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Trust Issues Webinar – June 2016


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Trusts Issues Webinar - June 2016

TRUST INCOME

The provisions which deal with the taxation of trusts are primarily contained in Division 6 of ITAA36.

Section 95 defines ‘net income’ of the trust as assessable income less allowable deductions of the trust estate,

calculated as if the trustee were a resident taxpayer. Thus, ‘net income’ is taxable income.

Where beneficiaries are presently entitled to the income of a trust estate (typically referred to as ‘distributable

income’), those beneficiaries will most commonly become assessable pursuant to s97 however, following the

introduction of the ‘streaming’ provisions in the 2010-11 year beneficiaries may also be assessed pursuant to sub

divisions 115-C (capital gains) and 207-B (franked dividends) ITAA97.

Net income of a trust estate which is not included in the assessable income of a beneficiary will be assessable to

the trustee under s99A, unless the Commissioner considers this unreasonable, in which case s99 will apply.

ASSESSING BENEFICIARIES: S97

The principal provision assessing trust beneficiaries is s97, a section which can create particular difficulties and

inequitable outcomes for beneficiaries returning assessable income pursuant to that provision.

Section 97 provides that:

... where a beneficiary of a trust estate is presently entitled to a share of the income of the trust estate:

(a) The assessable income of the beneficiary shall include:

(i) So much of that share of the net income of the trust estate ...

‘Share of the income of the trust estate’

Considerable debate has occurred over many years as to the correct interpretation of the word ‘share’. The High

Court in the case of Commissioner of Taxation v Bamford (2010) HCA10 confirmed that ‘share’ means a

proportion, or fraction (commonly referred to as the proportionate approach). Details of the Bamford case and

the implications of the Court’s decision are set out at Appendix B.

The term ‘income of the trust estate’ was considered by the High Court in Bamford and by the Commissioner of

Taxation in draft tax ruling TR 2012/D1. Commentary can be found at Appendix B.

Proportionate view

Under the proportionate view, the trustee firstly determines the proportion, or fraction, of the trust income to

which a beneficiary is presently entitled; that proportion or fraction (‘share’) is then applied to the net (taxable)

income of the trust to determine the amount of assessable income to be returned by the beneficiary.

This approach was explained in Zeta Force Pty Ltd v FCT (1998) 98 ATC 4681 as follows:

Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the

notion of present entitlement has served its purpose, and the beneficiary is taxed on that share (or

proportion) of the taxable income of the trust estate.

The High Court in Bamford’s case noted what it indicated was the intention of s97(1) ITAA36 by referring to the

Zeta Force decision:


The contrast between the expressions ‘share of the income of the trust estate’ and ‘that share of the net

income of the trust estate’ shows that the draftsman has sought to relate the concept of present

entitlement to distributable income, and not to taxable income, which is, after all, an artificial tax amount.

Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the

notion of present entitlement has served its purpose, and the beneficiary is to be taxed on that share (or

proportion) of the taxable income of the trust estate.

An illustration of the application of the proportionate view is set out below.

Illustration – Proportionate view

The Bright Discretionary Trust

Year ended 30 June 2015

Trust income ............................ $100,000

Net (taxable) income ................ $150,000

The trustee resolves to distribute in the following proportions:

A: 10%

B: 10%

C: 80%

Distribution of trust

income

Taxable income: Proportionate

view1

Beneficiary A $10,000 $15,0002

Beneficiary B $10,000 $15,000

Beneficiary C $80,000 $120,000

TOTAL $100,000 $150,000

1: The proportionate interest of the beneficiary in the trust income is applied to

taxable income to determine the amount upon which each beneficiary is

assessable (s97).

2: $10,000 x $150,000 = $15,000

100,000

Note: following the introduction of the ‘streaming amendments’ in the 2010-11

year, the operation of Division 6 will be modified where the net (taxable) income

of the trust includes:

(i) net capital gains;

(ii) franked distributions (net of directly relevant expenses); or

(iii) franking credits

Refer: Streaming Trust Income at p 17 for commentary and examples.


‘Income of the trust estate’ (Trust income)

‘Income of the trust estate’ is not defined in the tax laws and therefore the meaning has been developed by case

law, principally the decision of the High Court in the Bamford case.

The term ‘income of the trust estate’ is typically defined in a trust deed and might be, for example:

income according to ordinary concepts

income according to ordinary concepts and amounts deemed to be income for tax purposes

all profits or gains taken into account in calculating the net income of the trust under s95 ITAA36 and

any other amounts which the trustee may determine from time to time to be income

an amount equal to the net income of the trust under s95 ITAA36

an amount equal to the net income of the trust under s95 ITAA36, unless otherwise determined by the

trustee.

The trust income is commonly referred to as the distributable income.

The High Court in Bamford’s case concluded that ‘income of the trust estate’ is based on trust law principles, to

be ascertained by the trustee applying:

appropriate accounting principles, and

the relevant terms of the trust deed.

If the trust deed contains no definition of ‘income’ and no powers are vested in the trustee in that regard, it

would be reasonable to conclude that ‘income according to ordinary concepts’ (in a trust law context) would be

the appropriate measure.

Tax Ruling TR 2012/D1: meaning of ‘income of the trust estate’

In draft ruling TR 2012/D1 the Commissioner of Taxation has considered the term’ income of the trust’ for the

purposes of Division 6 ITAA36, and expressed views which are inconsistent with those expressed by the High

Court in the Bamford case.

A joint submission from five professional bodies representing the accounting and tax professions criticised the

draft ruling in that ‘it does not represent an appropriate interpretation of the High Court’s comments in

Commissioner of Taxation v Bamford (2010) HCA 10 …’ The submission called for the draft ruling to be

withdrawn, however that has not occurred.

The draft ruling concludes that the ‘income of the trust estate’ cannot exceed the net amount of income to which

beneficiaries could be made presently entitled or the trustee could accumulate.

Importantly, whilst acknowledging that the term is based on trust law principles, the Commissioner rejects the

view that ‘income of the trust estate’ is determined solely on the basis of the relevant definition in the trust deed.

The ruling states that notional income amounts cannot be taken into account in calculating the ‘income of the

trust estate’ (subject to an exception)*. Notional income is defined as:

An amount of assessable income taken into account in calculating the net income of an income year that

either does not represent any accretion (of either cash or value) to the trust estate in that year or that

represents an accretion coupled with a corresponding depletion (in cash or value) of the fund.

Examples of what the Commissioner refers to as ‘notional income amounts’ are set out below.

* the exception being where notional income amounts are matched by notional expense amounts (refer: paragraph 16 of the Ruling).


Notional Income Amounts

The following examples of notional income are provided in the ruling:

Franking credits

The Commissioner expresses the view that a franking credit ‘does not represent an accretion to the trust estate

nor an accounting asset of the trust (that is, it is not a future economic benefit of the trust) that can itself be dealt

with by the trustee’. It is merely a feature of the income tax law which confers benefits at the time of assessment.

The conclusion is therefore reached that a franking credit cannot form part of trust income.

CGT: Market value substitution rule

In certain circumstances a capital gain will be calculated taking into account the market value of the asset rather

than the actual capital proceeds (s116-30 ITAA97).

To the extent that capital proceeds are deemed rather than actual, that amount does not represent an accretion

to the trust estate and therefore cannot form part of the income of the trust estate.

Distributions from other trusts

If a trust distributes income to a beneficiary trust and the net (taxable) income is greater than the income of the

trust, the beneficiary trust will not be able to include the excess in its own distributable income as it does not

represent an accretion to the trust estate.

For the 2013-14 year, the ‘income of the trust estate’ of Family Trust would include

an amount of $10,000 from Operating Trust (according to TD 2012/D1).

Division 7A dividends

A trust estate may become assessable in respect of a deemed dividend pursuant to Division 7A ITAA36. For

example: a loan from a private company which contravenes s109D ITAA36. In these circumstances the deemed

dividend is described as notional income and therefore not able to be included in the distributable income of the

trust estate.

Attributable income

If a trustee is an attributable taxpayer pursuant to the transferor trust or controlled foreign company rules, the

attributed amount will be considered to be notional income and therefore excluded from the calculation of

income of the trust estate.


Ruling commentary

The ruling describes ‘income of the trust estate’ in these terms:

The income, being a product of, or a flow from, the trust estate, must represent, in total, an actual

accretion to the trust estate for the relevant period. In other words, that which is ‘income’ cannot in total

exceed (although it can be less than) the yield or accretion to the fund for the relevant period. And it must

represent an accretion that, following its production, is capable of adhering to, or forming part of, the

trust estate. However, in this context an accretion need not be a realised gain – it may in appropriate

cases reflect an unrealised gain which represents an increase in value which has accrued to the trust.

Income equalisation clauses

The ruling acknowledges the widespread practice of trust deeds defining ‘income’ as being equal to the net

income of the trust for tax purposes.

Notwithstanding the adoption of this definition, the Commissioner is of the view that ‘an amount which is

included in the net income of the trust but which is not represented by a net accretion to the trust fund (for

example, notional income amounts) cannot generally form part of the distributable income of that trust estate’.

Having reached that conclusion the Commissioner goes on to state that ‘notional income amounts ... do not

represent any amount to which a beneficiary could be made presently entitled’.


Examples

The following illustrations have been extracted from the draft ruling:

Example 2 – income equalisation clause – notional income

24. For the purposes of the Brisbane Family Trust deed ‘income’ is defined to mean the net income of the Fund in

any Financial Year determined in accordance with subsection 95(1).

25. For the 2014-15 income year, the trust’s net income as defined in section 95 is $100,000, made up of franked

dividend of $70,000 and franking credit of $30,000. The trustee has no other relevant income or expenses for

that income year.

26. The trustee resolves to distribute the trust income to resident beneficiaries (two of whom, Amy and Barry, are

under a legal disability) as follows:

Amy Brisbane ............................ $416

Barry Brisbane .......................... $416

Charitable Brisbane Inc ........ $20,000

Deal Brisbane Pty Ltd ......... $Balance

27. Despite the terms of the deed, the $30,000 franking credit does not represent an accretion of the trust fund and

therefore does not form part of the distributable income of the trust. The trust’s distributable income is $70,000.

28. Applying the proportionate approach, each beneficiary’s share of the trust’s distributable income and their

corresponding proportionate share of the trust’s net income, is as calculated in the table below:

Entity assessed Share of distributable

income Share of net income

Amy Brisbane $416 of $70,000 (ie. 0.59%) 0.59% x $100,000 = $594

Barry Brisbane $416 of $70,000 (ie. 0.59%) 0.59% x $100,000 = $594

Charitable

Brisbane

$20,000 of $70,000

(ie. 28.57%) 28.57% x $100,000 = $28,571

Deal Brisbane $49,168 of $70,000

(ie. 70.24%) 70.24% x $100,000 = $70,240

Trustee $0 $0

29. As Amy and Barry Brisbane are under a legal disability, the trustee will be assessed in respect of their share of

the net income of the Brisbane Family Trust (as set out in the table above) under s98. Both Charitable Brisbane

and Deal Brisbane will be assessed on their share of the net income of the Brisbane Family Trust (as set out in

the table above) under s97.


Example 4 – income equalisation clause – notional income

36. During an income year, the trustee of the Adelaide Family Trust derived the following amounts:

Rental income ...................................... $130,000

Franked dividend ................................... $70,000

Exempt income .................................... $100,000

Capital gain (before discount) .............. $200,000

37. There were no expenses or depletions to the Trust Fund.

38. Before the end of the income year, the trustee of the Adelaide Family Trust resolved to distribute 50% of the

income of the trust to each of Victoria and Albert (who are resident beneficiaries not under a legal disability).

39. The trust deed defines the ‘income’ of the trust as being the net income of the Fund in any Financial Year

determined in accordance with subsection 95(1).

40. The effect of the deed is that the exempt income and discount portion of the capital gain is treated as trust

capital for the year.

41. The net income of the Adelaide Family Trust as calculated under subsection 95(1), and the deed defined

income, is $330,000 ($130,000 rent + $70,000 dividend + $30,000 franking credit + $100,000 net capital gain).

However, for s97 purposes the income of the trust estate cannot exceed:

the total accretions to the trust fund for the income year (being $500,000 comprised of the $130,000

rent + $70,000 dividend + $200,000 actual capital gain + $100,000 exempt income)

less accretions to the trust fund for the income year which have not been allocated to income (being

$200,000 comprised of the $100,000 discount component of the capital gain + $100,000 exempt

income), and

less any depletions to the trust fund for that year chargeable against income ($nil).

that is, $300,000.

42. Accordingly, the net income of the trust estate for s97 purposes (its distributable income) is determined by

looking at the income otherwise calculated under the deed, limited to a maximum of $300,000.

43. Accordingly, for the purposes of Division 6, Victoria and Albert will be regarded as presently entitled to $150,000

of the income of the trust estate.

44. If the income year is the 2009-10 or an earlier income year, Victoria and Albert will each be assessed under s97

on their 50% share ($165,000) of the net income of the trust.

45. If the income year is 2010-11 or later, the changes effected by Tax Laws Amendment (2011 measures No.5) Act

2011 need to be considered.

46. In a broad sense, as no beneficiary is specifically entitled to the trust capital gain or franked dividend, these

amounts will be assessed to beneficiaries based on their original proportionate share to trust income.

Specifically, subdivisions 115-C and 207-B of the ITAA97 will apply to each as follows:

under subdivision 115-C – they will be taken to have a capital gain equal to the 50% of the capital gain

included in the net income of the trust, grossed up to reverse the effect of the discount (that is

$100,000 each), which they (being individual taxpayers) can then discount by 50% again in working

out their own net capital gain, and

under subdivision 207-B – they will be assessed on 50% of the franked distribution and attached

franking credits (that is, $35,000 franked distribution plus $15,000 franking credits each).

47. Division 6E will apply to ensure that Victoria and Albert are not taxed on any part of the capital gain or franked

distribution under Division 6. And will result in them each being assessed on a 50% proportionate share of the

$130,000 that would have been the Adelaide Family Trust’s net income if these things were ignored (that is,

$65,000 each).

48. Accordingly, assuming Victoria and Albert have no relevant losses available in their own right (for example,

capital losses), they will each be assessed on $165,000 in total in respect of their distribution from the Adelaide

Family Trust, irrespective of what income year these transactions occurred.


In summary, example 4 results in the following:

Income derived by the trust ................................................................ $500,000

Income of the trust for Division 6 purposes

Accretions to the trust................................................ $500,000

Less accretions not allocated to income ..................($200,000)

Less depletions not charged against income ........... $0

$300,000

Net (taxable) income of the trust ........................................................ $330,000

Application date

The final ruling is intended to apply both before and after the date of issue. However, it will not apply where:

For the 2009-10 and earlier years, taxpayers have relied on the Commissioner’s administrative practice

as outlined in PS LA 2009/7 and the outcome was more favourable to the taxpayer, and

There is conflict with the terms of settlement of a dispute agreed to before the date of issue of the

Ruling.

Legislative drafting

The Tax Laws Amendment (2011 Measures No. 5) Bill 2011 introduced the amendments

connected with the streaming of trust income.

The Explanatory Memorandum (EM) which accompanied the Bill contained numerous

examples indicating how the legislation was intended to apply.

In a number of the EM examples trusts had received franked dividends. In those instances

franking credits were excluded from the calculation of ‘income of the trust estate’. Refer:

examples 2.4 and 2.7 of the EM.


COMMENT

Pursuant to Division 6 ITAA36 a beneficiary presently entitled to a share of the ‘income of the trust

estate’ will be assessable on the same proportionate share of the net (taxable) income.

The High Court in the Bamford case confirmed that the income of the trust estate should be determined

in accordance with the law of trusts.

Whilst in the draft ruling the Commissioner has stated broadly that ‘income’ should be determined on the

basis of the trust deed and the general law of trusts, he has also stated this is limited by the requirement

that there must be a ‘net accretion to the trust estate’. Further, income must be ‘an amount in respect of

which a beneficiary can be made presently entitled’.

This approach may have significant implications for trustees seeking to achieve particular distribution

outcomes. For example:

1. Assume a trust which defined ‘income’ as being the net (taxable) income pursuant to s95 ITAA36 had

the following outcome for the 2013-14 year:

Trading loss ................ ($90)

Franked dividend .......... $70

Franking credits............ $30

Taxable income ............ $10

Based on TR 2012/D1, no distribution could occur as there would be no income of the trust

estate (loss of $10) and therefore no present entitlement could be created. Note: it may be

possible to ‘stream’ the franked dividend if the trust deed empowered the trustee to do so and

the legislative requirements were satisfied. Refer: p 17.

