THE SHIP OF THESEUS AND OTHER TRUST PERPLEXIONS. Fiona Dillon Australian Taxation Office

Transcription

1 THE SHIP OF THESEUS AND OTHER TRUST PERPLEXIONS Fiona Dillon Australian Taxation Office

2 Commonwealth of Australia 2012 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth.Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General s Department, Robert Garran Offices, National Circuit, Barton ACT 2600 or posted at Disclaimer: This presentation represents laws and policies at the time it was presented. Persons should m ake appropriate inquiries, check the law for currency, and seek independent advice before acting in reliance on it.

3 Overview Introduction Division 6 Step by step approach Includes streaming of capital gains and franked distributions Treatment of bare trusts Trust resettlements 3

4 Introduction The taxation of trusts is inextricably linked to the general law of trusts Significant legislative change happening or planned in relation to trusts 4

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6 Applying Division 6 1. Calculate the net income (called here the taxable income) of the trust 2. Calculate the income of the trust estate 3. Calculate the share of the income of the trust estate to which each beneficiary is presently entitled 4. Each beneficiary is assessed on that same (percentage) share of the trust s taxable income (and/or trustee assessed on their behalf) (sections 97, 98, 98A) 5. Trustee is assessed on balance of taxable income (sections 99A, 99) 6. Consider modifications if trust has capital gains or franked distributions in or later income year 6

7 Step 1 Calculate trust s taxable income Basically, the taxable income of the trust calculated as though the trustee were a resident taxpayer. 7

8 Step 2 Determine income of the trust estate Subject to deed and settlor s intention If no specific definition would be broadly akin to ordinary income. However, most modern trust deeds define or enable income to be different to (or include amounts in addition to) ordinary income. 8

9 Income equalisation clauses These clauses operate to automatically deem income to include particular components of, or to be equal to, the trust s taxable income (or give the trustee a discretion to do that). Clauses generally not effective in aligning trust income with the trust s taxable income in cases where the trust s taxable income includes notional amounts, which do not represent accretions to the trust estate. Notional amounts include: Franking credits Market value substituted gains. 9

10 Notional amounts - Example Assessable amount greater than entitlement Head trust has $200,000 income of the trust estate but $1.2M taxable income Interposed trust entitled to the $200,000 and has an income equalisation clause That is, its income is purportedly $1.2M, but only $200,000 has come in. Interposed trust makes company beneficiary entitled to the $200,000 Is trustee of Interposed trust assessed on $1M of taxable income corresponding to income to which no beneficiary is presently entitled? 10

11 Notional amounts Example cont. Gain - $1M (taxable) Rent $200K Trust income = $200K $200K (100% of income) Trust income = taxable income $200K income Trust 1 Trust 2 $1M capital Family members Company 11

12 Step 3 Present entitlement A beneficiary is presently entitled to income if they can demand immediate payment of the income (or could if not under a legal disability). Present entitlement of a beneficiary is not affected by: Whether or not the amount has been precisely ascertained at year end. Whether or not the trust has the funds available for immediate payment. Only beneficiaries can be presently entitled. Clauses in the deed may deem present entitlement if trustee fails to exercise discretion (so called default beneficiary clauses). 12

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14 Present entitlement after 30 June? Beneficiaries must be presently entitled by end of the income year. Previous administrative practice to allow until 31 August for present entitlement to arise. Administrative practice had limited application could not apply where the deed requires income to be appointed (or automatically appoints income) by 30 June. Increasingly common in litigation for taxpayers to argue that resolutions made under administrative practice are not effective. Administrative practice withdrawn from 1 September 2011 Education campaign: 14

15 Step 4 Assessed on proportionate share 15

16 Nominal distribution to exempt entity - example The trustee of a trust derives $1000 sales income Under a power in the deed, the trustee determines that only $100 of this forms part of the income of the trust The trustee makes a charity presently entitled to all (100%) of the income of the trust estate ($100 as determined) The charity is assessed on the $1000 taxable income (this is exempt) Other beneficiaries enjoy the remaining $900 in the form of a capital distribution [New s100ab may apply here] 16

17 Nominal distribution to exempt entity example cont. $1000 sales Trust income determined to be $100 $100 Trust Charity $900 Family members 17

18 Anti-avoidance rules for exempt beneficiaries Two rules Pay or notify within two months Exempt entity only assessed on the share of amounts representing trust s total taxable income to which it is entitled. Under both rules, trustee is assessed instead Discretion not to apply rule if it would be unreasonable 18

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20 Un-dissected proportionate share Amounts assessed to beneficiaries under section 97 bear no particular character for tax purposes Confirmed in Commissioner of Taxation v. Greenhatch (though taxpayer has sought special leave to appeal to the High Court) Conduit theory High Court decision in CPT Custodian has cast doubt on the conduit theory ATO now thinks as a general rule that there is no character flow-through

21 Step 5 Trustee assessed on balance Administrative practice Period of review Trustee at year end has liability Alternative assessments 21

22 Step 6 apply streaming provisions Interim amendments ensure the tax effective streaming of franked distributions and capital gains for the and later income years net capital gain now assessed under Subdivision 115-C franked distributions now assessed under Subdivision 207-B Division 6E adjusts amount assessed under Division 6 to avoid double tax Issues remain as to the tax effectiveness of other streaming (e.g. streaming foreign income to nonresidents) 22

23 Applying the streaming provisions Streaming not prevented by deed Capital gains and franked distributions assessed to beneficiaries who are specifically entitled to them - Specifically entitled entitlement condition financial benefit recording condition timing If no beneficiary specifically entitled to some part of gain or distribution, then assessed proportionally 23

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25 Other issues Division 6 is not a code s6-5 assessments controversial Issues with CGT event E4 Division 7A interactions trust entitlement can be loans for Division 7A purposes 25

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27 Treatment of bare trusts Federal Court says: Colonial (Jan 2011) - Colonial held units in a wholesale fund via a bare trust (a custodian) - Held: Colonial was a beneficiary of the wholesale fund Howard (Dec 2011) - Howard held shares via two trusts, top one a bare trust (a nominee) - Held: nominee trust could not be ignored; bare trustee was shareholder for purposes of buy-back provisions 27

28 Administrative approach to bare trusts Special rules required to look-through all socalled bare trusts? Administrative Practice Colonial DIS amended PSLA 2000/2 28

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30 Trust resettlements Trust in Clark not a new taxpayer no resettlement In addition to highlighting need for capital loss rules, Clark suggests no resettlement unless trust terminated Statement of Principles withdrawn TD 2012/D4 issued 13 June 2012 Valid amendments will not resettle trust 30