Example Trustee Resolutions for Trust Supplement

Transcription

1 2016 Trust Supplement

2 Disclaimer The National Tax and Accountants Association Ltd (NTAA) and the seminar presenters do not hold an Australian Financial Services Licence to provide financial product advice under the Corporations Act 2001 (Cth). This material covers general taxation information which is only one factor to consider when making a decision on a financial product. If you are seeking financial product advice, you should contact a person who is licensed under the Corporations Act These notes are intended to be a guide only. None of the comments contained in these notes are intended to be advice, whether legal, financial or professional. You should not act solely on the basis of the information contained in these notes because many aspects of the material have been generalised and the tax laws apply differently to different people in different circumstances. Further, as tax and related laws change frequently, there may have been changes to the law since the notes were written. Specific advice should always be obtained from a tax professional. The NTAA, its directors, employees, consultants, contractors and authors expressly disclaim any and all liability to any person, whether a purchaser or not, for the consequences of anything done or omitted to be done by any such person relying on a part or the whole of the contents of this publication. Copyright Copyright 2016 National Tax & Accountants' Association Ltd. All rights reserved. Except as permitted by the Copyright Act 1968, no part of these notes may be reproduced or published in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without prior written permission from NTAA. Law The law is stated as at 1 May 2016.

3 Supplement to example trustee resolutions for the 2016 income year General overview As 30 June 2016 fast approaches, trustees will need to start turning their minds to the documentation they need to put in place to make beneficiaries presently entitled to trust income. For trustees to avoid a S.99A assessment (at the top marginal rate of 49%, inclusive of the Medicare levy and the Budget repair levy) or to prevent a default beneficiary clause from taking effect, it is crucial that all relevant and necessary decisions are made no later than 30 June 2016, or even potentially earlier depending on the trust deed. To assist with this process, you have been provided with two example trustee resolutions as well as an example minute of meeting. All documentation provided has been specifically designed to be used in conjunction with the NTAA Corporate Discretionary Trust Deed ( the deed ). TAX WARNING Resolutions for NTAA Corporate deeds only The two example resolutions and the minute of meeting have been specifically designed for trustees who are governed by the NTAA Corporate Discretionary Trust Deed. The determination and distribution of trust income (including the streaming of capital gains and/or franked dividends) are based on specific powers contained in the deed. The wording in the documents has paid particular heed to ensuring that such determination and distribution are effective for trust and tax purposes. The NTAA strongly advises trustees against using the resolutions or minute where they are not governed by the NTAA Corporate Discretionary Trust Deed, unless legal advice has been sought as to their suitability (or otherwise). The NTAA can offer no guarantee that they are effective for any purpose other than the one for which they have been designed. Each of the documents is designed to be used in the following circumstances: Example resolution 1 This example resolution is designed to be used by trustees who are not seeking to stream either a capital gain or franked dividends. A meeting is not required, but the resolution must be signed and dated no later than 30 June 2016 (by all trustees, or directors of the corporate trustee). Example minute of meeting 1 This is to be used in the same circumstances as Example resolution 1 but where the resolutions are passed at a meeting (i.e., of directors or individual trustees). The meeting must be held no later than 30 June 2016, however the minute recording the meeting may be prepared and signed after year end. Example resolution 2 This example resolution is designed to be used by trustees who are seeking to stream capital gains and/or franked dividends included in trust income. The resolution must be signed and dated no later than 30 June Example resolutions 1 and 2 assume the trustee is a company (although this can be modified for individual trustees) and are circulating resolutions. This means there is no need for a meeting if there are multiple directors. The resolution will take effect when the last director (or the sole director) signs it. If the trustee/s are one or more individuals, the note regarding it being a circulating resolution can be removed.