2. For the trustees seeking to limit the amounts distributed to certain beneficiaries, say minors, see

page 46.

Note: From the 2011-12 year it is necessary to report the ‘income of the trust estate’ in the trust

tax return. For the consideration of the effect of TR 2012/D1 in this regard refer to page 4.

Suggested action

1. Review the definition of ‘income’ in trust deeds.

2. If the definition equates income to the net (taxable) income, consider the implications and whether

an amendment to the deed is appropriate.

3. If an amendment to the deed is contemplated, obtain legal advice confirming that the amendment

will not constitute a resettlement.

4. If the trust deed provides the trustee with the power to determine whether income is equated to net

(taxable) income or, alternatively some other basis, identify what is required in order to evidence the

trustees decision in this regard.

5. Establish a procedure to ensure that notional amounts (as described in TR 2012/D1) which arise in

future years are identified.

6. Where necessary, review prior year distributions to ascertain whether any trustee actions would

contravene the approach described in TR 2012/D1.

7. Monitor the progress of TR 2012/D1 to a final ruling and Tax Office approach to enforcing the views

expressed in the draft ruling.


‘Net income’ of the trust estate

The term ‘net income’ in s97 ITAA36 refers to the taxable income of the trust estate calculated in accordance with

s95 ITAA36 ie total assessable income less allowable deductions. In the Decision Impact Statement issued by the

Commissioner of Taxation in response to the High Court judgement in the Bamford case, it is stated that the

amount upon which a beneficiary is assessable will be an unallocated proportionate share of the net (taxable)

income ie where the taxable income of the trust is made up of different classes of income, beneficiaries will share

proportionately in each class.

From the 2010-11 year this outcome is subject to the application of the streaming provisions which enable capital

gains and/or franked distributions to be ‘streamed’ to particular beneficiaries.

Possible implications of the ‘income’ definition in a trust deed

Establishing that there is ‘income of the trust estate’ is vitally important. The structure of s97 is such that, in the

absence of trust income, the trustee is unable to distribute taxable income to beneficiaries.

Whether or not capital gains can be distributed may be impacted by the definition of income in the trust deed.

Capital gains will not generally be considered to fall within the parameters of income according to ordinary

concepts, however capital gains may form part of trust income if:

trust income is defined as being equal to taxable income

the definition of ‘income’ in the trust deed includes capital gains, or

the trust deed allows the trustee to treat capital gains as income for trust purposes, and the trustee

properly determines to do so.

Example

Assume that, for the 2015 year, the Miracle Family Trust has incurred a net trading loss of $10,000 whilst deriving a

capital gain of $20,000. The deed of the Miracle Family Trust empowered the trustee to determine whether income and

expenditure were on revenue or capital account. In accordance with these powers the trustee decided to treat the capital

gain as income and appropriately recorded that decision in the records of the trust.

Outcome: The trust income for the 2015 year would be $10,000 and therefore a distribution to beneficiaries could occur.

If however, trust income had been defined as ‘income according to ordinary concepts’ there would be no trust income

(loss $10,000) and therefore the operation of s97 would preclude the trustee from making a distribution.

Note: Where there is net (taxable) income of the trust which includes capital gains and/or franked

distributions, the streaming provisions may enable these amounts to be distributed to beneficiaries. Refer

to: p 17.

Trust taxable income exceeds trust income - the proportionate approach

When trust income and trust net (taxable) income differ, application of the proportionate approach may result in

a beneficiary becoming liable to tax on an amount that is more or less than the beneficiary’s actual entitlement

from the trust. This situation was acknowledged by both the High Court and the Full Federal Court in the Bamford

case.

This problem can be particularly evident where a trust has different income and capital beneficiaries.


Example – Proportionate approach

The Blue Trust position for the 2015 year is:

Trading income ................................. $200,000* (*Trust income per Blue Trust deed.)

Net capital gain ................................... $50,000

Trust taxable income (s95) ............... $250,000

Beneficiaries:

Income: A and B

Capital: C

The trustee resolves to distribute the trust income as follows:

Beneficiary A ............................................ 50%

Beneficiary B ............................................ 50%

Capital is distributed to Beneficiary C.

The outcome is:

Taxable income Cash entitlement per trust deed

Income Capital gain

Beneficiary A $125,000* $100,000** 0

Beneficiary B $125,000 $100,000 0

Beneficiary C $0 $50,000

*50% of $250,000 (net income)

**50% of $200,000 (trust income)

Up to 30 June 2010, the means available to avoid this outcome was to apply the principles outlined in PSLA

2005/1 (GA). The practice statement was withdrawn as a result of the amendments contained in Tax Laws

Amendments (2011 Measures No. 5) Bill 2011: Trust Income which are designed to enable capital gains to be

streamed to particular beneficiaries which should overcome the problem outlined in the illustration above

(provided the deed of the Blue Trust empowered the trustee to stream classes of income).

Practice Statement PS LA 2010/1

An administrative decision by the Tax Office which may trouble taxpayers who have previously relied on PS LA

2005/1 (GA) is the release of PS LA 2010/1 in response to the High Court’s Bamford decision. In the Practice

Statement the Tax Office indicates that should the assessment of trust net income for 2009-10 or an earlier year

be re-opened (for example, as a result of a disallowed deduction), it would apply its current view of the law when

issuing amended assessments. Inherently, this includes the view that PS LA 2005/1 (GA) is incorrect and that its

withdrawal is warranted. Although the Tax Office does not preclude the ability of taxpayers to rely on PS LA

2005/1 (GA) in prior years, this ‘retrospective’ withdrawal of the Practice Statement is not in line with the premise

that taxpayers are entitled to rely on the Commissioner’s stated practices at the time. In particular, since the

withdrawal of the Practice Statement takes effect from the 2010-11 year, taxpayers should be entitled to rely

upon it for disputes relating to earlier years, which would provide greater fairness, certainty and consistency with


the terms of withdrawal.

There is presently no indication whether the proposed legislative rewrite of the tax law affecting trusts will have

any bearing on the approach adopted in PS LA 2010/1.

Proportionate approach: Trust income exceeds trust taxable income

In a non-fixed trust, where trust income exceeds trust taxable income, the distribution paid to a beneficiary which

is in excess of their share of the net income should be a non-assessable receipt. Whilst s99B ITAA36 would seem

to be capable of assessing such an amount, there is no evidence publicly available of the Commissioner adopting

that approach.

For example: if a trustee was empowered to classify capital receipts as capital or income for trust purposes and

that resulted in, say:

Trust income .......... $60,000

Taxable income ...... $50,000

it would be expected that beneficiaries presently entitled to the trust income would be assessed on only $50,000

even though the amount received was $60,000.

The same outcome should arise where timing differences arising in a trading trust resulted in trust income

exceeding taxable income in a particular year.

A different outcome may arise if accumulated income is distributed by a non-resident trust to a resident

beneficiary. Refer: ATO ID 2004/66.

In the case of a fixed trust, consideration must be given to CGT event E4. See page 47 for a detailed analysis.

Non-resident beneficiaries

Where a beneficiary that is presently entitled to a share of the income of the trust estate is a non-resident at the

end of the income year, s98(3) operates such that the trustee of the trust is liable to pay tax on the beneficiary’s

share of the trust net income at the beneficiary’s applicable tax rates.

The non-resident beneficiary is not assessable under the primary assessing provisions of s97. However, s98A

assesses the non-resident beneficiary on the part of their share of the net income that comprises Australian

sourced income (less associated deductions). If the non-resident beneficiary was a resident at any time during the

income year, all of their share of the net income attributable to that part of the year is assessable under s98A.

Section 98A(2) allows the non-resident beneficiary to claim a credit for any tax already paid by the trustee on the

income under s98(3). Furthermore, the non-resident beneficiary may claim a refund under s99D for any tax paid

by the trustee on non-Australian sourced income which is not assessable to the beneficiary.

Where a beneficiary that is presently entitled to a share of the trust income is a resident at the end of the year

but had been a non-resident for part of the year, the beneficiary is not assessed under s98A but under s97

instead. The beneficiary is not assessed on non-Australian sourced income attributable to the period of non-

residency. The trustee is not liable for tax in respect of a beneficiary that is a resident by year end.

Note: The withholding tax provisions may apply to certain income.

Present entitlement

The meaning of present entitlement in s97 is not defined. The concept of ‘entitlement’ refers to a beneficiary’s

vested and indefeasible interest in trust income.


To establish a present entitlement, the Courts have held that the trustee must, under the terms of the trust, be

legally required to pay the trust income to the beneficiary, or deal with the trust income on the beneficiary’s

behalf.

A beneficiary may have a present entitlement even though the precise entitlement has not been ascertained

before the end of the year of income, and whether or not the trustee has the funds available for immediate

payment.

Note: In the amending legislation which introduced the streaming provisions the term ‘specifically entitled’

has been adopted when describing the circumstances in which a beneficiary may be assessed on a streamed

capital gain or franked distribution.

For a beneficiary to be ‘specifically entitled’ it is necessary for the relevant trust deed to enable the trustee to

exercise a power to ensure that the beneficiary has received, or can reasonably be expected to receive, the

‘share of the net financial benefit’ referrable to the capital gain or franked distribution.

Establishing present entitlement

A beneficiary’s entitlement to trust income will ultimately depend on the type of trust concerned and the terms

of the trust deed.

In the case of a fixed trust, the trust deed may confer upon beneficiaries an automatic entitlement to trust

income in proportion to their interest in the trust. Alternatively, the trust deed may require some action by the

trustee, such as a resolution to distribute trust income, in order to establish the present entitlement of a

beneficiary.

In the case of a discretionary trust, a beneficiary has no present entitlement to trust income until the trustee

exercises a discretion in the beneficiary’s favour. A final and irrevocable resolution of the trustee to pay, or apply

income for the benefit of a beneficiary, has the effect of vesting the income in the beneficiary.

Deemed present entitlement

Section 95A(2) states that where a beneficiary has a vested and indefeasible interest in the income of a trust, but

is not presently entitled to that income, the beneficiary is deemed to have a present entitlement.

This might occur, for example, where a trust was maintained absolutely for the benefit of a particular beneficiary,

but the trustee was precluded from actually paying monies to, or applying them for the benefit of, the beneficiary

until a stipulated event occurred, eg. reaching a certain age. If the beneficiary was an individual, not under legal

disability, the trustee would be assessed under s98(2).

Time at which present entitlement must be established

A present entitlement to trust income must be established by the end of an income tax year for a beneficiary to

be assessable in respect of that year, unless the deed requires the entitlement to occur at an earlier date.

A beneficiary can have a present entitlement to trust income even though the precise amount has not been

quantified at year end.

The administrative concession provided by the Tax Office which permitted trustee resolutions to be completed

within two months of year-end was withdrawn with effect from the 2011-12 year.


TRUSTEE RESOLUTIONS MUST BE MADE BY 30 JUNE

The Tax Office undertook what they described as an ‘education campaign’ in respect of the 2011-12 year to

highlight the fact that trust distribution resolutions were required by 30 June. The former administrative practice

of allowing trustees up to two months after year-end to effect present entitlements upon beneficiaries was

discontinued.

In addition to the education campaign, the Tax Office conducted a targeted compliance project to test the extent

to which trustee distribution resolutions were completed by 30 June.

The Tax Office have indicated that there will not be a specific compliance project in respect of the 2013-14 year.

There will however, be review as they state

‘… it is expected that officers undertaking other compliance action involving trusts will confirm at an early

stage that relevant trustee resolutions were made by the time required by the deed or by 30 June

(whichever is the later)’.

WARNING: Impact of the Commissioner’s approach on streamed distributions

The legislative amendments which occurred on 29 June 2011 enabled trustees to stream

capital gains and franked dividends to particular trust beneficiaries by making them

‘specifically entitled’. In the case of capital gains the legislation enables the specific

entitlement to be established by 31 August ie. two months after year end.

It is important to note that for a streaming strategy where this occurs (specific entitlement

created by 31 August) to be effective, it is likely that the trustee distribution resolution will

be required by 30 June where the relevant capital gain forms part of trust income. This

appears to be the result which would flow from the approach adopted by the Commissioner

in example 2 of tax determination TD 2012/11.

An example of where this requirement would arise is if the ‘income of the trust estate’ is

defined as being an amount equal to the net income in accordance with s95 ITAA36 and the

trust has derived a taxable capital gain during the year. The capital gain would form part

of trust income.

Note: Where no effective appointment of trust income has occurred by 30 June (or such earlier date as

required by the deed) it is necessary to determine whether there are ‘default beneficiaries’ who may become

presently entitled to the income pursuant to the terms of the trust deed.

Where such present entitlement is established the default beneficiaries will be assessed on the trust income

rather than the trustee under s99A ITAA36. This outcome occurred in the recent case of Kingston and

Commissioner of Taxation (2012) AATA 898.


Streaming trust income

The Tax Laws Amendment (2011 Measure No.5) Bill 2011 amended the tax law to enable a trustee to ‘stream’

capital gains and/or franked distributions, provided the trustee is empowered to do so under the relevant trust

deed and the legislative requirements are satisfied. An Explanatory Memorandum (EM) accompanied the Bill. The

amending provisions apply from the 2010-11 year.

GENERAL OPERATION OF THE LAW

The new provisions will apply where the net income of a trust estate includes a capital gain and/or a franked

distribution.

Whilst trust income is generally determined solely in accordance with Division 6 ITAA36, that will no longer be the

case where capital gains and/or franked distributions are included. From the 2010-11 year, Division 6E ITAA36

applies if the trust has a positive taxable income, and:

i. capital gains (after applying capital losses, discounts if applicable and any small business CGT concessions),

ii. franked distributions (after deducting directly relevant expenses) and/or

iii. franking credits,

are taken into account in working out that taxable income.

As a result of the new provisions assessable distributions received by a beneficiary may now be included in

taxable income pursuant to:

Division 6 (being the Division 6E income ie. exclusive of capital gains and franked distributions),

Subdivision 115-C in respect of capital gains:

- s115-227 (a) where there is specific entitlement to capital gains

- s115-227 (b) for other capital gains

Subdivision 207-B in respect of franked distributions:

- s207-55(4)(a) where there is specific entitlement to franked distributions

- s207-55(4)(b) for other franked distributions

The new provisions do not alter the requirement to adopt the ‘proportionate approach’ to all trust income other

than capital gains and franked distributions for which specific entitlement has been created under the streaming

provisions.


Example

The Green Family Trust derived the following in the 2014-15 year:

Trust income Taxable income

Trading Profit $10,000 $10,000 $10,000

Discount Capital Gain 4,000 4,000 2,000

Franked Dividend 14,000 14,000 14,000

Franking Credits 6,000 0* 6,000

$28,000 $32,000

*applying TR 2012/D1

Applying Division 6E

Trust Taxable income $32,000

Less Capital Gain 2,000

Franked Dividend 14,000

Franking Credits 6,000 22,000

Division 6E Amount $10,000

Trustee Distribution Resolution

Trust income distributed to:

Arnold ..................... 60%

Bill ......................... 40%

(No beneficiary specifically entitled to an amount in respect of the capital gain or franked

dividend)

Beneficiaries assessable amount:

Div 6 Sub div 115-C Sub div 207-B Total

Arnold $6,000 1,200 12,000 19,200

Bill 4,000 800 8,000 12,800

$10,000 2,000 20,000 32,000


The amending legislation introduces the following definitions:

‘Division 6 percentage’ is the share of the income of the trust estate (distributable income) to which a beneficiary

or trustee is presently entitled. The share is expressed as a percentage.

If the income of a trust estate is nil, a beneficiary will have a Division 6 percentage of nil and the trustee will have

a Division 6 percentage of 100%.

‘Adjusted Division 6 percentage’ is the Division 6 percentage of a beneficiary or trustee calculated on the

assumption that the amount of any capital gain or franked distribution to which a beneficiary or trustee is

specifically entitled has been disregarded in working out the income of the trust estate.

Under the amending legislation capital gains are, in effect, transferred from Division 6 ITAA36 to subdivision 115-

C ITAA97 whilst franked distributions are transferred to subdivision 207-B ITAA97.

