Taxation of Trusts Australia

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Book on the taxation of trusts Australia
Whilst there are no inheritance taxes in New South Wales, capital gains tax and income tax are ever present. When dealing with family trusts, proper
estate planning requires a consideration of the six methods for assessing trust income.

Below is an explanation of taxation of trusts Australia. It does not apply to superannuation trusts, which are subject to the Superannuation Industry (Supervision) Act 1993.

Before discussing the six methods of taxation income assessment, there are three key terms that need to be defined.

  • Legal disability definition: Legal disability is defined by case law, as legislation has not given any such definition. A person is considered to have a legal disability when they fall under one of the following classes: Minors (anybody under 18; Bankrupts who have not been discharged; Persons who are determined to be mentally incompetent; Felons (criminals);
  • Present entitlement definition: Beneficiaries have present entitlement to trust income where they have an indefeasible vested interest in possession (ie. A right to present enjoyment). The monies need not have been received for the beneficiary to be presently entitled to them. The concept of present entitlement is illustrated in FCT v Whiting (1943) 68 CLR 199 and includes the beneficiary’s right to demand an immediate payment of their portion of a trust’s net accounting income. Taylor v FCT 70 ATC 4026 which demonstrates that the notion of present entitlement also covers beneficiaries who would have rights to payment if not for their legal disability. Statute also extends the breadth of present entitlement:s95A(2) ITAA 1936 allows trust beneficiaries with a ‘vested and indefeasible interest’ in income which they are not ‘presently entitled’, to be ‘deemed to be presently entitled’ to that income. s101 applies only to discretionary trusts. It deems a beneficiary ‘to be presently entitled’ to the amount of trust income that the trustee has applied for the beneficiary’s benefit.
  • Australian resident trust definition: This is where any of the trustees is an Australian resident or if the control and management of the trust is in Australia at any time in the year of income (s95(2)).

The trustee is to pay tax on behalf of either the trust or a beneficiary. The trustee is liable if there is an insufficiency of trust assets to indemnify him.

Taxation of trusts Australia: 6 methods of assessing income

1. When a beneficiary isn’t under legal disability and is presently entitled

Where a beneficiary is not under legal disability, and is presently entitled, their portion of the trust income to which they have present entitlement will be included in their assessable income (s97(1)). This amount is included in the beneficiary’s other assessable income, and tax is paid (after deductions) on their taxable income at their marginal rate.

2. When a beneficiary is under legal disability and is presently entitled

Where the beneficiary is under a legal disability, and is presently entitled, the tax on this portion of trust income is to be paid on the beneficiary’s behalf by the trustee (s98(1)).

Should the beneficiary have other income, their share of the trust income is included in their assessable income, so they may obtain a credit for the tax the trustee has paid (s100).

Where s98(1) applies:

  • For a beneficiary who is a non-resident (at any time except on 30 June): tax is paid by the trustee at the beneficiary’s marginal rate on their share of the trust net income derived from Australia (while they were a non-resident) and their portion of the worldwide net income of the trust (while they were a resident);
  • For a beneficiary who is a minor: Div 6AA requires that penal tax rates are applied to minors’ (‘prescribed persons’) unearned income.
      • The penal tax rates apply to prescribed persons unless they are ‘excepted persons’ under s102AC(2) – being persons in a full-time job on the final day of the income year, or incapacitated or handicapped. 
      • The income of prescribed persons is taxed as eligible assessable income using penal tax rates unless it is “excepted assessable income” (s102AE(1)) – i.e. income from employment or business.

3. When an individual beneficiary isn’t legally disabled but is presently entitled

If the beneficiary is an individual, not legally disabled, and deemed to be presently entitled under s95A(2), the tax is to be paid by the trustee on behalf of the beneficiary at the beneficiary’s marginal rate (s98(2)).

If the beneficiary has non-trust income, then the share of trust income is included in the beneficiary’s assessable income (s100(1)), and a credit for tax the trustee has paid can be obtained (s100(2)).

4. When the beneficiary is a non-resident and presently entitled

Where the beneficiary is a non-resident, and presently entitled to trust income, then the trustee pays tax for the beneficiary:

  • At the beneficiary’s tax rates: ss98(2A), 98(3) on the net income of the trust attributable to Australian sources
  • If the beneficiary is a trustee of another trust which has a non-resident trustee: s98(4), then the trust pays tax on the beneficiary’s share at 45% (47% for the next 3 years).

The beneficiary’s portion of trust income is to be included in their assessable income, and a tax credit will be given for the tax paid by the trustee (s98A).