4 WARNING Reading this document is essential The example resolutions and minute of meeting ( the documents ) are to be used and understood in the context of this supplement. The supplement further explains terminology used in the example resolutions and minute of meeting. Each of the documents have certain assumptions built into them and therefore may not be suitable (i.e., may not achieve the desired tax outcomes) in some circumstances. We have set out below a more detailed explanation of each example document, including the assumptions that have been made. In all cases, and particularly if none of the documents are appropriate or reflect your specific requirements, the NTAA recommends that specialist advice be sought as to the exact form the trustee resolutions or minute of meeting should take. Whilst the documents have been prepared for use in common scenarios, there may be unforeseen factors that render them inappropriate for a particular client. The NTAA accepts no liability for inappropriate use of the documents. Meaning of income for accounting purposes Under Example resolution 1, the trustee determines that the income of the trust for the year ending 30 June 2016 comprises: all those amounts that are income for the purposes of the accounting records; less the expenses and outgoings properly attributable to that income for the purposes of the accounting records. This determination also forms the basis for Example resolution 2 (which additionally includes the amount of any capital gains after the recoupment of any current year and carried forward capital losses for trust purposes). The above determination is consistent with the trustee s powers under the deed and the relevant case law. As stated in Zeta Force v FCT [1998] FCA 728 and endorsed in Bamford v FCT [2010] HCA 10: The words income of the trust estate in the opening part of s 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument [Emphasis added]. ATO draft ruling sets statutory cap on income Whilst the income of the trust can be determined in accordance with the trust instrument (i.e., the deed), the ATO does not automatically agree that the income so determined will necessarily be the income of the trust estate for S.97 purposes. The ATO has set out its views in this regard in TR 2012/D1 ( draft ruling ), as follows: The income of the trust estate in the context of Division 6 (of Part III of the ITAA 1936) is a reference to the net amount of income to which a beneficiary can be made presently entitled. That is, it is the income available for distribution (often referred to as the distributable income ). Irrespective of how the trust deed defines income, the Division 6 income of the trust estate must be represented by a net accretion to the trust estate for the relevant year. As a consequence, the ATO view sets a statutory cap by providing that the income of the trust estate cannot exceed the sum of: (i) the accretion to the trust estate (whether property, cash or value); less

5 (ii) any accretions that have not been allocated to income; less (iii) any depletions to the trust estate (whether property, cash or value) that have been allocated as chargeable against income. The main thrust of the ATO s argument is that, if part of the income (as determined in accordance with the deed) represents a notional amount or a tax fiction, it is not capable of being distributed and therefore cannot form part of the income of the trust estate for Division 6 purposes. Often these notional amounts form part of the trust s net (taxable) income. They are recognised for tax purposes but do not involve an accretion to the trust estate. The draft ruling cites the following as examples of notional amounts : A franking credit; So much of a capital gain that is attributable to the operation of the market value substitution rule (i.e., the part of capital gain attributable to a deemed reduction in the cost base and/or a deemed increase in the capital proceeds); and A deemed dividend under Division 7A. There is an exception to the rule regarding notional income amounts. It is acceptable for these amounts to be included in trust income where they are matched by notional expense amounts. Where this is the case, the statutory cap will not be exceeded. A notional expense is one that is an allowable deduction but does not represent any depletion (in cash or value) of the trust estate (or where the depletion is coupled with a corresponding accretion). By way of example, the draft ruling provides that where deductions for depreciation exceed the depletion of the trust estate, the excess would be a notional expense. That is, if a trust was allowed a $20,000 deduction for depreciation but those assets only decreased in value by $15,000, the excess $5,000 would be a notional expense amount as it does not represent a depletion of the trust estate. This would justify the inclusion of up to $5,000 of franking credits in the income of the trust estate (assuming this is allowed by the deed), as the statutory cap would not be exceeded. (Note: it should not be assumed there is necessarily any benefit from having the franking credits included in trust income in these circumstances). Where the deed allows, the ATO takes no issue with reducing the income of the trust by the excess of notional deductions over notional income (if any). This, of itself, does not compromise the ATO s view that the amount of the income must be distributable, i.e., it is something which a beneficiary can be made presently entitled to. How are the example resolutions affected by the statutory cap? Both example resolutions (and the minute of meeting) have been designed to ensure there is limited risk that the income determined by the trustee will exceed the statutory cap. The reference in both resolutions to income for the purpose of the accounting records assumes the trustee has determined the trust income without reference to notional income amounts. For example, franking credits will not (under ordinary accounting principles) be included in trust income. Likewise, a reference to expenses and outgoings properly attributable to that income for the purposes of the accounting records assumes the trustee does not charge against that income any notional deduction amounts. For example, a deduction under Division 43 (building write-off) is not ordinarily charged against the trust income. To the extent there are amounts (income or expenses) that are not taken into account in the determination of trust income (i.e., they have a different treatment for tax purposes), they are simply treated as reconciliation items in the trust s income tax return. In relation to Example resolution 2, the trust income is specifically stated to include capital gains less any unrecouped capital losses.