A streaming strategy can only be adopted where the trustee makes a beneficiary specifically entitled to a share

of the net financial benefit in respect of a capital gain or franked distribution, and:

the beneficiary has received, or can be reasonably expected to receive, the financial benefit

the benefit is referable to the capital gain or franked distribution

it is recorded in its character, as referable to the capital gain or franked distribution in the accounts or

records of the trust (by year end for franked distributions and within two months of year end for capital

gains).

IMPLEMENTING A STREAMED DISTRIBUTION

If a trustee wishes to ‘stream’ some or all of capital gains or franked distributions derived by the trust, the

following requirements must be satisfied:

1. The trust deed must empower the trustee to:

separately account for different classes of income, specifically capital gains and franked distributions,

and

distribute the different classes of income separately to particular beneficiaries.

If consideration is given to amending the trust deed to create a streaming capability, trustees should:

consider the definition of ‘income’ in the deed in light of the views expressed in tax ruling TR 2012/D1,

and

obtain legal advice to confirm that proposed amendments would not result in a resettlement of the

trust.

2. The beneficiaries must be ‘specifically entitled’ to the streamed capital gain and/or franked distribution.

The EM which accompanied the amending legislation confirmed (at paragraph 2.43) that the entitlement

can be created by formula with the exact amounts being determined at a later time.

3. In order to be specifically entitled, the beneficiary:

must receive, or can reasonably be expected to receive, an amount equal to their share of the ‘net

financial benefit’ referable to the capital gain or franked distribution in the trust, and

the entitlement must be recorded in its character as such in the accounts or records of the trust.

The EM which accompanied the Bill comments as follows:

‘A beneficiary has received an amount when, for example, it has been credited or distributed to them

(including under a reinvestment agreement) or paid or applied on their behalf or for their benefit.


A beneficiary can reasonably be expected to receive an amount if, for example, the beneficiary has a

present entitlement to the amount; a vested and indefeasible interest in trust property representing the

amount; or the amount has been set aside exclusively for the beneficiary’.

If a beneficiary’s entitlement has not been physically paid, it should follow that the ‘specifically entitled’

requirements would be satisfied if:

the relevant amount was credited to an account in the beneficiary’s name, or

the amount was credited to an unpaid present entitlement account for the beneficiary.

The term ‘can reasonably be expected to receive’ has been considered by the Commissioner of Taxation in

tax determination TD 2012/11. The determination contemplated a situation where a CGT event occurs prior

to year-end (say, May, when a contract is executed) but the occurrence of a capital gain is not established

until after year-end (say, December, when the contract is settled).

In these circumstances could it then be said, at 30 June, that a beneficiary is reasonably expected to receive

a share of the net financial benefit referable to the capital gain?

The Commissioner confirms that the ‘reasonably expected’ requirements can be satisfied; however this will

be dependent upon the individual circumstances of the case.

4. The ‘share of the net financial benefit’ to which a beneficiary is entitled is that part of the benefit that:

the beneficiary has received or can reasonably be expected to receive,

is referable to the capital gain or franked distribution, and

is recorded ‘in its character as referable to a capital gain or franked distribution in the accounts or

records of the trust’.

The EM indicates that ‘accounts or records of the trust’ would include resolutions and distribution

statements. A record merely for tax purposes (such as a tax return schedule) would not suffice.

5. The capital gain or franked distribution must be recorded in its character as being referable to the capital

gain or franked distribution in the accounts or records of the trust on the following basis.

For a capital gain – no later than two months after year-end,

For a franked distribution – no later than year-end.

6. In relation to franked distributions:

it will not be possible to flow franking credits through a trust if there is no overall trust net income to

which beneficiaries can become entitled,

provided there is overall trust net income to which beneficiaries can become entitled, it will be possible

to flow franking credits through a trust,

it is not possible to stream franking credits separately from franked distributions.


Streaming on a quantum basis

Streaming of capital gains and franked distributions occur on a quantum basis. The EM describes this change in

the law in the following manner:

New law Previous law

Where a beneficiary is specifically entitled to a capital gain included in the trust’s taxable income, that beneficiary is treated as having made a capital gain (or a trustee is assessed and liable to pay tax on their behalf on an equivalent amount).

Net capital gains form part of the trust’s taxable income assessed under Division 6.

In addition, so much of the amount assessed to a beneficiary under Division 6 that is attributable to a capital gain of the trust forms the basis of an extra capital gain taken to be made by that beneficiary under subdivision 115-C.

Capital gains and franked distributions which have been streamed are taken out of Division 6 ITAA36 and taxed in

the hands of the beneficiary on a quantum basis under subdivision 115-C ITAA97 (capital gains) and 207-B ITAA97

(franked distributions) respectively.

A Streaming example (2.22 – 2.24 from EM)

In the 2010-11 year the Coffee Trust has trust income made up of:

Rental income .................................... $100,000

Franked distribution ............................. $70,000

Capital gain (discount) ....................... $300,000

Trust income .................................... $470,000

The trust has a carried forward capital loss of $100,000.

The net (taxable) income of the Coffee Trust is:

Rental income .................................... $100,000

Franked distribution ............................. $70,000

Franking credit ..................................... $30,000

Capital gain ........................................ $100,000

Taxable income ................................ $300,000

The trustee resolves to distribute:

to Anthea ....................... 100% of rental income

to Cameron .......... 100% of franked distribution

to Graeme ........................ 100% of capital gain

Division 6E net income

Taxable income ................................... $300,000

Less Franked distribution .................. ($70,000)

Franking credit .......................... ($30,000)

Capital gain ............................. ($100,000)

Division 6E net income ........................ $100,000


Tax position of beneficiaries

Anthea Cameron Graeme Total

Division 6 s971 $100,000 0 0 $100,000

Subdivision 207-B2 0 $100,000 0 $100,000

Subdivision 115-C3 0 0 $100,000 $100,000

$300,000

1: Division 6E amount: Anthea entitled to 100%

2: Franked distribution including attached franking credits: Cameron entitled to 100%

3: Net capital gain: Graeme entitled to 100%

STREAMING A CAPITAL GAIN

The example which follows outlines the detailed steps involved in applying the streaming provisions where a

capital gain is included in the net income of a trust estate.

Example

Assume the following position for the Frost Family Trust for the year ended 30 June 2015:


Trading profit $100,000 $100,000

Net rental loss $(20,000) $(20,000)

Discount capital gain $200,000 $100,000

$280,000 $180,000

Trustees resolution:

Specific entitlement:

Amy ............................ 50% of capital gain

All other income:

Amy ................................................... 50%

Frost Pty Ltd ...................................... 50%

Implementing the terms of the trustee resolution:


Step 1 – Division 6 percentages

Trust income is $280,000

Div 6 percentage

Amy $100,000 + $50,000 + $40,000 = $190,000 67.85%

Frost Pty Ltd $50,000 + $40,000 = $90,000 32.15%

Step 2 – Adjust: Division 6 percentage adjusted

Capital gains and franked distributions for which specific entitlement has been created are excluded to the extent they

are included in trust taxable income.

Amy $190,000 – $100,000

= 50%

$280,000 – $100,000

Frost Pty Ltd $50,000 + $40,000

= 50%

$180,000

Step 3 – Apply subdivision 115-C

a. Determine each beneficiary’s share of the capital gain

Specific entitlement Unallocated gain Total %

Amy $100,000 $50,000* $150,000 75%

Frost Pty Ltd $0 $50,000* $50,000 25%

$100,000 $100,000 $200,000

*$100,000 x 50% = $50,000

b. Determine each beneficiary’s attributable capital gain

Share of capital gain Taxable capital gain

Amy 75% $75,000

Frost Pty Ltd 25% $25,000

Total $100,000

c. Gross up the capital gain where applicable

Share of capital gain Gross up Total gain

Amy $75,000 $75,000 $150,000

Frost Pty Ltd $25,000 $25,000 $50,000

$100,000 $100,000 $200,000


Step 4 – Assessable amounts Division 6E*

The Division 6E income is $80,000

Division 6E percentages: Amy and Frost Pty Ltd each 50%

Amy ......................... 50% x $80,000 = $40,000

Frost Pty Ltd............ 50% x $80,000 = $40,000

*excludes capital gains and franked distributions

Step 5 – Overall beneficiary’s assessable income

Division 6 (s97) Subdivision 115-C Gross up capital gain Total

Amy $40,000 $75,000 $75,000 $190,000

Frost Pty Ltd $40,000 $25,000 $25,000 $90,000

$80,000 $100,000 $100,000 $280,000

Note: Amy may be eligible to apply the 50% discount to the capital gain distributed from the trust.

Streaming example: Capital Gains and Franked Dividends

Assumptions

The Blue Family Trust reported the following items for the year ended 30 June 2015:

Net rental income $110,000

Discount capital gain $100,000

Franked dividend – ANZ Bank $70,000

Franking credits $30,000

Interest expenses

Loan to acquire ANZ Bank shares $(40,000)

General bank overdraft $(10,000)

The deed of the Blue Family Trust defined ‘income’ for a financial period as being the amount of net income of the trust

calculated in accordance with s95 ITAA36.


In respect of the year ended 30 June 2015 the trustee resolved the following:

Specific entitlement

Ben Blue................................................ 100% of ANZ dividends

Cam Blue ................................. $30,000 of discount capital gain

Remaining

Cam Blue and Dan Blue ................... 60% and 40% respectively

The deed of the Blue Family Trust empowers the trustee to stream classes of income and the resolution of the Blue

trustee satisfies the requirements of the deed.

Trust taxable income


Franked Dividends $70,000

Franking credits $30,000


Interest expenses $(50,000)

$210,000

Application of the streaming rules

Step 1: Determine Division 6 percentages

Trust income


Franked dividends $70,000

Interest costs ($50,000)


$180,000*

*adopting the approach taken in the EM and TR 2012/D1 franking credits

have been excluded from trust income.


Division 6 percentages Trust income Percentage

Ben Blue $30,000 16.67%

Cam Blue $90,000 50.00%

Dan Blue $60,000 33.33%

$180,000 100%

Step 2: Calculate adjusted Division 6 percentages

Trust Income $180,000

Less specific entitlements

Franked dividends ($30,000)*

Capital gain ($30,000)

$120,000

Adjusted Division 6 percentages

Ben Blue $0 0%

Cam Blue $72,000 60%

Dan Blue $48,000 40%

$120,000 100%

*franked dividend net of directly relevant expenses ($40,000)


Step 3: Apply subdivision 115-C

Allocate capital gains for which specific entitlement is created and capital gains allocated on the basis of the beneficiaries

adjusted Division 6 percentages.

Ben Blue Cam Blue Dan Blue Total

Specific entitlement $0 $30,000 $0 $30,000

Adjusted Division 6 Share

(subdivision 115-C) $0 $12,000 $8,000 $20,000

$0 $42,000 $8,000 $50,000

Step 4: Apply subdivision 207-B

Allocate franked dividends for which specific entitlement is created and franked dividends allocated on the basis of the

beneficiaries adjusted Division 6 percentages.

Ben Blue

Specific entitlement $30,000 (100%)

Step 5: Calculate assessable amounts arising under Division 6E

The Division 6E amount is the trust income reduced by capital gains and franked dividends.

Trust income $180,000

Less

Capital gains ($50,000)

Franked dividends ($30,000)

$100,000

Share of Division 6E income

Cam Blue $60,000 60%

Dan Blue $40,000 40%

$100,000 100%

The assessable amount arising under Division 6E will be assessable to beneficiaries under s97 of Division 6 ITAA36.


Step 6: Overall position

Ben Blue Cam Blue Dan Blue Total

Division 6 $0 $60,000 $40,000 $100,000

Subdivision 115-C $0 $42,000 $8,000 $50,000

Subdivision 207-B $30,000 $0 $0 $30,000

Trust income $30,000 $102,000 $48,000 $180,000

Franking credits $30,000 $0 $0 $30,000

Taxable income $60,000 $102,000 $48,000 $210,000

FACTORS WHICH MAY IMPACT THE STREAMING OF INCOME DISTRIBUTIONS

1. No ‘net financial benefit’ in the trust

One of the legislative requirements for a capital gain or franked distribution to be streamed, is that there must be

a net financial benefit which is referable to the capital gain or franked distribution. Therefore, it will not be

possible to stream distributions in circumstances such as where:

a. a capital gain has arisen as a result of the application of the market value substitution rule, or

b. the gross benefit has been reduced to zero by losses (in the case of capital gains) or directly relevant

expenses (in the case of franked distributions).

Example 1

Assume the following position for the Burns Family Trust for the year ended 30 June 2015.



Franked dividend $7,000 $7,000

Interest paid* ($7,000) ($7,000)

Franking credit $0 $3,000

$50,000 $53,000

*loan funds applied to acquisition of the shares which paid the franked dividend.


The trustee cannot stream the franked dividend as the directly relevant expenses ($7,000) reduce the amount of the

dividend to zero and therefore no net financial benefit can arise in respect of the franked distribution.

The trustee resolves that the income of the trust will be distributed:

Kathy ....................... 60%

Kenny ...................... 40%

The Division 6 percentages are therefore 60% (Kathy) and 40% (Kenny). As no specific entitlement has been created,

the adjusted Division 6 percentages will be the same.

Determine Division 6E amounts

Kathy 60% ......... $30,000

Kenny 40% ....... $20,000

$50,000

Outcome for beneficiaries

Division 6

(s97)

Franked

dividend

Franking

credit

Total

assessable

Kathy 60% $30,000 $0 $1,800 $31,800

Kenny 40% $20,000 $0 $1,200 $21,200

$53,000

Important: although there is no net dividend income, the franking credits can be distributed due to there

being overall trust net income.

Example 2

Assume the following position for the Barton Family Trust for the year ended 30 June 2015:



Capital gain $20,000

Capital loss from prior year $(30,000)

The capital gain arising during the 2014-15 year could not be streamed as no net financial benefit remains after the

application of an offsetting capital loss.

2. Rateable reduction

Capital gains and franked distributions are streamed on a quantum basis which could result in beneficiaries being

subject to tax on amounts greater than the taxable income of the trust. In these circumstances a rateable

reduction of the taxable amount occurs.

The rateable reduction would have application where the aggregate of net capital gains and total franked

distributions (net of directly relevant expenses) exceeds the taxable income of the trust (excluding franking

credits).


Example

Assume a trust derived the following:

Royalty income .......................... $5,000

Franked distribution ................... $7,000

Franking credits ......................... $3,000

Trading loss ........................... ($10,000)

Taxable income .......................... $5,000

The trustee resolves to distribute 100% of franked distributions to Kathy and 100% of remaining income to Kenny.

Beneficiaries’ position

Kathy – entitlement .................... $7,000 franked distribution

$3,000 franking credits

Trust taxable income .............. $5,000

If Kathy was assessed on the streamed distribution of $7,000, it would exceed the taxable income of the trust.

Rateable reduction formula

Trust taxable income (excl. franking credits)

Net capital gain + net franked distribution

$2,000 = 0.2857

0 + $7,000

Beneficiaries’ tax outcome

Kathy

Franked distribution: $7,000 x 0.2857 ................... $2,000

Franking credits .................................................... $3,000

Taxable Income ................................................... $5,000

The rateable reduction formula is designed to enable beneficiaries to retain franking credits notwithstanding a

reduction in the assessable franked distribution.

3. Directly relevant expenses

It is necessary that expenditure directly relevant to the derivation of franked distributions be deducted from

those distributions for the purposes of the streaming provisions (s207-37 ITAA97).

New s102UW ITAA36, which determines when Division 6E will have application, requires franked distributions to

be taken into account ‘... to the extent that an amount of the franked distribution remained after reducing it by

deductions that were directly relevant to it’.

The EM at 2.56 indicates that ‘it is not possible to stream tax amounts to beneficiaries where there is no referable

net financial benefit remaining in the trust – such as when the gross benefit has been reduced to zero by losses or

directly relevant expenses’.

It will be necessary for taxpayers to exercise judgement in order to determine when expenses are ‘directly

relevant’. The legislation contains no guidance in this regard. Common examples of expenses which might be

‘directly relevant’ would include interest on borrowings used to acquire securities and portfolio management

fees. There is no requirement to apportion expenses which are not directly relevant to the franked distribution.


TRUSTEE MAY CHOOSE TO BECOME SPECIFICALLY ENTITLED TO A CAPITAL GAIN

Amendments to s115-230 ITAA97 which apply from the 2010-11 year enable a trustee to make a choice to be

assessed on a capital gain provided:

the capital gain was taken into account in working out the net capital gain of the trust for an income

year, and

trust property representing all or part of that capital gain has not been paid to or applied for the benefit

of a beneficiary of the trust by the end of two months after the end of the income year.

