As 30 June approaches, it will be important to ensure that additional care is taken in relation to trusts. This is mainly because the ATO has increased the level of scrutiny that they apply to trusts in recent years. With this in mind, we have set out below a listing of issues to be considered in respect of trusts at year end.
1. Timing of trust distribution resolutions
Trust distribution resolutions should be completed by the time required under the relevant trust deed. For most discretionary trusts, this will require the trustee to determine where the income will be appointed prior to midnight on 30 June.
However, it is imperative that each trust deed is reviewed prior to making the resolution. Some deeds, particularly older deeds, require the trustee to make their decision regarding trust distributions prior to 30 June. For example, we have identified some deeds which require the trustee to make a resolution by 27 June.
2. Distribution of trust income
The trustee’s distribution resolution, in most instances, will determine how the trust’s ‘income’ is distributed. This may be a different amount than the trust’s ‘taxable’ income for the year. As such, the beneficiary’s proportionate interest in the trust income will determine the proportionate share of the trust’s ‘taxable’ income that is assessable to them.
This may mean that it is not possible to be precise when determining the amount that a beneficiary will be assessed on. This is particularly relevant in light of the fact that the trustee resolution is likely to be completed at a point in time when the trust’s income and ‘taxable’ income has not been accurately determined (i.e. before the end of the income year).
Particular care should be taken when distributing to minors, who are subject to tax at penalty rates for distributions in excess of $416.
3. Make sure income or capital can be distributed to a particular beneficiary
Prior to making an income or capital distribution in favour of a particular person or entity, the trust deed must be reviewed in order to ensure that that particular person is an eligible beneficiary of the trust.
If the trustee purports to make a distribution to a person who is not a valid beneficiary, the distribution is unlikely to be effective. Depending on the terms of the deed, this could mean that no person was presently entitled to that share of the trust’s income for the year.
4. Make sure a beneficiary is a member of the “family” where a Family Trust Election has been made
If a trust has made a Family Trust Election (“FTE”), distributions of income or capital to persons who are not members of the “family” of the specified individual will be subject to Family Trust Distributions Tax at the rate of 46.5%.
Trusts and companies will be members of the family group of a specified individual if the entity is 100% owned by the specified individual and/or other members of their “family” as defined. A trust or company also will be a member of the family group if it has made a FTE or Interposed Entity Election (“IEE”) in respect of the same specified individual.
Importantly, because no-one ‘owns’ a discretionary trust, a discretionary trust can only be a member of the family group if a FTE or IEE has been made in respect of the same specified individual.
5. TFN reporting
New Tax File Number (“TFN”) reporting obligations were introduced for closely held trusts in 2010. Under the transitional rules, trustees were able to disclose TFNs for beneficiaries as part of the 2010 trust tax return, which satisfied the trust’s TFN reporting obligations for those beneficiaries. Transitional provisions were also allowed in respect of the 2011 trust tax return, which allowed the TFN report to be lodged with the trust tax return.
The transitional provisions have now ended and therefore trustees need to be aware of the TFN reporting obligations.
Closely held trusts are required to report the TFN of a beneficiary, who has not previously been reported to the ATO in the approved form, on a TFN Report. This TFN Report needs to be lodged with the ATO by the end of the month following the quarter in which the TFN was provided to the trustee. For example, if a TFN was reported in the July to September quarter, the TFN Report needs to be given to the ATO by 31 October.
The ATO has identified a large degree of non-compliance with the TFN reporting requirements. To assist, we have set out a number of tips below:
- Review the 2010 tax return to identify which beneficiaries already have been reported to the ATO. Also review any TFN reports that subsequently have been lodged by the trust;
- A trustee will not have satisfied the TFN reporting obligations merely because a person was a beneficiary in an earlier year’s income tax return (except for the 2010 tax return). If a new beneficiary received their first distribution last year, and they were not reported to the ATO on a TFN report, it would be advisable to report them to the ATO in respect of the current income year within the required timeframe if they are to receive a distribution in the current year;
- A trustee is not required to report a TFN for a beneficiary who is a minor. However, if a distribution is to be made to a person who turns 18 in a particular income year, it will be necessary to collect that minor’s TFN and provide it to the ATO within the required timeframe for the year in which they turn 18;
- When setting up a new trust, it would be advisable to complete a TFN report for all potential beneficiaries and lodge it as soon as possible (after the ABN and TFN for the trust have been received from the ATO); and
- When planning distributions at year end, make sure you know which beneficiaries already have been reported to the ATO. Make sure any new beneficiaries (including corporate beneficiaries) are reported to the ATO within the required timeframe.
- Failure to collect and report the TFN as required can result in the trustee being liable for withholding tax at the rate of 46.5% of the distribution.