6 The following table outlines several common income and expense items and how they should generally be treated (assuming the accounts are prepared using ordinary accounting principles) when calculating trust income for the purposes of the example resolutions and minute of meeting. Income / expense item Franking credits Capital gains Deemed capital gain Unrealised gains/losses Div.7A deemed dividend due to loan Capital works deduction under Division 43 Expenses disallowed for tax purposes Expenses that do not involve an actual outgoing Depreciation Treatment / Explanation Whilst they form part of net (taxable) income, they are not included in trust income. They are considered to be a notional amount as they do not represent an accretion to the trust estate. Whilst they represent an accretion to the trust estate, they do not form part of income for accounting purposes. However, under Example resolution 2 the trustee specifically determines to include these amounts (less unrecouped capital losses) in trust income. However, refer below regarding deemed capital gains. Where all or part of a capital gain is attributable to the operation of the market value substitution rule, it is considered to be a notional amount as it does not represent an accretion to the trust estate. It is therefore not income for accounting purposes. Refer also to the warning on Example resolution 2. Whilst these may represent an accretion/depletion to the trust estate, they do not form part of income for accounting purposes. The amount of a loan deemed to be a dividend under S.109D or S.109E is considered to be notional as it does not represent an accretion to the trust fund, and therefore does not form part of income for accounting purposes. The conservative approach is to treat this deduction as a notional expense as it does not clearly represent a depletion to the trust estate. It is not offset against income for accounting purposes. Where an expense would be properly charged against income for accounting purposes, the fact that it is not tax deductible does not alter its treatment, i.e., it may still be recognised for accounting purposes. Expenses such as entertainment or fines may fall into this category. Where an amount is tax deductible but does not involve an actual outgoing, there is no depletion to the trust estate. The deduction is notional and is not offset against the income for accounting purposes. Depreciation is based on the premise that depreciating assets decrease in value over time. As such, it generally represents a depletion to the trust estate and is therefore not a notional amount. Accordingly, it can be charged against the income for accounting purposes. The draft ruling states that, if the depreciation expense actually exceeds the decrease in value of the depreciating assets, the excess is a notional amount. This is problematic as it presupposes that the trustees will obtain valuations of all depreciating assets to determine if there is notional amount, which is very onerous, and in many circumstances, unnecessary (however, a notional expense will not cause a trust to breach the statutory cap). In most cases it is suggested that the depreciation in the accounts would serve as a reasonable approximation of the decrease in value of the depreciating assets unless there is evidence to the contrary.

7 Example resolution 1 (No streaming) When to use this resolution This resolution is designed to be used where the trustee is not seeking to stream capital gains or franked dividends to a particular beneficiary. This may be the case where: The trustee has not derived any capital gains or franked dividends; The trustee has derived capital gains and/or franked dividends, but is not seeking to stream them (i.e., the trustee is comfortable with them being distributed proportionately to each beneficiary presently entitled to trust income); or The trustee has derived a capital gain but it is reduced to nil by unrecouped capital losses and/or the CGT small business concessions. WARNING Resolution to be signed no later than 30 June 2016 The trustee must ensure that this resolution is signed no later than 30 June Regardless of the number of persons required to sign the resolution, all parties must have signed no later than 30 June Where this does not occur the following will happen: 1. The trustee will not have determined the trust income, thereby causing the default definition in the deed to apply (i.e., trust income will basically equal net (taxable) income); and 2. The trustee may not have distributed the trust income, thereby causing the default distribution clause in the deed to apply. WARNING 11.30pm deadline Under the NTAA Corporate Discretionary Trust deed, the default distribution clause will apply unless a valid and effective distribution resolution is made by 11.30pm on 30 June All references to actions needing to be taken no later than 30 June 2016 in this supplement should be read as references to such actions needing to be taken prior to 11.30pm on 30 June 2016.