Adoption of this approach would result in the trustee being assessed rather than:

i. an income beneficiary who cannot benefit from the gain, or

ii. a capital beneficiary who is unable to immediately benefit from the gain.

The trustee would be treated as being specifically entitled to the capital gain and assessed under s99A ITAA36 or

s99 ITAA36 if the Commissioner of Taxation considered it was unreasonable to apply s99A.

A choice of this type was previously only available to the trustee of a testamentary trust.

ANTI AVOIDANCE PROVISIONS

The new s100AA or s100AB ITAA36 applies where:

an exempt entity is made presently entitled to income of a trust estate but has not been notified of their present entitlement within two months of the end of the income year (s100AA), or

where an exempt entity is presently entitled to income of a trust estate and the exempt entity’s ‘adjusted Division 6 percentage’ of the income of the trust estate exceeds the ‘benchmark percentage’ established under subsection 100AB(3).

Where s100AA applies, the distribution to the exempt entity is deemed not to have occurred.

Where s100AB has application, the ‘excess’ (see the example which follows) is deemed not to have been

distributed.


Example

Assume the XYZ Trust derived net rental income of $60.000 and a capital gain of $10,000 (no discount)

Trust income ..................................... $60,000

Taxable income ................................. $70,000

Pursuant to a discretion contained in the trust deed, the trustee resolves to treat $55,000 of the rent receipts as being on

capital account.

Trust income becomes ......................... $5,000

Taxable income remains ................... $70,000

The trustee resolves to distribute:

100% of capital to Jethro ............... ($65,000)

100% of income to the Red Cross ... ($5,000)

Exempt entity (Red Cross):

Adjusted Division 6% ............................ 100%

Benchmark %

$5,000* = 8.33%

$60,000**

* actual entitlement

**net (taxable) income after excluding capital gains and/or franked distributions to which beneficiaries are specifically

entitled.

The excess of the adjusted Division 6 percentage amount over the benchmark percentage amount will be considered not

to have been the subject of an effective distribution and therefore the trustee will be assessed pursuant to s99A ITAA36.


Sample Trustee Resolution (includes streaming)

TRUSTEE: Name

CAPACITY: The company is acting in its capacity as trustee of (name of trust)

Minutes of meeting of directors held on day of …………………………………………….

PRESENT:

DETERMINATION OF

TRUST INCOME: RESOLVED that income of the trust estate for the year ended 30 June ….. be determined in

accordance with clause ………… of the trust deed as follows:

an amount equal to the net income of the trust estate as defined in s95(1) ITAA

1936, or

an amount calculated after taking into account discretions exercised by the

trustee –

- to include all realised capital gains in the income of the trust estate

- to recoup capital losses of prior years against current year capital gains and

include the net amount in the income of the trust estate

- (include other relevant terms), or

(include other relevant terms)

APPOINTMENT OF

TRUST INCOME: RESOLVED that income of the trust estate for the year ended 30 June ……. be appointed to

the beneficiaries in the proportions and with the tax attributes as follows:

1. Specific entitlement to capital gains:

Pursuant to the powers conferred on the trustee by clause ………of the trust deed, in respect of the capital gain arising from the sale of BHP Billiton Ltd shares during the year ended 30 June…….., the following beneficiaries are in respect of the capital gain specifically entitled to the share indicated and each beneficiary has an equivalent share of the ‘net financial benefit’ that is referable to the capital gain:

50% to Beneficiary A

50% to Beneficiary B

Further, that the relevant amounts will be set aside in the trust records for the absolute benefit of each beneficiary.

Further, that this resolution records the character of the amount attributable to each beneficiary as being referable to the capital gain.

2. Specific entitlement to franked dividends:

Pursuant to the powers conferred on the trustee by clause ….. of the trust deed, in respect of franked dividends received during the year ended 30 June……, the following beneficiaries are in respect of the franked dividends specifically entitled to the share indicated and each beneficiary has an equivalent share of the ‘net financial benefit’ that is referrable to the franked dividends:

50% to Beneficiary C

50% to Beneficiary D

Further, that the relevant amounts will be set aside in the trust records for the absolute benefit of each beneficiary.

Further, that this resolution records the character of the amount attributable to each beneficiary as being referable to the franked dividends.

3. Other income of the trust:


Pursuant to the powers conferred on the trustee by clause ….. of the trust deed, the income of the trust estate for the year ended 30 June (other than capital gains and franked dividends previously appointed) is appointed as follows:

50% to Beneficiary E

50% to Beneficiary F

Further, that the amounts so appointed (less any amounts previously paid to or applied for the benefit of a beneficiary) be credited to or set aside for the benefit of the beneficiary in the books of account of the trust.

CLOSURE: There being no further business the meeting was closed.

……………………………………………………………..

Chairman

Important

1. When framing a distribution resolution it is imperative that the requirements of the particular deed are

followed, which may mean that the approach adopted in the sample resolution requires modification.


Sample Trustee Resolution (no streaming)

TRUSTEE: Name

CAPACITY: The company is acting in its capacity as trustee of (name of trust)

Minutes of meeting of directors held on day of …………………………………………….

PRESENT:

DETERMINATION OF

TRUST INCOME: RESOLVED that income of the trust estate for the year ended 30 June ….. be determined in

accordance with clause ………… of the trust deed as follows:

an amount equal to the net income of the trust estate as defined in s95(1) ITAA

1936, or

all amounts determined by the trustee to be income of the trust estate (including

realised capital gains), or

- (include other relevant terms), or

(include other relevant terms)

APPOINTMENT OF

TRUST INCOME: RESOLVED that income of the trust estate for the year ended 30 June ……. be appointed to

the beneficiaries in the proportions and with the tax attributes as follows:

Pursuant to the powers conferred on the trustee by clause …… of the trust deed, the income of the trust estate for the year is appointed as follows:

50% to Beneficiary X

50% to Beneficiary Y

Further, that the amounts so appointed (less any amounts previously paid to or applied for the benefit of the beneficiary) be credited to or set aside for the benefit of the beneficiary in the books of account of the trust.

CLOSURE: There being no further business the meeting was closed.

……………………………………………………………..

Chairman

Important

1. When framing a distribution resolution it is imperative that the requirements of the particular deed are

followed, which may mean that the approach adopted in the sample resolution requires modification.


Alternative forms of identifying beneficiaries proportionate entitlements:

1. Specific entitlement to capital gains

the first $10,000 to Beneficiary A

the balance (if any) to Beneficiary B

2. Specific entitlement to franked dividends

the first $10,000 to Beneficiary C

the next $10,000 to Beneficiary D

the balance (if any) to XYZ Pty Ltd

3. Other income of the trust

the first $416 to Beneficiary E*

the next $416 to Beneficiary F*

the balance (if any) in the following proportions:

- 50% to Beneficiary G

- 50% to Beneficiary H

*where net (taxable) income of the trust exceeded trust income, the taxable amount for the beneficiary would exceed $416.

Note: It is unclear whether an alternative style of resolution might result in a beneficiary’s share of net

(taxable) income being capped.

A resolution which arguably would achieve this objective is:

Trustee resolution

To pay to or apply for the benefit of (name of Minor Beneficiary) that proportion of the income of

the trust estate which when that proportion is applied to the net (taxable) income of the trust

calculated in accordance with s95 ITAA36 produces an amount of $416.

There is no authority at this time which would indicate the effectiveness or otherwise of such a resolution.


WHAT IF NET (TAXABLE) INCOME OF THE TRUST IS SUBSEQUENTLY INCREASED?

The Commissioner of Taxation has considered this question in tax determination TD2012/22. The examples

contained in the determination indicate that the outcome of a subsequent increase in the taxable income of a

trust will be impacted by:

i. how ‘income of the trust estate’ is determined

ii. whether the trust deed contains default beneficiaries who would become presently entitled to income in

the event the trustee fails to appoint trust income for the year in accordance with the deed, and

iii. the style of income distribution resolution adopted by the trustee

The examples which follow have been extracted from TD 2012/22.

Example 1

Assumptions

Income of the Riverdale Family Trust is defined as being the same as net (taxable) income

Year ended 30 June 2012

- net (taxable) income $120,000

Trustee resolution

- distribute $40,000 to each of Ann, Ben and Cy

Subsequent increase in net (taxable) income to $129,000

Outcome

Ann, Ben and Cy each assessed on $40,000

Trustee assessed under s99A on $9,000

Example 2

Assumptions

The same as for Example 1 except that the deed provides that, if the trustee fails to appoint trust income, it is taken to be

appointed for particular default beneficiaries

Outcome

Ann, Ben and Cy each assessed on $40,000

Default beneficiaries assessed on $9,000

Note: if the trustee had included a ‘balance’ beneficiary in the resolution, that beneficiary would be assessed on $9,000

(Example 3).

Example 4

Assumptions

The same as for Example 1 except that the trustee resolved to distribute 1/3 of trust income to each of Ann, Ben and Cy

Outcome

Each beneficiary would be assessed on $43,000 being 1/3 of trust net (taxable) income of $129,000


Example 5

Assumptions

Income of the Farmer Trust is defined to be the amount determined by the trustee, or if no determination is made,

the net (taxable) income

The trustee determined the trust income for the year to be $120,000

Trustee resolution

- distribute $40,000 to each of Ed, Fred and Greg

It was subsequently determined that the net (taxable) income was $129,000 as the trustee had failed to include an

amount of $9,000 in assessable income

The trustee’s determination that the trust income was $120,000 had the effect of fixing the income as that amount

Outcome

Each beneficiary is entitled to 1/3 of the income of the trust

Each beneficiary is therefore assessable on 1/3 of trust net (taxable) income ie. $43,000

Example 6

Assumptions

The deed of the Surrey Trust equates income of the trust with s95 net (taxable) income unless the trustee

determines otherwise

The trust income tax return for the 2011 year disclosed net (taxable) income of $100,000 which was also the trust

income

Trustee resolution

- 50% to each of Daisy and Rose, any subsequent additional income to be distributed to Bouquet Pty Ltd

The net (taxable) income was subsequently found to be $120,000 (which also became the revised income of the

trust)

Outcome

All of the trust income has been allocated to Daisy and Rose and therefore under the proportionate approach each would

be assessed on $60,000 (50% of $120,000)

No amount would be assessed to Bouquet Pty Ltd

Example 9

Assumptions

Income of the Bus Family Trust is not defined under the deed and therefore takes its ordinary trust law meaning

Income for the 2011 year was determined to be $100,000 which was also the net (taxable) income

Trustee resolution

- the first $30,000 to Cane

- the next $30,000 to Alex

- the balance (if any) to Russ

The beneficiaries were assessed on $30,000 (Cane), $30,000 (Alex) and $40,000 (Russ)

The trustee subsequently determined that net (taxable) income should have been $110,000


Outcome

The net income of the trust is $100,000 and the net (taxable) income is $110,000

The assessable amount for each beneficiary is therefore:

Cane $30,000 x 110,000 = $33,000

100,000

Alex $30,000 x 110,000 = $33,000

100,000

Russ $40,000 x 110,000 = $44,000

100,000

Example 11

Assumptions

The deed of the Walnut Trust defines ‘income’ to be the s95 net (taxable) income unless the trustee determines

otherwise and allows the trustee to stream classes of income

For the 2011 year, the trustee received

- Franked dividends.......... $70,000

- Franking credits ............. $30,000

- Interest income .............. $50,000

The trustee determined the income of the trust estate to be net (taxable) income as defined in s95 less franking

credits

Trustee resolution

- Franked dividends

Pecan Pty Ltd................. 100%

- Other income

Pecan Pty Ltd.............. $20,000

Laura ........................... Balance

It was subsequently determined that interest income was understated by $10,000 and therefore net (taxable)

income was $160,000

Trust income was therefore $130,000 ($160,000 less $30,000 franking credits)

Outcome

Assessable s97 ITAA36

Pecan Pty Ltd

$20,000 x 60,0002 = $20,000

60,0001

Laura

$40,000 x 60,0002 = $40,000

60,0001

1: trust income ($130,000) less franked dividends ($70,000)

2: net (taxable) income ($160,000) less franked dividends ($70,000) and franking credits ($30,000)

Assessable subdivision 207-B ITAA97

Pecan Pty Ltd

100% of franked dividends and franking credits: $100,000


COMMENT:

When considering the potential impact of a subsequent increase in trust taxable income,

a trustee should review such things as:

Whether there are default beneficiaries who would become presently entitled to trust

income in the absence of an effective appointment of income by the trustee

- who are the default beneficiaries and what are the implications of them

becoming presently entitled?

The definition of ‘income of the trust estate’

- if trust taxable income changes due to the denial of deductions or the inclusion

of omitted income, will trust income change?

A desire to cap the amount of trust income upon which a beneficiary may be assessed

- minor beneficiaries – up to $416;

- other beneficiaries – avoiding a move to the next higher marginal tax rate

Whether to frame the income distribution resolution in percentage or dollar amounts

- compare the outcomes in examples 5 & 7 in TD 2012/22.


TRUST INCOME INCLUDES ITEMS SUBJECT TO WITHHOLDING TAX?

If dividends, interest or royalties form part of trust income which is distributed to a non-resident beneficiary, the

withholding tax provisions become operative.

Once income has been subjected to withholding tax it will be excluded from assessable income (s128D ITAA36),

becoming non-assessable non-exempt income (NANE). What then is the effect of s128D on the operation of

Division 6 ITAA36?

The minutes of the NTLG trust subgroup meeting of 18 September 2012 state the following:

‘….. section 128D provides that income upon which withholding tax is payable (or on which such tax would

be payable but for certain exclusions) is non-assessable non-exempt income (NANE) ‘of a person’.

Where, in accordance with a power in the deed, the trustee specifically makes a non-resident beneficiary

presently entitled to interest income that has formed part of the income of the trust estate, subsection

128A(3) will apply to deem the non-resident beneficiary to have derived income consisting of that interest.

Similarly in relation to dividends and royalties.

Taxation Ruling IT2680 confirms this approach.

While section 128D will apply to make the income which has been subject to withholding tax NANE of a

person, it is far from clear what follows from this in a Division 6 context.’

‘The High Court in Bamford (2010) HCA10 has confirmed that Division 6 operates on a proportional basis

……… A remaining issue, that is yet to receive judicial consideration, is how the proportional operation of

Division 6 interacts with the Division 11A/Schedule 12-F withholding tax provisions, which by contrast to

Division 6 apply on a quantum basis.’

The Tax Office went on to state that ‘consistent with ATO IDs 2002/93 and 2002/94 a non-resident beneficiary

entitled to such income that is subject to withholding may be taken to have NANE income.’

The Tax Office did not provide any useful guidance as to how the tension between Division 6 and the withholding

tax provisions would be dealt with administratively in the absence of judicial consideration.

Recoupment of past losses

Based on the decision of the English courts in Upton v Brown (1884), losses in one year must generally be

recouped out of profits of later years and not out of the capital of the trust, in order to preserve the trust

property for the benefit of any capital beneficiaries.

In Raftland v FCT (2008) HCA 21, the High Court held that the rule in Upton v Brown does not apply where there is

only one person capable of benefiting under a trust, or if all the beneficiaries have the same interest in the

income and capital of the trust. It was the High Court’s view that the general rule in Upton v Brown applies only

where there are separate income and capital beneficiaries.

The Decision Impact Statement on Raftland issued by the Commissioner on 24 October 2008, might be

summarised as follows:

Losses incurred by a trust must be recouped out of future profits, except where:

the deed directs the trustee to recoup losses from capital, or empowers the trustee to do so and the

trustee exercises that power

all beneficiaries under the trust have the same rights and interests in respect of income and capital, or

there is a single beneficiary of the trust.


Example: The ABC Trust

Application of the principle (losses recouped out of future profits)

Trust income1 Taxable income

2013 year ($18,000) $10,0002

2014 year $10,000 $9,0002

Prior year loss ($18,000)

Loss carried forward to 2015 ($8,000)

1: ‘Income’ defined in the relevant trust deed as being income according to ordinary concepts.

2: As there is no trust income for the 2013 or 2014 years, in each case the taxable income could

not be distributed and therefore the trustee would be assessed under s99A unless capital

gains or franked dividends are included in the taxable incomes, in which case it may be

possible to effect a distribution under the streaming provisions introduced in the 2010-11 year.

