Changes to the taxation of trusts

Following on from the decision of the High Court in Commissioner of Taxation v Bamford (2010) HCA 10, tax law amendments have been enacted to address a number of uncertainties arising from that decision. The changes are an interim measure pending a broader review of the taxation of trusts.

The Bamford case confirmed that the proportionate approach applies to the taxation of beneficiaries. Under the proportionate approach beneficiaries are taxed on the trust’s taxable income in the same proportion as their entitlement to trust law income.

The decision created uncertainty as to the ability of trustees to stream categories of income to particular beneficiaries of a trust for tax purposes.

Amendments have now been introduced to specifically accommodate the ‘streaming’ of capital gains and franked distributions (dividends) to beneficiaries of a trust. The changes apply from 1 July 2010 and will be reflected in trust income tax returns for the year ended 30 June 2011.

Streaming provisions in a trust deed give the trustee the power to distribute a specific class or category of income to one beneficiary to the exclusion of other beneficiaries. Streaming allows flexibility in tax planning as discount and concessional capital gains and franked dividends can be distributed to beneficiaries who are best able to use franking credits or who can take advantage of concessional capital gains.

It should be noted that streaming is not possible unless a trust deed provides a trustee with the power to stream. Most modern trust deeds will have the necessary streaming clauses. Older trust deeds may not and will require variations to accommodate the new changes.

Under the amended law, a beneficiary needs to be made specifically entitled to a franked distribution or capital gain. For franked distributions a beneficiary’s entitlement must be recorded in the accounts or records of the trust by no later than the end of the year of income. For the 2011 income year only, the Commissioner, under an administrative concession, will allow a trustee to record the entitlement by 31 August 2011.

A beneficiary’s specific entitlement to a capital gain must be recorded by a trustee by 31 August of each year. This will ordinarily be done in a trustee’s resolution. The Commissioner will accept a beneficiary’s specific entitlement expressed as a dollar amount or as a precise methodology for determining the dollar amount eg the amount of franked distribution remaining after application of directly relevant expenses.

The Commissioner has advised that in respect of the 2011 income year, cases will not be selected for audit for the sole purpose of determining compliance with the new streaming provisions, unless clear and material abuse exists. However, taxpayers can expect no such reprieve in future years.

The changes have made the administration of trusts more complex. Trustees and their advisers must ensure that they understand the new law and work within its parameters.

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