The Government recently passed new Trust Legislation which clarifies the taxation treatment of trust income and the manner in which the trust beneficiaries are taxed when made presently entitled to a share of the trust’s net income. The legislation rewrite puts to rest the debate that arose after the ATO released its Practice Statement regarding its view of how trust income should be taxed following the 2010 High Court decision in Bamford v F C of T.
As an administrative Practice (and as outlined in Taxation Rulings IT 328 and IT 329), the ATO has permitted trustees to have a two month period after year end to put a valid trustee resolution in place regarding the distribution of income for the preceding year. In the absence of such a resolution (and where the Trust Deed does not specify a default beneficiary), the ATO can deem that no beneficiary is presently entitled to the trust income which results in the trustee being assessed on the income at the highest marginal tax rate. In the case of Capital Gains, this results in the loss of the 50% CGT discount which is only available where the gain is distributed by the trustee to an individual beneficiary. In addition, where an individual beneficiary could have otherwise received a refund of excess franking credits, the trustee instead can only have its liability to tax reduced to nil.
On 1 September 2011, the Australian Taxation Office withdrew Taxation Rulings IT 328 and IT 329 which allows this two month grace period after year end.
As a result of the withdrawal of the Taxation Rulings, the concept of “present entitlement” to income from a trust must now be based on the principals outlined by the High Court in Harmer v. Federal Commissioner of Taxation (1991) as follows:
- The beneficiary has an interest in the income which is both vested and vested in possession; and
- The beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.
From 1 September 2011, the issue of whether a beneficiary is presently entitled to the net income of a trust is to be determined by the above principles and to the facts of the particular circumstances. The facts to be taken into account include the terms of the trust deed, the terms of any trustee resolutions and any other actions by the trustee relevant to creating the entitlement of a beneficiary to the income of a trust.
In addition, up to 31 August 2011, the Commission accepted that while strictly the income of the trust is required to be paid or applied before the end of the income year (e.g. before 30 June), the payment or application of income of the trust within two months of the close of the income year satisfied the requirements.
In most cases (and certainly in the case of a discretionary trust), a present entitlement to a share of the trust income will arise where the trustee makes a valid resolution under the terms of the trust deed. The ATO will no longer follow its previously accepted administrative practice of allowing trustees two months grace after year end to consider the manner in which they should distribute the net income of the trust.
As a result of the withdrawal of the Taxation Rulings, effective from 1 September 2011 the trust is required to pay or apply the income of the trust by no later than 30 June of each income year.
What should you be doing prior to 30 June 2012?
- Review the terms of your trust deed and be familiar with the requirements to make a valid resolution within the timeframe;
- Keep track of the annual income and expenses of the trust (including capital gains) to determine the anticipated annual results;
- Contact your Blaze Acumen advisor before year end to discuss the results and the potential beneficiaries of the trust income; and
- Ensure that you have prepared and signed valid trust resolutions to distribute the income of the trust to the beneficiaries.
Careful management of your records will ensure that the benefits of using trusts as part of your business or investment structure will continue to be available under the new rules. We recommend that you talk to your Blaze Acumen advisor prior to June 2012 to ensure that you comply with all of the requirements and continue to benefit from the flexibility that trusts offer when managed appropriately.
If you have any queries regarding the above and how it will impact you, please don’t hesitate to contact your Blaze Acumen advisor.