Paul Anderson | January 2013 | Corporate & Commercial
The recent Queensland Supreme Court decision of Wilson v Chapman raised the interesting question of what was precisely meant by the phrase ‘income and profits’ in a Will.
Who does this impact? Anyone who makes a Will and his or her legal and accounting advisers.
What action should be taken? Anyone making a Will, particularly those involving life estates, should be aware of the impact of the particular wording adopted.
Is ‘Income’ the same as ‘Profits’?
Facts Marion Fraser died on 9 January 1963. Under her Will dated 7 January 1959, she left one third of her estate in trust to pay the ‘income and profits derived therefrom’ to her daughter for life and the capital was then to go to specified residuary beneficiaries. The Estate comprised cash investments, shares and debentures. Over the years, the daughter was paid interest and dividends only. The question before the court was whether she was also entitled to realised and/or unrealised capital gains arising from the shares. The normal rule is that a life tenant is entitled to the net income of the Estate and the remainderman is entitled to any increase in the value of the capital. Did the use of the phrase ‘income and profits’ in the Will make any difference?
Considerations Justice Daubney first considered whether the word ‘profits’ was synonymous with the word ‘income’ or whether the phrase indicated an intention that the daughter was to receive more than just income. Particular words ought not to be read in isolation and must be looked at in the context of the whole document. Words will be given their ordinary meaning. The Will appeared to have been professionally drawn and words in a professionally drawn Will are barely regarded as ‘otiose’.
Is ‘Income’ the same as ‘Profits’?
The judge then considered the meaning of the word ‘profits’. He quoted Moulton, LJ in the 1911 English case of Re Spanish Prospecting Co Limited where it was said: “’Profits’ implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates.”
was that the concept of ‘income’ encompassed both revenue and gain and that ‘gains’ need not be realised if they represented increases in economic benefit. The result in Clark v Inglis was that ‘income’ was held to include unrealised capital gains. In the present case, counsel then sought to distinguish Clark v Inglis on a number of grounds, namely: •
Accounting evidence – Clark v Inglis turned very much upon the evidence of experts that the accounting practices adopted were permissible. The court gave considerable weight to the opinion of such experts. In the present case, there was no similar accounting practice because the daughter had not been paid any unrealised capital gains.
Power to distribute capital – In Clark v Inglis the trustees had an express power to determine whether a receipt was capital or income. There was no such power in the present case.
Time periods for calculating capital gains – In Clark v Inglis, the trust deed directed the trustee to make the calculations annually. There was no corresponding provision in the current Will. When was profit to be determined? How were losses to be dealt with? The judge concluded – ‘If a life tenant is to diminish the trust corpus by taking unrealised capital gains, the capital assets of the trust will become more vulnerable to capital loss…It is not sensible to allow the life tenant to continually draw down on unrealised gains when the life tenant is not accountable for capital losses.’
Apply v pay – In Clark v Inglis, the trust required the trustee to ‘apply’ the income. This was done by crediting the unrealised capital gains to the beneficiary’s account, although no money had actually been paid. In the present case, the trustees were required to pay the income and profits. It was difficult to see how any payment could be made without the profit being realised and the daughter did not have any power under the Will to demand or require that an unrealised capital gain be realised.
The judge concluded that the addition of the words ‘profits’ meant that the testatrix intended her daughter to receive something more than just ‘income’. However, did this mean unrealised and/or realised capital gains?
Realised Capital Gains In some Wills or trust deeds, the trustees are empowered to determine the character of a receipt, i.e. whether it is capital or income. There was no such power in the present Will. However, after a consideration of the relevant authorities, the judge concluded that even if realised capital gains did not come within the word ‘income’ they would come within the ‘profits’. In the result, the daughter was entitled to the realised capital gains.
Unrealised Capital Gains The Judge began by considering the 2010 NSW Court of Appeal decision of Clark v Inglis. In that case, the Will provided that the ‘income’ was to be applied to the benefit of named beneficiaries. The Estate largely consisted of a share portfolio. From the trust’s inception in 1982, the share portfolio was valued in the annual accounts at the lower of cost or net realisable value. However, in 1999 a new accountant took over responsibility for the accounts which he then prepared on the basis of valuing the share portfolio to market each year. Conflicting evidence was given as to whether this was a proper accounting practice. However, the primary judge preferred the evidence of experts that the practice was permitted and this finding was not disturbed on appeal. The expert opinion
Paul Anderson | January 2013
Is ‘Income’ the same as ‘Profits’? Paul Anderson | January 2013
Ruling The judge quoted Byrne, SJA in the unreported 2009 Queensland Supreme Court decision of Graham v Trust Company Australia. That case concerned similar wording in a Will, namely ‘the net profits and income therefrom’. Byrne, SJA said ‘whatever view may be taken about the operation of the clause in respect of realised capital gains, it cannot be applied to unrealised capital gains. Such an outcome would involve consequences so inconvenient that a construction of the Will producing them should not be adopted unless compelled by clear words and there are no such words here.’ Daubney, J agreed that, although realised capital gains were included in the phrase ‘income and profits’, unrealised capital gains were not. The Judge’s final words summed up his ruling: Similarly, in the present case, a conclusion that the term ‘profits’ included unrealised capital gains would yield extremely inconvenient consequences. It would provoke uncertainty as to the time at which the quantum of such gains should be ascertained. It would require an accounting (if that were possible) in circumstances where there has in the past apparently been no such accounting records kept. It would also yield a result which is not consistent with the overall scheme of the Will. Accordingly, I am not inclined to adopt such a construction of the word ‘profits’.
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The decision is both sensible and useful in clarifying an area of the law previously undecided. Its relevance will be particularly of value to anyone seeking to establish a life tenancy in a Will. In the result, the consequences can be vastly different if on the one hand the word ‘income’ is used compared to adopting on the other hand the phrase ‘income and profits’.
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