Alternative scenario

Assume the trust deed of the ABC Trust directed the trustee to recoup losses from trust capital. In these circumstances

the position would be:

2015 year

Trust income............... $10,000

Taxable income ............ $9,000

Beneficiaries presently entitled to trust income would include $9,000 in their assessable income for the 2013 year.

2014 year losses

Recouped from trust capital in accordance with the deed.


Distributions when there is no trust income

Where there is no ‘income of the trust estate’, no distribution to beneficiaries can occur pursuant to Division 6

ITAA36 as the trustee is required to:

firstly determine the proportionate share of trust income to which a beneficiary is presently entitled,

and

then, apply that proportion to the taxable income.

Where there is no ‘trust income’, there is no proportion which can be determined to be applied in respect of the

taxable income.

Any taxable income would be assessed to the trustee under either s99A or s99.

Example

Trust income for the year ........................... ($10,000)

Less provision for doubtful debts ................... $15,000

Taxable income ................................................ $5,000

If trust ‘income’ pursuant to the deed is, for example, income according to ordinary concepts, the taxable amount of

$5,000 cannot be distributed and would therefore be assessed to the trustee.

If trust ‘income’ is defined as being the amount of taxable income, it should follow that a distribution to beneficiaries may

occur (subject to the possible application of TR 2012/D1).

Note: From the 2010-11 year capital gains and franked distributions can be

‘streamed’ where they are included in the net (taxable) income of a trust.

It is not necessary that there be an amount of trust income where the streaming

provisions are applied.


Trustee distribution checklist

Some or all of the matters listed below may require consideration by the trustee when determining the basis

upon which income is to be distributed and the resolution to be drafted. Individual circumstances may require

other considerations to be taken into account.

Year ended 30 June 2014 and subsequent years

Issue Comments

1. Definition of ‘income’ in

the trust deed

How is income defined?

Is there no definition of income?

Are there discretions available to the trustee as to how

income and capital items should be treated?

If so, what is required in order to effect an exercise in

discretion?

What is the effect of TR 2012/D1?

2. Implementing the

distribution

What are the requirements of the deed to create present

entitlement?

3. Identification of

beneficiaries

Are there different classes of beneficiary?

Characteristics of the beneficiaries which may impact the

distribution eg. minors, non-residents.

4. Streaming of some or all

of the distribution

Is it intended that classes of income be streamed?

Does the deed confer that power on the trustee?

If not, should an amendment to the deed be considered to

grant such a power?

Will the specific requirements of the tax law be satisfied?

5. Do franked dividends

form part of the trust

income?

Can franking credits be ‘distributed’?

Which beneficiaries can best utilise franking credits?

Will the specific requirements of the tax law be satisfied?

6. Do capital gains form

part of the trust income?

Review definition of ‘income’ in the deed

7. Is there trust income? If the trust income may be nil, are there any steps which

could be taken to appropriately classify other amounts as

income so that a distribution can occur (thereby avoiding


Issue Comments

the operation of s99A)

8. Accumulation of income Does the trust deed allow income to be accumulated and,

if so, are there circumstances which may warrant

accumulating some or all of the income?

9. Trust losses Does the trust have prior year losses and, if so, must they

be recouped out of income?

Will the trust satisfy the loss recoupment rules in Schedule

2F ITAA36?

10. CGT concessions How can distributions be made to maximise the benefit

obtained from CGT concessions?

Are particular distributions required to ensure that:

a beneficiary is a ‘controller’ of the trust, or

a CGT concession stakeholder?

11. Corporate beneficiary If a distribution is made to a corporate beneficiary, will

there be Division 7A implications? Consider the

implications of

TR 2010/3 and PS LA 2010/4.

Are there any unpaid present entitlements in respect of

prior years which have been formally converted into loans?

12. Family trust Has a Family Trust Election (FTE) been made?

Is an FTE required?

13. Interim distributions Have interim distributions occurred during the year?

If so, ensure that the year-end distribution resolution is

appropriately worded to reflect the earlier distribution

14. Beneficiaries TFN

provided to the trustee

Ensure that beneficiaries in receipt of a distribution for the

first time have provided their TFN to the trustee by the

time of the distribution

15. Trustee resolution Has it been completed by 30 June (or such earlier date as is

required by the deed)?

16. Further resolution? Is any subsequent action required by the trustee to


Issue Comments

confirm resolutions in relation to income distributions?

17. The trustee distributes

an asset in specie to

satisfy a beneficiary’s

entitlement to income

or capital

If the trust is registered for GST will a liability arise?

(refer to GSTD 2009/1).


CGT events relating to trusts

For the purposes of calculating s95 net income, a trust estate is subject to the CGT rules; for example, a sale of

land may give rise to a taxable capital gain under CGT event A1. However, beneficiaries and other third parties

may also be subject to the CGT regime in relation to trusts pursuant to nine CGT events. These CGT events are

summarised in the following table:

CGT event What gives rise to the event Taxpayer to whom

the event occurs

E1 Creating a

trust over a CGT

asset

Creating a trust over a CGT asset by

declaration or settlement Settlor

E2 Transferring

a CGT asset to a

trust

Transfer a CGT asset into a trust Transferor

E3 Converting a

trust to a unit

trust

A trust that is not a unit trust is converted

into a unit trust and just before the

conversion, a beneficiary was absolutely

entitled to a CGT asset of the trust

Beneficiary that was

absolutely entitled

to the CGT asset

E4 Capital

payment for

trust interest

Receiving an amount (in cash or in kind) in

respect of the unit or interest in the trust and

the amount is not otherwise assessable

income

The holder of the

unit or interest in

the trust that

receives the non-

assessable amount

E5 Beneficiary

becoming

entitled to a

trust asset

Beneficiary becomes absolutely entitled to a

CGT asset of a trust, other than a unit trust or

a trust subject to Division 128 (relating to

death)

Trustee

Beneficiary

E6 Disposal to

beneficiary to

end income

right

Beneficiary receives a CGT asset of a trust,

other than a unit trust or a trust subject to

Division 128 (relating to death), from its

trustee in satisfaction of a right to receive net

income of the trust

Trustee

Beneficiary

E7 Disposal to

beneficiary to

end capital

right

Beneficiary receives a CGT asset of a trust,

other than a unit trust or a trust subject to

Division 128 (relating to death), from its

trustee in satisfaction of a right to receive

Trustee

Beneficiary


CGT event What gives rise to the event Taxpayer to whom

the event occurs

capital of the trust

E8 Disposal by

beneficiary of

capital interest

Beneficiary of a trust, other than a unit trust

or a trust subject to Division 128 (relating to

death), disposes of an interest in trust capital

Does not apply if the beneficiary provided

consideration for the interest or acquired the

interest by assignment

Beneficiary

E9 Creating a

trust over

future property

A person agrees, for consideration, to hold

property on trust when that property comes

into existence and no potential beneficiary

has a beneficial interest in the rights created

by this agreement

The future trustee

Resettlements: CGT Event E1

It is clear that a mere change of trustee will not trigger a CGT event. Further the Tax Office have expressed the

view that CGT Event 1 will not occur if the terms of a trust are changed pursuant to a power granted under the

deed unless the change is sufficient to conclude that a new set of rights and obligations have been created. Refer

TD 2012/21.

The document which previously outlined the Commissioner’s views in relation to resettlements, Creation of a new

trust – statement of principles August 2001, has been withdrawn.

Following the decision of the Federal Court in the case of FCT v Clark it can be concluded that a key factor in

determining whether a resettlement has occurred is continuity of the trust, determined by ‘the constitution of the

trusts under which the fund (if a trust fund) operated, the trust property and membership’.

Legal advice should always be obtained prior to the amendment of a trust deed in order to ensure that a

resettlement does not occur.


Distributions of non-assessable amounts – CGT Event E4

The distribution of a non-assessable amount by a trustee to a beneficiary may have CGT implications. CGT event

E4 will occur if:

a payment is made to a beneficiary in respect of their interest in the trust, and

some or all of the amount is non-assessable to the beneficiary,

unless the non-assessable amount is excluded by s104.71.

CGT event E4 may occur when non-assessable receipts arise from the distribution by a trustee of amounts

representing such things as:

an excess of trust income over trust net (taxable) income

frozen CGT indexation

the 50% Active Asset reduction in the CGT Small Business concessions (Division 152 ITAA97)

Division 43 ITAA97 building allowance deductions, or

a deduction claimed under Division 41 ITAA97 (the business ‘tax break’ additional deduction) in respect

of a new depreciating asset.

Note: For the purposes of CGT event E4 the term ‘payment’ would include the crediting of an amount by the

trustee in favour of the beneficiary.

Interest in a trust

For CGT event E4 to occur, a distribution must be made in respect of a beneficiary’s ‘interest’ in a trust (typically a

unit holding). The Tax Office considers that, for the purposes of CGT event E4, an ‘interest’ in a trust is effectively

an investment, in that it can be purchased or assigned (TD 2003/28).

CGT event E4 will not apply to a discretionary trust as a beneficiary’s potential entitlement under a discretionary

trust is not one in which another person can invest – it is a mere expectancy and cannot generally be purchased

or assigned. A different outcome may occur if a part of a trust was fixed (with the balance non-fixed) and the

payment of a non-assessable amount occurs in respect of the fixed portion of the trust.

Non-assessable payment

CGT event E4 requires a ‘payment’ to be made in respect of the unit or trust interest, which includes the giving of

property or the creating of an amount which may be paid at a later date. The CGT event is generally taken to

occur just before the end of the year in which the trustee makes the payment.


Whilst the general rule is that non-assessable payments will reduce the cost base, certain non-assessable

amounts are disregarded for the purposes of CGT event E4. Examples include:

Amounts which reduce cost base

Amounts which do not reduce cost base (refer:

s104-71 ITAA97)

the 50% active asset reduction

(Division 152 ITAA97)

amortisation reserves (Division 43

ITAA97)

the excess of accounting net profit over

taxable income (subject to the excess

being attributable to an amount which

is excluded by s104-71)

the 50% CGT discount

the 15-year small business CGT concession

non-assessable non-exempt income*

an amount that has been assessed to the trustee

an amount that is PSI included in the beneficiary’s

or another entity’s assessable income under the

PSI rules

an amount repaid by the beneficiary, or

compensation the beneficiary paid that can

reasonably be regarded as a repayment of all or

part of the trustee payment.

* The list of non-assessable non-exempt items in s11-55 ITAA97 includes small business CGT

retirement exemption payments to CGT concession stakeholders.

Calculation of capital gain: CGT event E4

If the non-assessable part of the distribution is less than the beneficiary’s cost base in its interest in the trust, CGT

event E4 reduces the cost base of the interest to the extent of the non-assessable part.

If the non-assessable part of the distribution is greater than the beneficiary’s cost base in its interest in the trust,

CGT event E4 will reduce the cost base of the interest to nil and the beneficiary will make a capital gain in respect

of the excess of the non-assessable distribution over the cost base of the interest.

However, the beneficiary may be able to apply the CGT discount and the CGT small business concessions to the

capital gain (if applicable) arising under CGT event E4 if they qualify to do so under the relevant legislation.


Example 1

Unit trust

Trust income ...................................... $200,000 (includes a capital gain)

50% CGT discount ............................. ($60,000)

50% Active asset reduction ................ ($30,000)

Trust net (taxable) income ................. $110,000

Unit holder

Non-assessable amount received .........$30,000 (active asset reduction)

Cost base in units (say) ....................... $10,000

Capital gain: Event E4 ......................... $20,000

In these circumstances the units remain a CGT asset of the taxpayer, with a nil cost base.

Any subsequent receipts of non-assessable amount which are not excluded by s104-71 would result in further capital

gains.

Example 2

ABC Unit Trust

2013-14 year

Net trading profit* ............................... $100,000

includes provision for doubtful debts .... $10,000

Taxable income .................................. $110,000

*income of the trust per the deed

Distribution to unit holder ................... $100,000

Unit holder taxable amount ................ $110,000

2014-15 year

Net trading profit ................................ $150,000

Less bad debt written off ...................... $10,000

Taxable income.................................. $140,000

Distribution to unit holder ................... $150,000

Unit holder taxable amount ................ $140,000

Unit holder

2014-15 year

Non-assessable amount ...................... $10,000

Cost base in units (say) ......................... $1,000

Capital gain: Event E4 ........................... $9,000

The units remain a CGT asset with a nil cost base

Any subsequent receipts of a non-assessable amount which are not excluded by s104-71 would result in further

capital gains


VESTING TRUSTS

In some situations it may be necessary for a trustee to exercise a power to vest the trust. When a trust vests,

assets of the trust can either be liquidated and cash proceeds distributed to the beneficiaries or alternatively, the

assets are directly distributed to the beneficiaries as an ‘in-specie’ distribution.

Key considerations

When voluntarily vesting a trust, some key practical and tax considerations that trustees and advisers should be

mindful of include:

i. Review the trust deed

It would be necessary to review the trust deed to ensure that the deed confers the trustee with a discretion

to vest the trust. Most trust deeds should provide the trustee with such a power, although the agreement of

all beneficiaries might be necessary.

ii. Establish the wind-up process

This process of vesting a trust is typically achieved by:

liquidating the assets of the trust, settling all liabilities and making a cash distribution, or

settling liabilities and distributing the assets of the trust to the beneficiaries in-specie.

As is the case with the process of winding-up a company, it is crucial that the trustee reviews the trust’s

balance sheet and maps out the steps in relation to how the assets and liabilities of the trust are to be dealt.

There are some circumstances where it may not be possible for a trustee to choose the option of making an

in-specie distribution to a beneficiary.

Consider the following scenario:

Example

The trustee of the Wilson Trust intends to make an in-specie distribution of property to Beneficiary A. The balance sheet

at that time shows the following:

Assets

Land and building .............. $1,000,000

Liabilities

Bank loan ............................. $500,000

Equity

Settled sum ................................... $10

Unpaid present entitlements

(Beneficiaries A, B and C) .... $499,990

In this case, an in-specie distribution of trust property to Beneficiary A cannot be legally effected unless the charge over

the asset (ie bank loan) has been discharged beforehand or otherwise dealt with to the satisfaction of the lender. Further,

it would be necessary for the trustee to settle its outstanding unpaid present entitlements. It would seem that the

settlement of these debts can only be achieved by realising the land and building and applying the sale proceeds against

these debts.


iii. CGT implications

Realisation of assets

Where assets are realised by the trustee to a third party, CGT event A1 is typically triggered.

In-specie distribution of assets

Where an in-specie distribution of trust property constituting CGT assets is made by a discretionary trust, this

would likely trigger CGT events E5 or E7 (s104-75 and s107-85 of the Income Tax Assessment Act 1997

(ITAA97) respectively).

The beneficiary would acquire the trust property with a cost base equal to its market value (typically at the

time of transfer or when the beneficiary becomes ‘absolutely entitled’).

Other CGT considerations

Irrespective of the option chosen in vesting the trust, other applicable CGT implications include:

to the extent that the CGT asset has been held for at least 12 months, the trust may be eligible for

the CGT general discount, and

where the trust is operating a business, or the asset is used in the conduct of such a business, there

may be scope to apply the small business CGT concessions to the extent that the requisite

conditions are satisfied (Division 152).

iv. Distribution of trust income

Any capital gain that is derived by the trust pursuant to CGT events A1, E5 or E7 would be included in the

trust’s net income (s95 of the Income Tax Assessment Act 1936 (ITAA36)).

Division 6E requires that the net (taxable) income of a trust excludes any net capital gain included in s95 net

income. Where the trust deed permits, the trustee is able to stream the net capital gain to nominated

beneficiaries in accordance with subdivision 115-C ITAA97. This requires that the beneficiary becomes

specifically entitled’ to an amount in respect of the capital gain.

The beneficiary may be entitled to the CGT discount.

v. Stamp duty implications

As a general rule, each Australian state and territory provides an exemption from stamp duty (or a nominal

amount is payable) for an in-specie distribution of dutiable property from a trust to a beneficiary. The

relevant conditions that effect the exemption (or nominal duty amount) vary from state to state. It would be

prudent to seek legal advice in this regard.

vii. GST implications

Whether GST is imposed on an in-specie distribution depends on whether it constitutes a ‘taxable supply’. In

the case of a discretionary trust, this depends on whether the beneficiary is registered (or required to be

registered) and whether the distribution is used solely for a creditable purpose.