6. Streaming discounted capital gains
The law specifically allows for the ‘streaming’ of capital gains and franked distributions if the relevant trust deed allows.
When streaming capital gains, it will be essential to review the deed to identify the extent to which the capital gain will be considered ‘income’ of the trust. In many trusts, where the deed defines income in line with ‘tax law income’, the non-taxable part of a discountable gain will not be ‘income’ of the trust.
To stream a capital gain effectively, it is necessary to ensure that the particular beneficiaries are entitled to the full net financial benefit of the capital. Therefore, to effectively stream a discounted capital gain where the trust has a ‘tax law’ income definition, it may be necessary to make two different distributions to the beneficiary; an ‘income’ distribution for the taxable part of the capital gain; and a ‘capital’ distribution for the non-taxable part of the gain.
Failure to adequately review the deed and draft the appropriate resolution may result in the trust’s income being taxed in a manner other than what was intended by the trustee.
7. Inability to stream other forms of income
The decision of the Full Federal Court in Commissioner of Taxation v Greenhatch  FCAFC 84 confirmed that, as the law currently stands, a trustee is only able to ‘stream’ capital gains and franked distributions. Under the current law, a trustee is unable to stream other types of income (e.g. interest income, foreign income, etc.).
Importantly, a trustee is only entitled to ‘stream’ if the deed allows.
8. Non-resident beneficiaries
If a trustee makes a distribution to a non-resident beneficiary, the trustee will be assessed on behalf of the beneficiary.
Income from a non-Australian source will not be assessable in Australia if the trustee distributes it to a non-resident. However, with effect from 1 July 2010, it seems that capital gains from all sources will be assessable in Australia when the capital gain is realised by an Australian trust, even if the capital gain is distributed to a non-resident beneficiary.
Prior to 1 July 2010, capital gains from a non-Australian source could be distributed by an Australian trustee to a non-resident beneficiary without being subject to tax in Australia. When the trust streaming provisions were introduced in a legislative form (in particular, Subdivision 115-C of the ITAA1997), the outcome appears to have changed despite the fact that there was no specific mention of a policy change in the accompanying Explanatory Memorandum.
In addition, trustees should be aware that if they distribute to a non-resident beneficiary the ATO may request further information prior to accepting the assessment. Such information may include:
- Identity documents for the non-resident beneficiary;
- Evidence that the beneficiary is aware of their entitlement to the distribution; and/or
- Evidence that the trustee actually makes a payment to the beneficiary.
9. Franking credits and trust income
In order to have beneficiaries assessed on the trust’s taxable income, the trust needs to have ‘income’ to which beneficiaries can be presently entitled. Whilst many trust deeds define income in line with ‘tax law’ income, there are some taxable amounts that are unlikely to create ‘income’ for the trust. An example is franking credits which are assessable to the trust.
In the ATO’s opinion (in a draft ruling), franking credits cannot create ‘income’ of a trust.
During an income year, the trust receives a fully franked dividend of $70 (with a $30 franking credit). The trust also incurs interest costs of $80 during the year. Despite the fact that the trust has $20 in ‘taxable’ income, the trust would not be able to make beneficiaries presently entitled to trust income. Thus, the trustee would be assessed in respect of the trust’s income.
10. Distributions of franking credits
Franking credits can only ‘pass’ through a non-fixed trust to beneficiaries where one of the following conditions is satisfied:
- The shares (from which the franked distributions were received) were acquired prior to 31 December 1997;
- The trust has made an FTE; or
- The beneficiary passes the small shareholder exemption. This requires the beneficiary to be a natural person, in receipt of less than $5,000 in franking credits (from all sources) during the relevant income year.
Therefore, in many instances, it will be necessary to make a FTE to pass franking credits to beneficiaries. This particularly will be the case where the beneficiary is a company or another trust.
11. Trustee beneficiary reporting schedule
When distributing from one trust to another trust, it may be necessary to complete a “Trustee Beneficiary Reporting Schedule” as part of the trust distribution statement in the trust tax return.
12. Care when distributing from trust to trust
In some instances, it may be desirable to distribute from one trust to another trust. There are a number of matters that need to be considered prior to making such a distribution:
- Ensure that the trust is an eligible beneficiary;
- If the ‘distributing’ trust has made a FTE, the ‘beneficiary’ trust also will need to have made an FTE (or IEE) in respect of the same specified individual in order to bring the trust within the same family group unless it is a unit trust in which 100% of the units are owned by family members; and
- If the ‘beneficiary’ trust has tax losses that are to be utilised, it will be necessary to consider the trust loss measures, in particular, the income injection test.
- Should you require any further information regarding the taxation of trusts, please contact the Tax Services team at William Buck.