The podcast transcript following, is of an interview with CPA Australia senior tax counsel Mark Morris and ATO senior tax counsel Fiona Dillon. The podcast which was recorded by CPA Australia in May 2012, provides general information about some of the 2012 trust changes. Note: The information in this transcript is current as at May 2012. The comments made reflect the ATO position at the date of publishing and the position on any issue may subsequently change.
(Note: As at April 2016 Continuum Financial Planners Pty Ltd is not aware of any changes to the ATO position on these matters as expressed below and which were reinforced by determinations made during 2015.)
Question
There seems to be a lot happening in relation to trust taxation in terms of both legislation and ATO activity.
Response
From the ATO’s perspective we are working to clarify our view of the current law and in some instances this has meant that administrative practices which the Commissioner previously had in place have been withdrawn. Some education and compliance campaigns are also planned in relation to trusts.
Question
Before we discuss these developments in more detail perhaps we should briefly recap on how trusts are taxed.
Sure. As you know a trust is not a separate legal entity. Liability to tax in respect of the taxable income of a trust rests with its beneficiaries and/or trustee. Putting to one side the provisions that apply where a beneficiary is made specifically entitled to a trust capital gain or franked distribution, the taxable income of the trust is basically assessed proportionately amongst those beneficiaries who are presently entitled to the income of the trust for trust law purposes. If there is some income to which no beneficiaries are presently entitled, then the trustee is assessed on that proportionate share of the trust’s taxable income.
Background to 2012 Trust changes
Response
You’ve mentioned two different concepts there – the income and taxable income of the trust – let’s talk about them.
As we all know the High Court in the case of Bamford determined that income of the trust is a concept founded in the general law of trusts. So there is no set meaning – the income of any particular trust will generally depend on the terms of the trust deed and the actions that the trustee has taken pursuant to it. So one thing we keep stressing both to our staff in the context of audits, litigation and private rulings that involve trusts and when speaking to practitioners about trusts is that the trust deed, and any other document evidencing actions or decisions of the trustee (such as relevant resolutions and the trust accounts) must be carefully considered before the income of the trust estate for trust purposes can be determined.
The taxable income of the trust on the other hand is determined in accordance with the tax law – broadly calculated on the assumption that the trustee was a resident taxpayer. In the legislation it is called ‘net income’ – but I just refer to it as taxable income as this generally causes the least confusion!
Question
I see that the Tax Office has issued a ruling recently about the meaning of the income of the trust estate.
Response
Yes, we have – for those who are interested that ruling is TR 2012/D1. It explains that the income of the trust estate as that phrased is used in the trust assessing provisions broadly is a reference to the income for trust purposes that a beneficiary could be made presently entitled to. One of the main reasons for issuing the ruling was to explain the Commissioner’s view that net notional amounts cannot generally form part of this income of a trust estate.
ATO explains the 2012 Trust changes
Question
Would you care to elaborate?
Response
Sure. Many trust deeds equate the trust’s income for trust purposes with its taxable income. However taxable income may include amounts that have not actually come home to the trust, other than for tax purposes – franking credits are a typical example but there are others.
For example, if a trustee disposes of an asset for less than its worth, the capital gain recognised for tax purposes will be greater than the actual gain realised by the trust due to the market value substitution rule. The additional amount taxed does not represent any real value that has come into the trust that a beneficiary could be made presently entitled to and demand payment of. Accordingly we say that these net notional amounts are not capable of forming part of the income of the trust estate for our purposes.
If we instead took the view that these amounts were income of the trust estate, then because they would still not be amounts than had come into the trust to which a beneficiary could be made presently entitled, it would be income that was not capable of distribution. This would mean that some part of the trust’s taxable income would be assessed to the trustee.
Administrative impacts of the 2012 Trust changes
Question
There’s that term present entitlement again. The Tax Office has withdrawn its previous practice which enabled trustees to make beneficiaries presently entitled to income by 31 August in any particular year. Would you like to explain why you’ve done that?
Response
As you say, the ATO previously had an administrative practice of accepting that a resolution made by a trustee to distribute income within two months of the end of an income year was effective to make beneficiaries presently entitled to that income at year end.
However, it only had limited practical application. For example, many deeds make named beneficiaries (often referred to as ‘default beneficiaries’) entitled to any income not distributed by the trustee by year-end. In these circumstances, there would be no income remaining after year end that a trustee could make others presently entitled to within that two month period anyway.
Moreover, as the taxable income of a trust is broadly assessed amongst beneficiaries and the trustees, this administrative practice, whilst concessional to the trustee, was not concessional to all concerned. This is because it had the effect of treating those beneficiaries who were made presently entitled within the two month period as being assessable instead of the trustee. But, as confirmed early last year by the Federal Court in the case of Colonial, those beneficiaries should not be assessable under the law.
As a result of the Federal Court confirming this legal position, the Commissioner last year had to withdraw this administrative practice.
But the first year it has an impact is this current year. This means that in order to be assessed on a relevant share of the trust’s taxable income, a trustee will need to make a relevant beneficiary presently entitled to trust income by 30 June 2012.