ATO Interpretative Decisions 2001/503, 2001/504 and 2001/505 considers the GST implications where a

discretionary trust makes an in-specie distribution to a beneficiary under a number of different scenarios.

For example, in ATO ID 2001/505, a discretionary trust which is registered for GST was considered to have

made a taxable supply where an in-specie distribution is made to a beneficiary who is not registered, or

required to be registered. The Commissioner concluded that, as the beneficiary was an associate of the trust,

Division 72 of the GST Act overcame the absence of consideration in reaching the decision that the

distribution was a taxable supply.


Case Study: Vesting of a discretionary trust

Facts

Structure

The Flintstone Family Trust is a discretionary trust which was established in 2009 to invest in the share market.

Rock Pty Ltd is the corporate trustee of the trust.

Trust deed

The terms of the Flintstone Family Trust deed provide the following:

‘income of the trust’ defined as income determined under s95 of the Income Tax Assessment Act 1936

(ITAA36)

the trustee is able to separately account for classes of income including capital gains and franked distributions

the trustee is able to distribute separate classes of income to particular beneficiaries

the class of beneficiaries to whom distributions can be made are members of the Flintstone Family and

related entities, and

the trustee is able to bring forward the vesting day of the trust and wind up the trust where necessary, and in

doing so, is able to make an in-specie distribution of property (if desired).

Since its creation, the trust has distributed income (mostly dividend income with imputation credits) to the following

beneficiaries:

Fred: adult - no legal disability

Wilma: Fred’s wife – no legal disability

Pebbles: Fred’s daughter who is eight years of age

Tax characteristics of relevant taxpayers

To enable access to imputation credits under the 45 day holding rule, the trust has made a Family Trust Election since its

creation.

Wilma has carry forward capital losses of $500,000 from prior income years.

Fred does not have carry forward capital losses.

Balance sheet

As at 30 May 2015, the balance sheet of the trust showed the following items:

Assets

Investment in publicly listed shares1 .......... $4,500,000

Cash ....................................................... $1,600,000

Liabilities

Beneficiary loan2 ..................................... $1,700,000

Equity

Settled sum3 ............................................... $100,000

Reserves (UPE)4 ..................................... $4,300,000


Other balance sheet information

1. Publicly listed shares: The value of the shares is recorded at cost. As at 30 May 2014, the share portfolio had a

market value of $9 million which is split as follows:

Shares in ABC (held at least 12 months):

Cost: $100,000

Market value: $4.1 million

Shares in XYZ (held for less than 12 months):

Cost: $4.4 million (Note: these shares were acquired all at the same time)

Market value: $4.9 million

2. Beneficiary loan: An interest-free loan made by Wilma as a cash account for the trust to acquire shares.

3. Settled sum: The settled sum is $100,000.

4. Reserves: This represents unpaid present entitlements which have been assessed in the hands of the beneficiaries

for income tax purposes in prior years. Fred and Wilma are entitled to $2.15 million each.

Vesting of trust

Due to a dispute between Fred and Wilma as to investment strategy of the trust going forward, as directors of the

corporate trustee, they decide to wind-up the trust and distribute the assets of the trust to the beneficiaries in-specie.

To take advantage of Wilma’s capital losses, the trustee’s objective was to create the following entitlements:

Fred becomes ‘absolutely entitled’ by way of in-specie distribution of the shares in XYZ (held for less than 12

months), and

Wilma becomes ‘absolutely entitled’ by way of in-specie distribution of the shares in ABC (held for at least of

12 months).

Settlement of liabilities

The beneficiary loan is to be repaid from cash reserves.

To the extent that there is insufficient cash to settle unpaid present entitlements, it would be necessary for some shares

to be realised in order to meet those liabilities. If so, it has been agreed that Fred’s interest in XYZ shares would be

liquidated to meet those liabilities and any capital gain distributed to him.

In-specie distribution of assets

The assets of the trust are transferred to the beneficiaries who are ‘specifically entitled’ by way of resolution of the

trustee. Based on the facts, this will be achieved as follows:

Step 1. Liquidate shares to pay off liabilities

As the balance sheet shows that there would be insufficient cash funds ($1.6 million) to meet the unpaid present

entitlements ($4.3 million), the beneficiary loan ($1.7 million) and any current present entitlement, it would be necessary

to realise the trust’s interest in the shares in XYZ (as agreed to by Fred and Wilma as directors of the corporate trustee).

In this case, all the shares in XYZ will be sold and none are to be distributed to Fred in-specie.

The CGT implications to the trustee are as follows:

TRUSTEE

Shares held for less than 12 months: XYZ shares

Capital proceeds1 ........................ $4.9 million

Less: Cost base ......................... ($4.4 million)

Capital gain2 3 ................................. $500,000

1: Shares are sold on-market.

2: No entitlement to CGT discount as shares have not been held for at least 12 months.

3: The capital gain of $500,000 is to be distributed to Fred (see below).


Following the disposal of shares, the balance sheet should look like this:

Assets

Investment in ABC shares ............................ $100,000

Cash from disposal of shares .....................$4,900,000

Cash - other ................................................$1,600,000

Liabilities

Beneficiary loan ..........................................$1,700,000

Equity

Settled sum .................................................. $100,000

Reserves (UPE) .........................................$4,300,000

Profit on sale (UPE) ...................................... $500,000

The cash balance of $6.5 million can then be applied against the following debts:

Beneficiary loan ...................................... $1,700,000

Unpaid present entitlement ..................... $4,300,000

Present entitlement (profit on sale) ............ $500,000

This effectively settles all outstanding liabilities.

Step 2. In-specie distribution of shares to beneficiaries

Once all liabilities are fully settled, the balance sheet will look like this:

Assets

Investment in ABC shares ............................ $100,000

Equity

Settled sum .................................................. $100,000

In accordance with the resolution made by the trustee, the shares in ABC can now be distributed in-specie to Wilma with

the following implications:

TRUSTEE

CGT event E5

An in-specie distribution of the shares to Wilma as a beneficiary would typically trigger CGT event E5 to the trustee

(s104-75).


CGT event E5 happens if a beneficiary becomes ‘absolutely entitled’ to a CGT asset of a trust as against a trustee

(disregarding any legal disability that the beneficiary is under). CGT event E5 does not apply to a unit trust or a

trust to which Division 128, which relates to the effect of death, applies.

A beneficiary is considered to be ‘absolutely entitled’ where the beneficiary’s interest is vested in possession and

indefeasible. The concept of absolute entitlement is considered in Draft Taxation Ruling TR 2004/D25.

Specifically, para. 90, 93 and 95-96 of TR 2004/D25 states:

Where more than one beneficiary has an interest in the trust assets, absolute entitlement can only be

established if the assets are fungible….

Assets are fungible if each asset matches the same description such that one asset can be replaced with

another. Assets are fungible if they are of the same type (for example, shares in the same company and

with the same characteristics)…

Fungible assets form a separate class for the purpose of determining the number and type of assets to

which each beneficiary is regarded as being absolutely entitled.

For example, if the trust property consists of 1,000 listed public company shares and 800 of them are in Co

A and 200 are in Co B, then the Co A shares form one asset class and the Co B shares form another. If there

are two beneficiaries and under the terms of the trust each is entitled to one-half of the total number of

shares, and assuming the other conditions are met, each beneficiary will be absolutely entitled to 400 Co A

share and 100 Co B shares.

Further, para. 71 states:

Because an object of a discretionary trust does not have an interest in the trust assets, they cannot be

considered absolutely entitled to any of the trust assets prior to the exercise of the trustee’s discretion in

their favour.

The resolution to make an in-specie distribution to Wilma and the fact that assets are fungible would appear sufficient to

create an ‘absolute entitlement’ (see also Private Ruling 91322).

The net capital gain under CGT event E5 is $2 million and calculated as follows:

Shares held for at least 12 months: ABC

Capital proceeds1 ......................... $4,100,000

Less: Cost base ............................. ($100,000)

Capital gain ................................... $4,000,000

Less: 50% CGT discount2 ........... ($2,000,000)

Net capital gain ............................ $2,000,000

1: The market value of the property pursuant to s116-20 would become the capital proceeds.

2: The asset has been held by the trust for at least 12 months, the trust would be eligible for the CGT 50% general

discount (refer Division 115).


Note: CGT Event E7

There are certain situations where CGT event E7 may be triggered instead of CGT event E5.

Broadly, CGT event E7 happens where the trustee of the trust disposes of a CGT asset to a beneficiary in

satisfaction of that beneficiary’s interest, or part of it, in the trust capital (s104-85). An in-specie distribution

made to a beneficiary of a discretionary trust would typically not trigger this CGT event as such beneficiaries do

not have an interest in the trust capital.

Nonetheless, for a discretionary trust, CGT event E7 may apply in the following situations:

As CGT event E5 applies where there is strictly an ‘absolute entitlement’ to a fungible asset, CGT event

E7 may apply where assets are disposed to multiple beneficiaries who become joint owners of that

asset (such as real property) (see: Private ruling 1011459976490).

An in-specie distribution made in satisfaction of a beneficiary loan account can also trigger CGT event

E7. A beneficiary loan is considered to be an interest in trust capital (see ATO ID 2002/365).

ATO ID 2002/365 (withdrawn merely because it is not considered interpretative) contemplates the application of

CGT event E4 where an in-specie distribution is made by a trustee to a beneficiary with a balance sheet which

may look like this:

Assets

Investment property .......................... $500,000

Liabilities

Beneficiary loan ................................... $499,980

Equity

Settled sum ................................................... $20

In the case study under consideration, notwithstanding that Wilma’s beneficiary loan has been settled, it may

have been possible for the in-specie distribution of shares to have been made in satisfaction of that loan.

Further, it should be noted that the application of CGT event E7 should give rise to a similar capital gain to that

under CGT event E5 to both the trustee and beneficiary.


Beneficiaries

CGT event E5

Prima facie, a capital gain applies to Wilma, as beneficiary, under CGT event E5 if the market value of the asset (at

the time of the event) is more that the cost base of the beneficiary’s interest in the trust capital to the extent that

it relates to the asset (s104-75(5)) (or vice versa for a capital loss).

However, the capital gain is disregarded if the beneficiary who acquired the CGT asset that is the interest (except

by way of assignment from another entity) for no expenditure.

Note: A similar exemption applies if CGT event E7 is triggered.

As Wilma is a mere object of the trust, no consideration would have been paid for an interest in the trust (ie. a

right to be considered for a distribution of income). As such, there are no CGT consequences under CGT event E5.

Note: Wilma will be assessed on the capital gains from distributions made by the trustee from CGT event E5

(see below).

Cost base

To the extent that CGT event E5 applies, Wilma will inherit cost base of $4.1 million for the shares transferred to

her by way of in-specie distribution. The market value substitution rule applies as the shares have been acquired

for no consideration (s112-20(1)(a)).

For CGT discount purposes, she is considered to have acquired the asset when she became ‘absolutely entitled’

(s109-5(2)).

Income assessed to trustee and beneficiaries

Trustee

Net capital gain of $2.5 million from the disposal and transfer of the shares is included in net (taxable) income –

s95 ITAA36.

Division 6E requires that the net (taxable) income of trust excludes any net capital gain included in s95 net

income. The net capital gain will be assessed to the beneficiaries in accordance with subdivision 115-C (see

below).

Beneficiary

Each beneficiary will be assessed on the following amounts:

Fred

Capital gain distributed from trust:

Net capital gain from trust1:

Net capital gain (share sale) .......................................... $500,000

Gross-up for CGT discount2 ..................................................... nil

Capital gain .................................................................... $500,000

Apply carry forward capital losses ........................................... nil

Net capital gain .............................................................. $500,000


Wilma

Capital gain distributed from trust:

Net capital gain from trust1

Net capital gain (in-specie distribution)....................... $2,000,000

Gross-up for CGT discount2 ........................................ $2,000,000

Capital gain ................................................................. $4,000,000

Apply carry forward capital losses3 ............................ ($500,000)

Capital gain ................................................................. $3,500,000

Apply 50% discount ................................................. ($1,750,000)

Net capital gain ........................................................... $1,750,000

1: The net capital gain of $2.5 million is to be distributed to Fred and Wilma in accordance with the resolution made (as

allowed by the trust deed).

Therefore:

Fred is ‘specifically entitled’ to a non-discount net capital gain of $500,000 (see s115-127 and

s115-228) representing the non-discount shares. This will be assessed to him.

Wilma is ‘specifically entitled’ to a discount net capital gain of $2 million (see s115-127 and

s115-228) representing the non-discount shares. This will be assessed to her.

2: Wilma would be required to gross-up the net capital gain and apply the CGT general discount (s115-215(3)).

3: Carry forward capital losses are applied before considering application of CGT discount (s102-5).


Testamentary trusts

A testamentary trust is a trust established under a will. A testamentary trust is separate to the trust which is

created when a deceased estate comes into existence.

Testamentary trusts can be structured in many different ways to achieve the objectives of the testator, including:

fixed interests created for specific beneficiaries

discretionary powers conferred on the trustee regarding entitlements to capital and income

a power available to the trustee to vary the terms of the trust

the conditions to be satisfied before beneficiaries become entitled to trust assets, and

the creation of life interests where a beneficiary is entitled to the income arising from a trust asset (or

has the right to utilize that asset) during their lifetime (life tenant) and remainder interests who are

entitled to the asset upon the death of the life tenant.

Consideration might also be given to the establishment of multiple testamentary trusts where circumstances

warrant such action eg. one trust per child where their individual circumstances are significantly different.

The benefits of utilising a testamentary trust can include:

1. Income distributed by a testamentary trust to a minor beneficiary will be ‘excepted trust income’ as

defined in s102 AG ITAA36 and therefore taxed at ordinary marginal rates. The extent of the benefit is

increased as the tax-free threshold is currently $18,200.

2. Where the testamentary trust is discretionary in nature:

i) the trustee has the flexibility to distribute income on the basis which achieves the most

advantageous after-tax outcome

ii) there is no requirement that the trustee transfer asset(s) to particular minor beneficiaries

unless the deed directs to the contrary.

3. Provided the trust deed empowers the trustee to do so:

i) capital gains and franked dividends can be streamed to particular beneficiaries

ii) the trustee can elect to be taxed on a capital gain that would otherwise be assessed to a

beneficiary who cannot benefit from the capital gain (s115-230 ITAA97).

4. Protection of estate assets can be achieved in situations such as where:

i) beneficiaries may be potentially liable personally to third party actions

ii) beneficiaries may squander the assets or otherwise put them at risk

iii) beneficiaries may not be capable of adequately looking after their own affairs due to incapacity

or other forms of vulnerability.


POTENTIAL INCOME TAX ADVANTAGES

Example

Bernie Barton is a successful entrepreneur who wishes to apply $1,500,000 of his assets for the benefit of his three

grandchildren (presently aged 5, 7 and 9) and his daughter Kathy. It is anticipated that the annual income generated by

the assets would be $100,000.

Bernie is contemplating establishing a discretionary inter vivos trust or alternatively directing the executor of his estate to

place the assets into a testamentary trust for the benefit of his grandchildren and daughter.

Tax Liabilities

Testamentary Trust Inter vivos Trust

Income distribution Tax liability Income distribution Tax liability

Child 1 18,200* 0 416* 0

Child 2 18,200 0 416 0

Child 3 18,200 0 416 0

Kathy 45,400 6,983 98,752 25,966

$100,000 $6,983 $100,000 $25,966

*utilising the tax-free threshold

Streaming

The Tax Laws Amendment (2011 Measures No 5) Bill 2011 also introduced provisions which enable a trustee to

stream capital gains and/or franked distributions to particular beneficiaries. A person establishing a testamentary

trust should consider the appropriateness of providing the trustee with streaming powers within such a trust.

Application of CGT rules generally to testamentary trusts

The Commissioner takes the approach that assets owned by the deceased at the date of death which pass to a

testamentary trust created under the deceased’s will are subject to Division 128 ITAA97. Broadly, Division 128

provides that a capital gain or loss arising on the death of a person, as a result of assets passing to a legal personal

representative or beneficiary, will be disregarded.

Where assets are transferred from:

the deceased to a testamentary trust, and

the testamentary trust to a beneficiary*

no CGT event will be recognised (refer: Practice Statement PSLA 2003/12).

