any income as a result of her life interest?

The AAT stated that, with a life interest in the property, Fogarty was entitled to the profits earned from both the farming business and from the rental of the tenanted houses.

As the farm ran at a loss, the income from this was not at issue. Although the evidence showed that the rental payments from the houses had been applied by the trustees to the farming business generally, and Fogarty may not have received the payments, the Tribunal held that they were still earned and derived by her (Inguanti v Department of Social Security (1988) 15 ALD 348 at 350 and Re Sas and Secretary, Department of Social Security (1987) 12 ALD 497) and constituted income of Fogarty under the definition in s.8(1) of the Act.

The AAT also considered the submission made on behalf of Fogarty that the farming business and the renting of the houses were effectively two limbs of a single business enterprise and had been treated in that manner for taxation purposes. The Tribunal noted that the Act had its own definitions and structure which did not depend for their application on the legislation relevant to the assessment of liability for income tax. However, if there was a single business enterprise, as determined in accordance with the provisions of the Act, the income of Fogarty would be the sum of the profits from rentals and the losses from the farming operations. In Re Donges and Secretary to the DFaCS (2003)72 ALD 713 it was found that a pump business and farm business constituted a total business enterprise with two limbs and with each limb dependant on the operation of the other, because both businesses utilised the same farm tools, equipment, truck and personnel in its operations. Therefore farming losses could be offset against income from the pump business which was carried out on the farm.

In Fogarty’s case, however, the renting of the two houses was an activity separate from the farming operations carried out on the property. Because there were two separate sources of income, the process of setting off one income against another was not available under the Act (Secretary to the DFaCS v Garvey (1989) 19 ALD348 at 352).

Formal decision

The AAT affirmed the decision under review.

[A.T.]