2012 Trust changes address distribution streaming
Question
Now, I don’t want to get into a detailed discussion about the recent streaming changes relating to capital gains and franked distributions, but I think that it is worthwhile noting that despite now only having until 30 June to make beneficiaries presently entitled to trust income, trustees still have until 31 August to make beneficiaries specifically entitled to capital gains.
Response
Well, that’s right Mark. Under the streaming provisions, the law is concerned not with who is presently entitled to income, but who is specifically entitled to any capital gains and franked distributions of the trust. For any capital gains of the trust, the trustee will have until 31 August to record a beneficiary’s entitlement to receive a trust capital gain.
However, there is something to watch out for here. As I have already mentioned, many modern trust deeds will equate the income of the trust estate with its taxable income. This means, that to the extent to which a trust capital gain is ultimately assessable (for example, after any discounts are applied), it will form part of the income of the trust estate. If beneficiaries are already presently entitled to all of the income of the trust estate by 30 June, then a different beneficiary cannot later become specifically entitled to receive that which another beneficiary is already entitled to. In these cases, after year end at best the trustee will be able to make beneficiaries specifically entitled to any part of the trust capital gains not forming part of the income of the trust.
Question
From a practical point of view (under the 2012 Trust changes) it might be easiest to make all resolutions relating to income and capital distributions by 30 June.
Response
Sure, this will certainly avoid this issue. And even for other trusts, it will be a way of ensuring that a resolution relating to a capital distribution won’t be overlooked later.
Question
Many accountants don’t get around to working out a trust’s income until well after the end of an income year. Does the 2012 Trust change in practice mean that they will have to have the trust accounts prepared by 30 June?
Response
No certainly not. Trustee resolutions do not have to specify an actual dollar amount in order for the resolution to be effective in making a beneficiary presently entitled to trust income. Instead, a resolution is effective if it simply prescribes a clear methodology for calculating the entitlement, the result of which will not be known until the accounts are drawn.
For example, the entitlement can be expressed as a specified percentage of the income – whatever that turns out to be. Alternatively, if the trustee knows that the income of the trust will be at least a certain amount, but how much beyond that amount is unknown, it may choose to make one or more beneficiaries presently entitled to the certain amount, and other beneficiaries entitled to the balance – whatever that turns out to be.
Question
I understand that the Tax Office intends to undertake some compliance activities to make sure that resolutions were made by 30 June (as required under the 2012 Trust changes).
Response
Yes but those activities will be relatively small scale. The project in respect of 30 June distributions is primarily educational, and will involve the publication of relevant articles and alerting bulletins, some which have already taken place.
In addition, we intend write to a group of about 1200 trustees advising them of the need to make resolutions to distribute trust income by 30 June. It is then proposed that a limited number of those trustees will be selected for follow up activity after 30 June. I understand they will be asked to provide details of their resolutions in July.
Question
Do resolutions have to be in writing by 30 June?
Response
All that needs to happen by 30 June (even before the 2012 Trust changes) is a relevant present entitlement has to be created. In discretionary trusts, this is typically done by a trustee resolving to distribute income to the relevant beneficiary. Not all deeds require a trustee to make resolutions in writing – so a decision to distribute income by 30 June that is not committed to writing at that time may very well be effective to create the relevant entitlement.
But there may very well be a question (or an evidentiary issue) in these cases as to whether or not a decision was in fact made. Accordingly, I would suggest that it would be prudent to note any decisions in writing by 30 June (for example, in minutes of a relevant meeting – even if the formal resolutions are drafted after this time) so as to avoid a later dispute (for example with the Commissioner or between relevant beneficiaries and the trustee).
Question
Is there any chance that the ATO will extend its prior practice just for this year? (despite the 2012 Trust changes)
Response
No. We have been discussing the scope and sustainability of the prior administrative practice with the National Taxation Liaison Group and the Trust Consultation Sub-group for the last few years. For example, in September 2008 the ATO flagged with the NTLG and the Sub-group that the scope of the practice was necessarily limited in that it could not apply to trustees who were prevented by the terms of their deed from appointing income after the end of the income year.
The Federal Court’s decision in Colonial in January 2011 confirmed that the law required a present entitlement to arise by 30 June. In April 2011 the Commissioner explained to the Trust Consultation Sub-group that this made our practice unsustainable, and this was confirmed publicly both in our published Minutes and in our Decision Impact Statement in respect of Colonial which issued in June 2011. Because this discussion came so late into the 2010-11, we agreed to continue our practice for that income year, and only withdraw it on 31 August 2011 after the two month period for that year had expired.
It has therefore been known for quite some time that the prior practice will no longer apply for this and later years.
Question
I hear that in addition, the ATO is planning to issue a ruling about the proportionate approach. Isn’t that a fairly straight forward issue?
Response
I suppose that we all know that under the proportionate approach a beneficiary who is presently entitled to a share of the income of a trust is assessed on that same percentage share of the trust’s taxable income. However, we are often asked about the application of the proportionate approach to particular sets of facts. The TD will therefore contain a number of examples which we hope practitioners will find useful.
Question
Now there is a link between present entitlement and closely held trust TFN withholding isn’t there.