*in accordance with the terms of the trust


Under s128-15, the legal personal representative or beneficiary who receives the asset under the terms of the

testamentary trust is deemed to have acquired the asset on the date of death. The cost base and reduced cost

base of the asset in the hands of the legal personal representative or beneficiary is subject to special rules,

depending on the type of asset.

Type of CGT asset in the hands

of the deceased

First element of cost base or reduced cost base

to the recipient of the asset

Pre-CGT

Market value on the date of death

(Becomes a post-CGT asset in the hands of the

recipient)

Trading stock


or

The value calculated under normal trading stock

rules

(by election)

or

Nil for certain crops and trees (by election)

Main residence Market value on the date of death

If the deceased was not an

Australian tax resident – an asset

that was not taxable Australian

property


(only applies if the recipient is an Australian tax

resident)

All other CGT assets Cost base or reduced cost base in the hands of the

deceased on the date of death

Where an asset is passed to a testamentary trust beneficiary that is the trustee of a complying superannuation

fund, s128-25 provides that the trustee of the superannuation fund is deemed to acquire the asset on the date of

death and the first element of the cost base is the market value of the asset on the date of death.

In some instances, an asset of the deceased devolves to a legal personal representative and not directly to a

beneficiary. When the legal personal representative transfers the asset to a beneficiary of the testamentary trust

at a later date, any capital gain or capital loss arising to the legal personal representative at that time is

disregarded. The beneficiary is deemed to have acquired the asset on the date of death (and not on the date the

legal personal representative transferred the asset to the beneficiary). The cost base to the beneficiary includes

any amount incurred by the legal personal representative, as though the beneficiary incurred it themselves, if the

legal personal representative would have been entitled to include the amount in the cost base. However, these

rules do not apply where the ownership of the asset is transferred because of a sale of the asset from the legal

personal representative to the beneficiary.


Example

Pursuant to the will of Tom Trembath, a testamentary trust is created for the benefit of his two children Tess and Ted

aged 21 and 15 respectively.

The assets passing from Tom's estate to the testamentary trust include:

Cost base/

Reduced cost base

Market value

at date of death

Cash $400,000 $400,000

Main residence (post-CGT) $600,000 $1,000,000

Private company shares

(post-CGT)

$500,000 $370,000

Land (pre-CGT) $300,000 $800,000

There are no related liabilities.

Under the trust deed:

the income of the trust is to be distributed annually at the discretion of the trustee

the main residence will be transferred to Tess once she turns age 25

the land and shares will be transferred to Ted once he turns age 25, and

the balance of any cash is to be split 50/50 between Tess and Ted once Ted turns age 25.

For the year ended 30 June 2013, the testamentary trust derived the following income:

Interest .............................................. $15,000

Fully Franked Dividends ..................... $7,000

Rental (land) ..................................... $20,000

$42,000

Tess earned $20,000 in salary and wages income from her employment.

The trustee resolves to distribute the net income of the trust as follows:

Ted ....................................... the first $31,000

Tess .................................................. balance

2012-13 tax position for beneficiaries

Tess Ted

Salary and wages $20,000 -

Trust distribution* $11,000 $31,000

$31,000 $31,000

* as the franked dividends have not been 'streamed' each beneficiary will be entitled to their proportionate share of franking

credits.

Ted will be taxed at ordinary rates on the distribution of $31,000.


CGT outcome

Main residence

Passes to Tess at age 25 but the CGT event is disregarded (Division 128 ITAA97 applied)

Cost base for Tess is $1,000,000.

Land and Shares

Pass to Ted at age 25 but the CGT event is disregarded

Cost bases for Ted:

Shares ........... $500,000

Land .............. $800,000 (becomes a post-CGT asset)

CGT Event K3

Where an asset passes from the deceased to a testamentary trust but the ultimate beneficiary is a non-resident,

CGT event K3 will occur unless the asset is taxable Australian property (s855-15 ITAA97). The most common

example of taxable Australian property is real property situated in Australia. If a CGT event is recognised (because

the asset is not taxable Australian property) it will occur at the time the beneficiary acquires a vested and

indefeasible interest in the asset (TD 2004/3).

Note: For the purposes of the discount capital gains provisions in Division 115 ITAA97, there are special rules

regarding the time of acquisition of an asset:

a pre-CGT asset of the deceased acquired by the legal personal representative or by a beneficiary of

the deceased estate - acquired when the deceased died, and

a CGT asset of the deceased acquired by the legal personal representative or by a beneficiary of the

deceased estate - deemed acquired when the deceased acquired the asset.

Testamentary trust acquiring new assets

Assessable income derived by a trust which resulted from a will is ‘excepted income’ and not subject to the

special taxing provisions in Division 6AA ITAA36 – refer s102AG(2)(a).

Is ‘excepted income’ status only applicable to income derived from assets passed to the trust by the deceased

estate at the time of death? On the basis of the decision of the Federal Court in The Trustee for the Estate of the

Late A W Furse No 5 Will Trust v FCT (1990) FCA 470, the answer would be ‘no’.

In the Furse case, the trustee acquired an investment asset more than two years after the date of death of the

deceased (and the establishment of the trust). The Court concluded that for s102AG(2)(a) to apply, it is not

necessary that the income of the trust be derived from assets of the deceased at the date of death. It is merely

necessary that the income was ‘assessable income of a trust estate that resulted from … a will’. It may be that an

asset is acquired as a result of borrowing by the trustee or from the proceeds of asset sales by the trustee. In

either instance, s102AG(2)(a) may still be applicable.

Warning: It should be noted that income of a testamentary trust must be derived on an arm’s length basis

(s102AG(3)) in order to ensure that the anti-avoidance provisions in s102AG(4) do not apply.

Testamentary Trusts: Where no beneficiary is presently entitled to the income of the trust

The trustee might be assessed under s99 or s99A.

Section 99A will not apply to a trust estate which results from, broadly, a will or bankruptcy, if the Commissioner

considers it unreasonable that it should apply. Refer: s99A(2).


Since the issue of Public Information Bulletin No 4 (1978) there has been no consolidated statement of the

Commissioner’s views, such as a public ruling or practice statement, however the Commissioner’s present

approach might be summarised as follows:

whilst a trustee is pursuing the administration of an estate genuinely and in a timely manner, s99 would

apply

where it would appear that assets have been transferred to the deceased with the intention that, upon

death, the assets will be held in the estate generating income taxed at the favourable rates applicable to

s99, the trustee will be assessed under s99A in respect of accumulated income, and

where a testamentary trust is established with only a nominal settled sum but steps are then taken to

inject income by relocating income-producing assets into the trust, the accumulated income generated

by those assets would typically be assessed under s99A.

Deceased estates

A deceased estate will be assessed as follows:

where the date of death is less than three years before the end of the deceased estate’s income year:

individual rates including the tax-free threshold, and

thereafter: individual rates with no tax-free threshold.

Refer: Income Tax Rates Act 1986.

Note: This will typically mean that the period assessed at individual rates including the tax-free threshold will

be less than three years; for example, if a taxpayer died on 1 May 2010, the periods would be 1 May 2010 to

30 June 2010 and the years ended 30 June 2011 and 2012.


Family trusts and interposed entity elections

A trust will be classified as a family trust if it makes a family trust election (FTE). Lodgement of the election creates

a ‘family group’.

The benefits which may be derived from a FTE are:

i. less onerous requirements to comply with the trust loss rules

ii. to enable companies and fixed trusts to satisfy the continuity of ownership test and 50% stake test

respectively, where a discretionary trust holds at least 50% of the issued shares/units, and

iii. to enable beneficiaries of discretionary trusts to satisfy the 45/90 day holding period rule in order to utilise

franking credits.

iv. easier access to Small Business Restructure Rollover (SBRR) from 1 July 2016.

The Family Group

A family trust election (FTE) must nominate a ‘test individual’ for the purposes of defining a ‘family group’.

The family group will include:

the individual’s family members

certain former family members (s272-90(2A) Sch 2F)

trusts with the same test individual

entities covered by an interposed entity election

entities wholly owned by members of the primary individual’s family

trustees of one or more family trusts, where the primary individual is specified in the family trust

election

deductible gift recipients, and

certain tax-exempt entities.

(s272-90 Schedule 2F ITAA36)

Note: The nominated individual is referred to as the ‘primary individual’ in defining the family

group (s272-90) and the ‘test individual’ for the purposes of defining the family of that person

(s272-95).

In order to make a valid FTE, a trust must pass the family control test (s272-87) at the end of the income year for

which the election is first made; in this regard it is necessary that the test individual and/or members of the test

individual’s family control the trust.

Control is determined in accordance with s269-95(1); for example, power to remove or appoint the trustee,

ability to control the distribution of trust income or capital and specify the individual who will be the basis upon

which the family group is established.


Members of the test individual’s family are identified diagrammatically below.

Members of the test individual’s family

(s272-95 Schedule 2F ITAA36)

Note: The spouses of these family members are included in the family group.

Family trust distribution tax will be payable at the rate of 46.5% in respect of any distribution of income or capital

to a beneficiary who is outside the family group. Amounts which have been subjected to family trust distribution

tax are exempt from income tax and withholding tax in the case of non-resident beneficiaries.


Trust loss rules

The table below sets out the tests to be satisfied by the most common categories of trusts, in order to deduct

losses.

Trust Tests to be satisfied

Fixed trust

(other than a widely held unit trust) 50% stake test

1

Income injection test

Non-fixed trust 50% stake test (if applicable)2

Pattern of distributions test

Control test

Income injection test

Family trust Income injection test

Excepted trust s272-1003 Income injection test

1. Includes the alternative stake test (s266-45 Schedule 2F)

2. Would only apply where some part of the trust was fixed.

3. Includes deceased estates and superannuation funds.

45-day holding period (franking credits)

In order to obtain the benefit of franking credits, it is necessary that a person hold the relevant shares substantially ‘at risk’ for a qualifying period of at least 45 days (90 days for preference shares). A beneficiary of a non-fixed trust cannot satisfy this at risk requirement as the beneficiary has no interest in trust assets. This can be overcome by the trust electing to be a family trust.

Situations where the ‘at risk’ holding rule will not apply are:

where the shares were acquired on or before 31 December 1997, and

if the beneficiary satisfies the ‘small shareholder exemption’, ie. franking credits during the year of less

than $5,000 from all sources.


Example

Outcome Annie Arnold

Direct franking credits $3,000 $6,000

Franking credits via Star Family Trust $750 $750

Total $3,750 $6,750

As Arnold has franking credits of $6,750 for the year, it will be necessary for the Star Family Trust to lodge an FTE or Arnold will be unable to utilise the franking credits of $750 from the family trust.

Company or fixed trust with tax losses

Where a company or fixed trust has tax losses, the company or fixed trust may be required to pass the Continuity

of Ownership Test (COT) or the 50% stake test respectively.

These tests require the same persons to hold greater than 50% of the shares/units from the beginning of the loss

year until the end of the year in which the loss is recouped. It is necessary to trace through to the ultimate natural

person beneficial owner of the shares/units for the purposes of this test.

Where the shareholder/unitholder is a discretionary trust which holds at least 50% of the issued shares/units, the

test cannot be satisfied as it is not possible to trace through the discretionary trust to determine underlying

beneficial ownership of the shares/units held by the trust, because the beneficiaries of a discretionary trust do

not have any interest in trust assets.

However, where an FTE is made, the trust itself is treated as a ‘person’ for the purposes of the COT and the 50%

stake test, potentially allowing the company or unit trust to pass the COT/50% stake test.

Disadvantages of making an FTE

The main disadvantage of making an FTE is that the trust will not be able to distribute to any person or entity

outside the trust’s defined ‘family group’ without incurring Family Trust Distributions Tax at the maximum

marginal tax rate of 46.5%.

When is an interposed entity election required?

An Interposed Entity Election (IEE) may be made by a trust, company or partnership and will only be required

where the interposed entity:

requires membership of the family trust’s ‘family group’, which will allow distributions to occur between

the family trust and interposed entity without the family trust incurring family trust distribution tax, or

is to distribute income to a related family trust, and the IEE will allow the related family trust to pass the

‘income injection test’ because the interposed entity is excluded from the definition of ‘outsider’ for the

purposes of the income injection test. (Refer: s270-10 and s270-25).


Example: Income distribution (income injection test)

If Profit Trust is a discretionary trust without an FTE nominating the same test individual as Loss Trust, it cannot be a

member of the Loss Trust Family Group.

An IEE lodged by Profit Trust would enable a distribution to Loss Trust to occur without failing the income injection test

and incurring family trust distribution tax.

Note: A family group will automatically include any entity in which the test individual, the test individual’s

family and/or any family trust with the same test individual beneficially hold, directly or indirectly, fixed

entitlements to all of the income and capital of the entity. In these circumstances an IEE would not be

required.

When should an FTE / IEE be in place?

Where an FTE is required in order to:

allow the trust access to concessional trust loss rules, or

allow a company or fixed trust to treat the trust as a ‘person’ when applying the COT or 50% stake test

the FTE must commence at the start of the year in which the trust loss is incurred.

Where an FTE is required to allow access to franking credits by beneficiaries of a discretionary trust, the FTE must

commence at the start of the income year when the first dividend was paid to the trust which required the 45-day

holding period rule to be satisfied.

An IEE election should commence from the start of the first income year in which membership of the family group

is required.

An FTE/IEE can be entered into at any time, provided that at all times from the beginning of the year in which the

FTE/IEE is to commence until 30 June in the income year before the one in which the election is made:

the trust passes the family control test, and

the trust has made no distributions to persons other than the test individual or members of the test

individual’s family group.


Revocation of FTE or IEE

From the 2008 income year onwards, an FTE can be revoked in cases where the FTE was not required or utilised in

order to enable a deduction to be obtained for losses or obtain the benefit of franking credits, ie. no benefit has

been derived as a result of the election being lodged.

IEEs may also be revoked from the 2008 income year onwards where the IEE was made in respect of the entity

that was already included in the family group or if the IEE relates to an entity that became part of the family

group as a result of being wholly owned by family members. Note that an IEE will be automatically revoked where

the FTE which caused the IEE has been revoked.

Time limit on FTE/IEE revocations

It is important to note that there is a limited time period to revoke an FTE/IEE.

For an FTE/IEE commencing in the 2006 income year onwards, the FTE/IEE must be revoked no later than the

income year ending four years after the commencement year, eg. if an FTE/IEE commenced in 2007, the FTE/IEE

must be revoked no later than in the income tax return for 2011, or two months post year-end if no income tax

return is required.

Varying a Test Individual

From the 2008 income year, a once off variation of a test individual is permitted. This amendment is designed to

assist family groups where an inappropriate choice of test individual has occurred. In order to vary the original

test individual, the following requirements must be met:

the new test individual must be a member of the original test individual’s family group when the FTE

commenced, and

all distributions made by the family trust and any interposed entities during the time in which the

FTE/IEE has been in force, must have been made only to members of the new test individual’s family

group.

Where these requirements are not met, it is not possible to make any variation to the test individual.


CGT small business concessions

Accessing the concessions

A trust which satisfies the legislative requirements may access the small business CGT concessions in order to

reduce or eliminate a capital gain derived by the trust.

The ‘basic conditions’ in section 152-10(1) ITAA97 require that the trust either:

satisfy the Small Business Entity (SBE) test (aggregated annual turnover is less than $2 million)

satisfy the $6 million maximum net asset test

be a partner in a partnership that is an SBE and the relevant asset is a partnership asset, or

if the trust is a non-business taxpayer, it

- has an affiliate or connected entity which is an SBE which uses the CGT asset in the carrying on of

a business, or

- is a partner in a partnership which is an SBE and the CGT asset (not being an asset of the

partnership) is used in the carrying on of a business by the partnership.

The asset which has resulted in the capital gain being derived must be an active asset which satisfies the active

asset test.

Maximum net asset value test ($6 million)

A taxpayer satisfies the ‘maximum net asset value test’ if, just before the CGT event, the sum of the following

does not exceed $6 million:

the net value of the taxpayer’s CGT assets

the net value of the CGT assets of any entities connected with the taxpayer, and

the net value of the CGT assets of any affiliates of the taxpayer or entities connected with the taxpayer’s

affiliates (s152-15).

What is ‘net value’ of the taxpayer’s CGT assets?

The net value of an entity’s CGT assets is the amount obtained by subtracting from the sum of the market values

of those assets the sum of:

the liabilities of the entity that are related to the assets, and

the following provisions made by the entity:

- provisions for annual leave

- provisions for long service leave

- provisions for unearned income, and

- provisions for tax liabilities (152-20(1)).