5. When there are no presently entitled beneficiaries

Should there be no presently entitled beneficiaries, then the trustee pays tax using either the s99A penalty tax rates, or the s99 rates. Both provisions may be applicable for the same trust income.

Sections 99A and 99 require that for Australian-resident trusts, the trustee pays tax on the worldwide income of the trust; and if non-resident, the trustee pays tax only on the trust’s Australian-based income.

Sections 99A and 99 tax rates are as follows:

  • s99A: 45% plus Medicare levy (1.5%) totalling 46.5%, and increasing to 49% for 3 years from 2014-15. The Medicare levy, if the trustee is assessed under s99A, is not included if the trust is a deceased estate.
  • s99: the s99 rates only apply where s99A is not applicable and the beneficiary is not presently entitled. s99A(2) contains examples of where s99A does not apply, for example, where a trust results from a will or bankruptcy, and the Commissioner believes it unreasonable to apply s99A.
    • If the resident trust estate is of a person who died within 3 years before the conclusion of the income year, the trustee is taxed (under s99) under the same rates as for resident individuals. Otherwise, the trustee is taxed under s99 rates which are as follows:
      2013-2014 s99 tax rates

Share of net income                   Tax on Column                              1 % on excess
$416                                                 Nil                                                        50
$670                                               $127                                                      19
$37,000                                           $7,030                                                  32.5
$80,000                                           $21,005                                                 37
$180,000                                         $58,005                                                45

  • The Medicare levy may also be required under s99, unless if the trust is a deceased estate.

6. When it’s a revocable trust or the settlor’s children are presently entitled and under 18

The Commissioner can apply s102 and tax the trustee using the settlor’s marginal tax rates (s102) on that part of the net income in the case of:

  • a revocable trust (where settlor can alter or revoke beneficial interests in the trust) 
  • a trust where the settlor’s children are both under 18 and presently entitled 

To avoid this, it is advisable to have the settlor be a person who is outside of the family.

So there you have it: the 6 methods of assessing income for taxation of trusts in Australia.

Problems with tax on trusts’ income

It should be kept in mind that distributable income is not the same as net income. Where net income is greater than distributable income, there are two approaches that may be taken – the quantum or the proportionate approach. The proportionate approach is the correct approach, as held in FC of T v Bamford & Ors [2010] HCA 10.

  1. The proportionate approach allows the beneficiary to include their portion of the net trust income in their assessable income.
  2. The quantum approach is where the beneficiary includes in their assessable income the distributable income to which they are presently entitled.

However, if distributable income exceeds net income, the excess distribution (over the beneficiary’s share of net trust income) is not subject to tax, although there may be implications with capital gains tax if the trust is fixed or a unit trust.

Income streaming

Income streaming requires different income types and sources to be accounted for separately. However, post Bamford and FCT v Greenhatch [2012] FCAFC 84, where a trustee is permitted by a trust deed to stream income to a particular beneficiary, the tax liability is not shifted from the presently entitled income beneficiaries to the beneficiary who receives the streamed amount.

2011 reforms

A statutory mechanism was introduced in 2011, and allows the streaming of franked distributions and capital gains in trusts in certain circumstances.

From 2010-2011 onwards, where the beneficiary is ‘specifically entitled’ by the trustee to the franked distribution amount or capital gain, streaming is effective for tax purposes. Prior to this, the two had been taxed under the Division 6 rules.

The 2011 trust reforms introduced a multi-step process, which accounts for franked distributions (under Subdiv 207-B of ITAA 97) and capital gains under Subdiv 115-C of ITAA 97.

Further issues

Family trusts: If a family trust election (s272-75 of Sch 2F of ITAA 1936) is made (making the trust a family trust), a specified individual must be nominated as the test individual – and thereafter, any distribution made is to the family group of the test individual, or to an entity which has elected to be part of this family group.

Should the family trust make a distribution to a non-family group member, the trustee becomes subject to family trust distribution tax equivalent to 46.5% (s271-10 Sch 2F), increasing to 49% for 3 years from the 2014-15 year.

Generally, discretionary trusts elect to be family trusts where:

  • There are prior year losses. The threshold tests to claim a tax deduction for prior year losses are much easier to pass for family trusts that have made the election than for those which have not.
  • Franked dividends have been derived from shares acquired after 31/12/1997. Beneficiaries of discretionary trusts are usually not entitled to franking tax offsets for trust distributions (such as franked dividends), unless it is a family trust. The exception is for individual beneficiaries with franking credits of $5000 or smaller.

Contact our Will and Estate Lawyers today for further advice about planning for your family’s future.

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