Response
Yes as part of the 2009 Budget the government announced a number of measures to improve the integrity of the tax system and help ensure everyone pays their fair share of tax. One such measure was the extension of the tax file number (TFN) withholding rules to cover the presently entitled beneficiaries of closely held trusts. This measure applies in respect of the 2010-11 and later income years.
Question
What happens under these rules if a beneficiary that is entitled to trust income hasn’t provided the trustee with their TFN?
Response
Where a beneficiary has not provided the trustee with their TFN, the trustee must typically withhold tax from the beneficiary’s share of trust’s taxable income at the highest marginal rate plus Medicare.
As already discussed, beneficiary’s share of trust’s taxable income is determined having regard to the proportionate share of income of the trust to which the beneficiary is presently entitled.
Certain exceptions apply to this withholding obligation, for example if the beneficiary is a minor, a non-resident or a tax exempt entity.
Question
And are beneficiaries entitled to a credit for the amount withheld by the trustee?
Response
Yes, beneficiaries can claim a credit for any amount withheld by the trustee in their income tax return for the year. There is no other option available – so even if a beneficiary is not taxable they will have to lodge a return to obtain the refund.
Question
But if the beneficiary has quoted their TFN to the trustee withholding is not required, is that right?
Response
Yes, though the trustee has to lodge a TFN report with the Commissioner setting out the beneficiary’s details. These are due by the last day of the month following the quarter the TFN was quoted by the beneficiary to the trustee.
Where a TFN report is lodged and the beneficiary details don’t match our records we will send the trustee a letter advising that another TFN report should be lodged with their correct information to avoid withholding. If the trustee does not provide the revised TFN report the beneficiary will be taken not to have quoted their TFN.
Question
So let’s get that straight, the requirement for a trustee to report a TFN is a once only obligation. A report does not have to be done each time a payment is made to a beneficiary.
Response
Yes, that’s right. And there is no need to lodge another TFN report if the beneficiary’s details (for example – their address) change.
One other thing worth noting is that there is nothing preventing a trustee completing a TFN report in respect of any beneficiary who they may consider making a payment to in the future. That way they won’t inadvertently get caught up in TFN withholding later on.
This might be particularly useful for trustees with minor beneficiaries (who are excluded from the rules until they turn 18). To avoid inadvertently triggering withholding obligations when they come of age, the trustee might like to consider lodging their details in a TFN report ahead of time.
Question
If I have taken on a new client from another firm, how can I ascertain if the TFN reports have been lodged for the beneficiaries of the trust?
Response
The best way to do this is to liaise with the previous accountant, remembering that the transitional TFN reporting arrangements may have taken the trust’s 2010 tax return as the TFN report for the 2010-11 income year, provided that all of the relevant details were provided (TFN, name, address and date of birth for an individual.) If there is any doubt, there is no harm in lodging another TFN report.
Question
OK. So how does the trustee go about reporting the TFN? Can they include the details in the trust tax return?
Response
No. This can only be done by lodging the TFN report. The report can be lodged electronically (ELS) or in paper form.
There were transitional arrangements whereby the TFN and details provided on the 2010 trust tax return could be taken as a TFN report for the 2010-11 income year, however those arrangements have concluded.
Question
Just to recap then – when trustees make beneficiaries entitled to income for the 2011-12 year one of the things they will need to consider is whether they have lodged a TFN report in respect of those beneficiaries?
Response
Yes and if they haven’t they will need to withhold or fill out a TFN report. If the entitlement arises by way of a resolution made in June, the report must be lodged by 31 July.
We don’t plan to extend the transitional arrangements which allowed later lodgment when these rules were first introduced to the 2011/12 TFN reports – under these 2012 Trust changes.
Question
If the trustee is liable to withhold, is there anything else they need to do?
Response
The trustee must also:
- register for withholding with the tax office (this will generate an annual activity statement for this withholding only)
- lodge an Annual TFN withholding report by 30 September
- pay the amounts withheld by 28 October (we will send activity statement for this), and
- provide a payment summary to relevant beneficiaries.
The trustee must also lodge an annual trustee payment report in respect of all beneficiaries who have received a payment or been made entitled to income during the year. But this is simply included in the trust tax return’s statement of distribution.
Question
Talking about Trust returns, I understand there are some changes in the 2011/12 year Trust return?
Response
That’s right there have been some changes to the trust return. The main one that practitioners should be aware of is that we are now asking for details of the trust income. This will enable us to determine, should we need to amend the taxable income of the trust, how that taxable income should be assessed.
As I explained at the outset, the calculation of the tax liability of beneficiaries (and the trustee) is based on the share (proportion) of the income of the trust estate (as determined in accordance with the trust deed) to which beneficiaries are entitled. So, we will now require trustees to provide in the trust return the total income of the trust estate at a new label 64 in the 2011/12 trust return.
The statement of distribution in the 2011/12 trust return has also been updated to require the trustee to record the share of income of the trust estate to which each beneficiary is entitled.
Finally there will be a new label in the statement of distribution to record a beneficiary’s share of net franked distributions so as to facilitate the new streaming amendments. Formerly these amounts would have been included at the share of non-primary production label.
