Taxing of Trusts
Taxation of Family trusts has been a focus of attention for the Australian Taxation Office (ATO) in recent months.
It has issued a number of statements lately, most notably in early June 2010 when it released important documents dealing with two issues:
1. Allocating trust income to company beneficiaries, and
2. The High Court decision in Bamford. As a result, trustees of family trusts should check their trust deeds and income distribution practices.
The ATO’s final ruling on the question of ‘unpaid present entitlements’ (UPEs) involving company beneficiaries of a trust has been released. Essentially, it maintains the same view as a draft ruling released late last year.
Broadly, the issues covered by the ruling arise when a family trust has allocated some of its income to a company beneficiary, but has not paid the full amount to the company by the due date for lodging the trust’s tax return for the year.
The ATO’s view is that, at this time, the unpaid trust distribution becomes a loan, thus triggering the deemed dividend rules in Division 7A (see example below).
This is a change from the previous understanding of whether Division 7A applied in such cases.
According to the tax ruling, Division 7A rules will be applied to any allocation of trust income made on or after 16 December 2009, which usually will mean from the 2010 tax year. The ruling will only apply retrospectively where something more has been done, such as the trustee actually creating a loan in its accounts.
Example - unpaid present entitlements
On 28 June 2010 the Pineapple Family Trust resolved to allocate $100,000 of its trust income for the 2010 year to Banana Pty Limited. Pineapple makes a cash payment of $30,000 to Banana on 15 February 2011. Pineapple lodges its 2010 tax return on the due date of 15 May 2011.
According to the ATO, on 15 May 2011 the unpaid entitlement of $70,000 is deemed to become a loan from Banana to Pineapple. Specific action, which may include entering into a complying loan agreement and charging interest to Pineapple, will be necessary to avoid the unpaid amount of $70,000 deemed to be a dividend under Division 7A.
The High Court recently made its final decision in the Bamford case confirming the earlier Full Federal Court decision which has resulted in the release of a Decision Impact Statement (DIS) by the ATO setting out its views on the issues discussed in the case.
In particular, the ATO states that any changes arising from Bamford will not be strictly applied until the 2011 year when some of the existing administrative concessions will be withdrawn.
The decision has confirmed that:
· A trust deed can define trust income in a way that is different to general legal concepts as to what constitutes income; and
· The proportion of a trust’s taxable income allocated to beneficiaries depends on their proportionate entitlements to trust income (where trust income and taxable income are different).
The easiest way to ensure that a beneficiary receives the desired amount of taxable income is for the trust deed to define trust income as being equal to the net income as defined in Section 95 of the tax legislation (perhaps with certain adjustments such as reversing the franking credit gross up).
Most modern trust deeds already do this, but it is still timely to review trust deeds to ensure that they still operate as originally intended given developments in this area in recent years.
As well as the points mentioned above, the ATO indicates that, from the 2011 year, it will no longer accept streaming of different types of trust income to different beneficiaries. This has been a common strategy for many discretionary trusts, for example to stream all discount capital gains to individuals and all franked dividends to a company.
In many cases inability to stream may not make a lot of difference to a family group’s overall tax position, but where this does have a significant impact, a great deal of planning may be required.
This information is provided as a guide only and is not intended to constitute advice whether legal or professional. You should obtain appropriate advice concerning your particular circumstances.
Please ring (02) 4731-1405 A Grade Tax Accountants Penrith for all your taxation accounting and tax service needs.
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