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Your annual Trust check-up

Tax Telegraph, November 2013

As 2013 is drawing to a close, we “trust” that everyone dealing with trusts has taken all the required steps to ensure compliance. These include:

  • Ensuring that beneficiaries were made entitled to trust income via resolution by 30 June 2013 (or earlier date if required by the trust deed)
  • Reviewed any minutes or resolutions
  • Reviewed accounting and general ledger records
  • Ensuring that you have not made any companies presently entitled and left amounts unpaid. If you do have unpaid present entitlements (UPEs) in place and there is a potential Division 7A issue, ensure that these are put on Division 7A complying loan agreements or paid out to the company by the due date of the trust tax return
  • Ensuring that capital gains streamed to specifically entitled beneficiaries are recorded in the accounts within two months of year end
  • Ensuring that streamed dividends were recorded in the trust accounts by 30 June 2013
  • Checking your trust deed to ensure it allows you to do all of the above!

Trusts are complex beasts and getting all of the above completed correctly and on time seems like a complex task… and it is. The taxation of trust income has long been an area which many have considered as requiring change to resolve and clarify a myriad of issues. Our publication has followed the many ups and downs that trusts have seen from UPEs being classified as loans under Division 7A to the famous Bamford decision to the tug-of-war surrounding the streaming rules.

One thing has been made clear as a result of these changes is that the trust rules require a re-write.

The government proposal to rewrite the rules on the taxation of trust income was originally set to occur on 1 July 2013; however this has subsequently been deferred and currently stands at 1 July 2014.

While these issues are undergoing further deliberation, temporary provisions have been enacted in light of developments in the courts. These included:

  • Adjustment to a trust’s net income where it includes a capital gain, a franked distribution or a franking credit to effectively ignore these amounts when otherwise included in a beneficiary’s assessable income under Division 6
  • Ensuring beneficiaries who are made specifically entitled to the capital gains of the trust are assessed on those gains
  • Ensuring beneficiaries who are specifically entitled to a franked distribution are assessed on the amount of the franked distribution and also a proportionate entitlement to any part of the franked distribution which has no beneficiary specifically entitled.

As it currently stands, there are multiple unresolved issues with the introduction of these temporary provisions. These range from definitions, such as whether a trustee can treat amounts as receipts or outgoings to determine distributable income, to calculation in instances where a trust deed allows for differing methodologies for working out its accounts and its distributable income. There are administrative issues too such as those which surround TFN withholding obligations which may arise on the same amount for different beneficiaries. This scenario could arise where streaming of amounts for accounting purposes is ineffective for tax purposes.

Returning to the topic of reform, guidance around the changes is currently provided by an Australian Treasury paper released in late 2012. The policy framework focuses on aligning tax liability with the economic benefit received by beneficiaries as well as provisions to address the longstanding clarity issues. As it currently stands, any likely reform would be compatible with the current principle that taxable income should primarily be assessable to beneficiaries with the trustee liable on undistributed amounts.

The two models which are being put forward for development are the economic benefit model (“EBM”) and the proportionate assessment model (“PAM”). Both have similar themes in their proposed treatment of trust deed powers.

Broadly, the EBM would require trustees to allocate amounts of taxable income to beneficiaries without any dependency on how the trust deed’s definition of income is distributed. This has also been described as letting the tax liability “follow the money” or economic benefit to wherever it is passed. It is a model which would appear to do without the concept of present entitlement and which leans towards the quantum approach.

True to its name, the PAM leans the opposite way towards the proportionate approach as visited in Bamford. It introduces a broad “trust profit” concept which calculates taxable income outside the influences of the trust deed and its definitions of profit. The PAM requires that the trustee determine the “trust profit”, and then to split this amount across various currently undefined “classes”. Beneficiaries would then be entitled to a proportion of the amounts in these classes with the trustee assessable for any remainder.

A vital distinction between the two models is the likelihood to which amounts of undistributed income will arise, triggering an assessment for the trustee at the highest marginal rate. Trustee assessments would be more common under the EBM with its underlying quantum approach although the Government appears willing to counter this by entertaining the idea of a reduction of the applicable tax rate.

An important similarity held in both models is that of character retention for all amounts of trust income, not simply limited to amounts related to capital gains and franked distributions. Another similarity is that of the ability for a trustee to stream income to beneficiaries and have that income retain its tax attributes as it flows through the trust.

Other details included in the policy framework include administrative changes to relieve some of the pressure from taxpayers and accountants by extending the deadline for the determination of beneficiary entitlements by a month or longer from the current 30 June date.

Although these policies outlined are a step in the right direction in resolving some of the biggest issues facing taxpayers utilising trusts, they are not without their respective drawbacks. For the EBM it is the likely to result in an increase in trustee assessments and significant added complexity to tax laws surrounding trusts without necessarily being able to direct tax liability to “follow the money” as intended. For the PAM it is dependent on the definition and operation of the introduced “trust profit” concept to achieve the required outcomes.

Provided that the developments in trust tax law reform adhere to the updated timetable, many of these issues will hopefully be addressed in a mid-2014 exposure draft.

Watch this space…

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