Liabilities extend to legally enforceable debts due for payment and to presently existing obligations to pay either a

sum certain or ascertainable sums (paragraph 1 of TD 2007/4).

Note: the question of what constituted a presently existing obligation was considered by the Federal Court in

Commissioner of Taxation v Byrne Hotels Qld. Pty Ltd (2011) FCAFC 127.


Only those liabilities that ‘relate to´ assets included in the net asset test are taken into account. In the

Commissioner’s view, circumstances where liabilities relate to assets include:

liabilities directly related to particular assets that are in themselves included in the calculation (eg. a

loan to finance the purchase of business premises), and

liabilities that, although not directly related to one particular asset, are related to the assets of the

entity more generally (eg. bank overdraft that provides working capital for the operation of the

business) (paragraphs 21 and 22 of TD 2007/14).

Note: the Federal Court considered the term ‘related to the assets’ in Bell v Commissioner of Taxation (2012)

FCAFC 32.

Additional basic conditions for shares in a company or interests in a trust

Note: There are additional basic conditions, of which at least one must be satisfied, if the asset giving rise to

the capital gain was a share in a company or an interest (such as a unit) in a trust:

the taxpayer must be a CGT concession stakeholder of the company or trust, or

where an interposed entity holds the shares/units, CGT concession stakeholders of the company or

trust must have an aggregate small business participation percentage in the interposed entity of at

least 90%.

Active asset

A basic condition to access any of the CGT concessions is that the CGT asset be an active asset, and satisfy the

active asset test.

A CGT asset is an ‘active’ asset if it is used, or held ready for use, in the course of carrying on a business. The

business may be carried on by the owner of the CGT asset, or by an affiliate or connected entity of the asset

owner.

An interest in a company or trust may be an active asset where, generally, 80% or more of the market value of the

underlying assets is represented by:

active assets

financial instruments connected with the business of the trust, and

cash connected with the business of the trust.

Business carried on by affiliate or connected entity

Where a CGT asset is held in a trust, and a business is conducted by a separate entity, the asset can qualify as an

active asset provided that the entity carrying on the business is ‘connected with’ or an ‘affiliate’ of the trust.


Connected entity

An entity will be ‘connected with’ another entity if:

either entity controls the other, or

both entities are controlled by the same third entity.

Example

Connected entities: 1 & 2, 1 & 3, 2 & 3.

Fixed trusts – control

An entity is taken to ‘control’ a trust (other than a discretionary trust) where the entity (or an affiliate, or together

with an affiliate) beneficially owns interests in the trust that carry the right to receive at least 40% of any

distribution of income or capital.

Non-fixed trusts – control

In relation to the control of a discretionary trust, there are two ways by which an entity may control a

discretionary trust:

Influence the trustee test: An entity controls a discretionary trust if the trustee of the trust acts, or

could reasonably be expected to act, in accordance with the directions of that entity, or its affiliates, or

together with its affiliates.

Note: In ATO ID 2008/139 the Commissioner concluded that an appointor with power to remove and appoint a

trustee would be considered to control a trust.

Note: The AAT considered this matter in the Gutteridge and FCT AAT Case [2013] 947

Distribution test: An entity is taken to control a discretionary trust for an income year if, for any of the

previous four income years:

- the trustee paid any income or capital of the trust to, or for the benefit of, the entity, its

affiliates, or the entity and its affiliates, and

- the percentage of the income or capital paid or applied to the entity and/or its affiliates, is at

least 40% of the total amount of income or capital paid or applied by the trustee for that

income year.


Note that where a trust did not make a distribution of income or capital due to having a tax loss or no

taxable income, the trustee of a discretionary trust may nominate up to four beneficiaries to be controllers of

the trust (refer: s152-42 ITAA97). Such a nomination may be necessary in order to satisfy the active asset

test.

Affiliate

An ‘affiliate’ is an individual or company (ie not a trust) that acts, or could reasonably be expected to act, in

accordance with the directions or wishes, or in concert with, the taxpayer in relation to the business of that

individual or company.

The affiliate test may be particularly relevant where a trust holds a CGT asset which is used in a business carried

on by an individual or a company, and there is a desire to satisfy the active asset requirements.

The Commissioner considers that whether a person acts, or could be reasonably expected to act, in accordance

with another person’s directions or wishes or in concert with that other person is a question of fact dependent on

all the circumstances of the particular case. The key consideration is the actions of the parties.

Spouses and children under 18 years

From 1 July 2007, spouses and children under 18 years are no longer automatically affiliates under the amended

definition of the term.

However, the law does provide that, an asset owned by an individual and used in the carrying on of a business by

their spouse or child under 18 years, will be considered to be used in the carrying on of a business by the

individual’s affiliate, but only for the purposes of the active asset test (refer: s152-40(1A).)

The definition of affiliate has been expanded by the enactment of the Tax Laws Amendment (Measures No.2) Bill

2009. The law now provides for the following process:

Step 1: Treat the spouse or child under 18 years as an affiliate of the individual; if by so doing an asset

becomes an active asset for the purposes of s152-40, apply step 2, and

Step 2: Treat the spouse or child under 18 years as an affiliate for the purposes of subdivision 152-A and

sections 328-110 to 328-115 (meaning of small business entity, turnover and connected entity).

Significant individual in relation to a trust

In certain circumstances, access to the CGT small business concession will require the identification of a

‘significant individual’ and/or a ‘CGT concession stakeholder’ in relation to trust. This will be the case where:

the CGT asset consists of a share in a company or an interest in a trust, or

a trust seeks to access the 15-year asset exemption, or the retirement exemption.

A ‘significant individual’ in relation to a trust is an individual who has a ‘small business participation percentage’ in

the trust of at least 20%.

CGT concession stakeholder

A ‘CGT concession stakeholder’ in relation to a trust is a significant individual, or the spouse of a significant

individual having a ‘small business participation percentage’ in the trust greater than zero.

A ‘small business participation percentage’ in relation to a trust is a direct and/or indirect interest, measured as

follows:


Fixed trust

percentage entitlement to any income distributed, or

percentage entitlement to any capital distributed.

Non-fixed trust

if the trustee makes an income distribution, the percentage entitlement of the beneficiary, or

if the trustee makes a capital distribution, the percentage entitlement of the beneficiary.

Important: Where the income and capital percentage entitlements differ, use the smaller percentage.

The maximum number of CGT concession stakeholders in relation to a trust is eight (ie. four individuals each

holding a 20% interest, and their spouses each having a small business participation percentage greater than

zero).

Example 1

Bland Family Trust: Year ended 30 June 2013

John Jones is a significant individual in relation to the Bland Family Trust (small business participation percentage is

80%).


Example 2

1: Distributions of income in respect of the year ended 30 June 2013

2: Fixed interests held

3: Capital gain derived by the Unit Trust in the 2013 year

Small Business Participation Percentage in Manufacturers Unit Trust:

Barney: 90% x 50% = 45%

Betty: 10% x 50% = 5%

CGT Concession Stakeholders of the Manufacturers Unit Trust are therefore:

Barney: Significant individual (interest at least 20%)

Betty: Spouse of a significant individual and holding a small business participation percentage of more than

zero.

Accessing the 15-year exemption

A trust can utilise the 15-year exemption concession if it meets the basic conditions (in s152-10), and the

following additional conditions:

the trust has owned the CGT asset continuously for a period of at least 15 years ending just before the

CGT event

the trust had a significant individual for the period/s totalling 15 years during the period of asset

ownership (it does not have to be a continuous period, or be the same significant individual), and

a significant individual just before the CGT event is either:


- age 55 or over at the time of the CGT event, and the event happens in connection with that

individual’s retirement, or

- permanently incapacitated at that time.

Important: It is only necessary that one significant individual be at least 55 years of age.

For the purpose of determining whether a discretionary trust has had a significant individual for a period of 15

years:

distributions of income or capital of at least 20% will make a beneficiary a significant individual in

respect of that year, and

if the trust made no distribution of income or capital in a particular year as the trust had a tax loss or no

taxable income, the trust is deemed to have a significant individual for that year.

Payment of exempt amount to beneficiary

Where a capital gain is disregarded under the 15-year exemption, and the disregarded amount is paid to a CGT

concession stakeholder within two years after the CGT event, the amount is treated as non-assessable non-

exempt income in the hands of the CGT concession stakeholder.

Where such an exempt amount is received by a beneficiary of a fixed trust, the exempt amount does not trigger a

CGT event E4.

Payments to CGT concession stakeholders cannot exceed the stakeholders small business participation

percentage interest in the trust.

In the case of a discretionary trust, CGT concession holders are taken to be entitled to equal shares of the exempt

amount.

Accessing the retirement exemption

A trust can utilise the retirement exemption if it meets the basic conditions (in s152-10), and the following

additional conditions:

the trust has a significant individual just before the CGT event, and

the trust makes a payment to at least one CGT concession stakeholder.

A trust may choose to disregard a capital gain under the retirement exemption up to a maximum of the CGT

retirement exemption limit of $500,000 for each CGT concession stakeholder. If the trust has more than one CGT

concession stakeholder, the trust must nominate a percentage entitlement of each stakeholder to the CGT

exempt amount in writing. The percentages must not exceed 100%.

The percentage entitlement of a CGT concession stakeholder to a CGT exempt amount does not have to be

proportional to the individual’s participation percentage in the trust. For example, a person having an entitlement

to 20% of trust income or capital can be nominated to receive a greater or lesser percentage of a disregarded

gain.


Payment to CGT concession stakeholder

A trust is required to make a payment to a CGT concession stakeholder(s) if:

the trust receives an amount of capital proceeds from a CGT event in relation to which the retirement

exemption is chosen, or

the disregarded capital gain arises from a CGT event J2, J5 or J6 (ie. in relation to a replacement asset

rollover).

Payments to CGT concession stakeholders must be made in proportion to their nominated percentage

entitlement to the CGT exempt amount. The amount paid must be equal to the lesser of:

the amount of the capital gain from CGT event J2, J5 or J6 that the company or trust disregarded

the amount of capital proceeds received, and

the CGT exempt amount.

Where the trust made the choice to disregard a capital gain arising from CGT event J2, J5 or J6, the payment must

be made within seven days of making the choice.

Where the trust receives an amount of capital proceeds from a CGT event and has chosen to utilise the

retirement exemption, the payment must be made by the later of seven days after the trust makes the choice and

seven days after trust receives the capital proceeds.

In the case of the retirement exemption, the choice must be specified in writing – s152-315.

Following amendments contained in Tax Laws Amendment (2009 Measures No. 2) Bill 2009, the law has been

clarified to ensure that the payment of retirement exemption amounts to CGT concession stakeholders through

an interposed entity or entities will not be treated as a dividend, a frankable amount or a deemed dividend under

Division 7A. The payment of retirement exemption amounts will not be deductible to the payer and will be non-

assessable, non-exempt to the recipient.

Where a CGT concession stakeholder is under age 55 just before the payment is made, the payment must be

contributed to a superannuation fund on behalf of the stakeholder.


Case study: The CGT small business retirement exemption

The Hann Family Trust is a discretionary trust with two resident individual income beneficiaries, Don Hann and his

spouse Betty Hann.

For 2013-14, the trustee of the family trust fully distributed the income of the trust in the following proportions:

Don – 85%

Betty – 15%

The Hann Family Trust owns 80% of the units of the Hann Unit Trust. The trust deed of the unit trust provides that all

units carry equal entitlements to distributions of trust income and capital. The deed also provides that the income of the

unit trust is fully distributed each year.

The unit trust carries on a trading business with an aggregated turnover of $1.6 million for the 2013-14 year.

The family trust sold its 80% unit holding in the unit trust to third parties on 28 February 2014 and derived a net capital

gain of $500,000.

The family trust acquired the units on 1 July 2006. At all times from 1 July 2006 to 28 February 2014, the total market

values of the unit trust’s active assets, financial instruments and cash assets has always comprised at least 80% of the

total market values of the trust’s total assets.

The trustee of the Hann Family Trust wishes to apply the CGT small business retirement exemption to the capital gain.

To qualify for the exemption, a number of basic and specific conditions have to be satisfied.


RETIREMENT EXEMPTION

Basic conditions

CGT event

CGT event A1 happened in relation to the units during 2013-14, resulting in a capital gain.

Small business entity

The Hann Family Trust is a small business entity as it is carrying on a business and its aggregated turnover is less than

$2 million.

Active asset test

The units satisfy the active asset test as the total market values of the unit trust’s active assets, financial instruments and

cash assets comprised at least 80% of the total market values of the trust’s total assets for more than half of the period of

ownership by the family trust.

Additional basic condition – units in a unit trust

CGT concession stakeholders

Don is a significant individual (and a CGT concession stakeholder) as he had a small business participation percentage

in the unit trust of at least 20%:

Direct small business participation percentage in the Hann Family Trust 85%

x

Indirect small business participation percentage in the Hann Unit Trust 80%

=

Total small business participation percentage in the Hann Unit Trust 68%

Betty is also a CGT concession stakeholder because she is the spouse of a significant individual (Don) and has a small

business participation percentage in excess of zero.

Direct small business participation percentage in the Hann Family Trust 15%

x

Indirect small business participation percentage in the Hann Unit Trust 80%

=

Total small business participation percentage in the Hann Unit Trust 12%

The Hann Family Trust satisfies the additional condition.

The Hann Family Trust satisfies the additional basic condition in relation to the units in the Hann Unit Trust because CGT

concession stakeholders in the unit trust together have a small business participation percentage in the family trust of at

least 90%:


Don’s direct small business participation percentage in the Hann Family Trust 85%

+

Betty’s direct small business participation percentage in the Hann Family Trust 15%

=

CGT concession stakeholders’ total small business participation percentage in

the Hann Family Trust 100%

Additional conditions – retirement concession

Significant individual / CGT Concession stakeholders

Don is a significant individual in relation to the trust just before the CGT event as he had a small business participation

percentage of at least 20% and is therefore a CGT concession stakeholder.

Betty is not a significant individual as she did not have a small business participation percentage of at least 20% however

as she has a percentage greater than zero and is the spouse of a CGT concession stakeholder, she also qualifies for

that status.

Trust payments

The trust makes payments in accordance with s152-325 ITAA97.

PAYMENTS

In order to qualify for the retirement exemption, the trust must pay the lesser of the proceeds received from the sale or

the amount of the capital gain to at least one CGT concession stakeholder.

Both Don and Betty are CGT concession stakeholders in relation to the trust:

Don is a significant individual

Betty is the spouse of a significant individual with a small business participation percentage in the trust of

more than zero.

The trustee of the family trust resolves to apply the retirement exemption and make payments to the CGT concession

stakeholders in the following proportions:

Don $350,000

Betty$150,000

The trustee must document the proportions chosen.

Note: The capital gain may be distributed to Don and Betty in any proportions provided the total does not

exceed 100% of the gain (refer: s152-315 ITAA97).

Since Betty is under 55 years of age, the trustee is required to contribute the amount of $150,000 to a complying

superannuation fund on Betty’s behalf. Note that this contribution will count towards Betty’s annual non-concessional

contributions cap.

The trustee must pay the amount of $350,000 to Don since he is over 55 years of age. The payment would be made to

Don through the interposed trust. The amount represents non-assessable non-exempt income.

Once the trustee has made the choice to apply the retirement exemption to the capital gain, payment must occur

within seven days of the later of making the choice to access the concession and receiving the capital proceeds.

The trustee may satisfy its obligation in respect of each beneficiary by making the payment in one lump sum or in

multiple tranches.


Re-writing the trust tax laws

In November 2011 the government announced a review of the taxation of trusts.

The announcement acknowledged that the current law was not adequately equipped to deal with modern usage

of trusts, in particular in relation to trading activities and capital gains.

The initial step in the review process was the issue of a paper by Treasury titled ‘Modernising the taxation of trust

income – options for reform’. The paper contained three possible approaches: the patch model, the

proportionate within class model and the trustee assessment and deduction model. Feedback was sought from

interested parties.

In October 2012, a further Treasury options paper entitled ‘Taxing Trust Income - options for reform’ was

published which synthesised the original three models into two, the ‘economic benefits model’ and the

‘proportionate assessment model’.

At the time of writing, there is still no public indication of the approach likely to be adopted by Treasury in

redrafting the law nor of a likely commencement date for the new law.

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