8 Assumptions made in this resolution This resolution makes the following assumptions that trustees must be aware of: The trust has a corporate trustee; The directors of the trustee will not hold a meeting, but will instead pass the relevant resolution by signing and dating a written record of the resolution; It is appropriate in the circumstances that the trustee determines that the income of the trust for the year ending 30 June 2016 comprises: (i) (ii) all those amounts that are income for the purposes of the accounting records less the expenses and outgoings properly attributable to that income for the purposes of the accounting records; It is appropriate in the circumstances that only amounts representing income for accounting purposes will be treated as income, and in particular: (i) That no part of any capital gain (i.e., the taxable part or otherwise) derived by the trustee will be included in the income of the trust; and (ii) That no franking credit attached to any franked dividends received by the trustee will be included in the income of the trust; The trustee is not seeking to stream any class of income (e.g., capital gains, franked or unfranked dividends, interest, foreign income, etc.). Do not use this resolution This resolution should not be used in any of the following circumstances: The trustee is seeking to modify income. That is, the trustee is seeking to determine the income of the trust by treating amounts other than in accordance with their treatment for accounting purposes (for example, the trustee wants to include all or part of a capital gain or a franking credit as income of the trust); and/or The trustee is seeking to stream any class of income. Non-NTAA Corporate Trust Deeds This resolution has been specifically developed to be used by a trustee governed under an NTAA Corporate Discretionary Trust Deed and then only in accordance with the circumstances detailed in this supplement. It should not be used or relied upon by a trustee who is governed under a non-ntaa Corporate Discretionary Trust Deed, or an NTAA Corporate Discretionary Trust Deed that has been varied from its original terms (without obtaining independent legal advice that it can so be used or relied on). The NTAA can offer no guarantee of its suitability for any purpose other than that for which it was designed.

9 Example minute of meeting (No streaming) This minute of meeting is designed to be used in the same circumstances as Example resolution 1, being where the trustee is not seeking to stream capital gains and/or franked dividends. The differences between the two documents relate to: The manner in which the trustee makes the beneficiaries presently entitled to the trust income; and The timing of its preparation. The minute (as opposed to the resolution) is only to be used where the trustees/directors hold a meeting to determine and distribute the trust income, and the conduct of the meeting is as set out in the minute which is signed after the meeting has occurred. Whilst the meeting must be held by 30 June 2016, the minute recording that meeting may be prepared and signed after year end. WARNING Minute must be a record of a meeting that is actually held The minute is a written record of a meeting held no later than 30 June If no such meeting is held, the minute must not be used. Where no meeting is held, but a minute purporting to record the meeting is signed, the minute and its contents will be void and of no consequence. Further, the parties to such conduct may expose themselves to criminal liability. The ATO has been known to request corroborating evidence to support claims by taxpayers that meetings have been held. Where the trustee purports to determine and distribute the trust income verbally at a meeting no later than 30 June 2016 (and prepares minutes of meeting after year end), reference should be made to the following excerpts adapted from the ATO s Resolutions checklist. The following text in italics represents the ATO view. Does a resolution have to be in writing? Whether the resolution must be recorded in writing will depend on the terms of your trust deed*. However, a written record will provide better evidence of the resolution and avoid a later dispute (for example, with us or with relevant beneficiaries) as to whether any resolution was made by 30 June. * Note: the NTAA Corporate Discretionary Trust Deed does not require that resolutions can only be made in writing. A written record will be essential if you want to effectively stream capital gains or franked distributions for tax purposes this is because a beneficiary can only be specifically entitled to franked dividends or capital gains if this entitlement is recorded in writing in the records of the trust either: by 30 June for franked dividends; or by 31 August for capital gains. A beneficiary cannot be made specifically entitled to a capital gain included in the income of the trust estate after 30 June if, as a result of the operation of the trust deed, another beneficiary (including a default beneficiary) was presently entitled to it.

10 Will records created after 30 June be accepted as evidence of the making of the resolution by that date? Yes. If a resolution is validly made by 30 June, we will accept records created after 30 June as evidence of the making of a resolution by that date. The following examples show the types of records and circumstances in which we will accept them. Example: Individual trustee On 29 June, an individual trustee writes a note, dated 29 June, stating that they have resolved to distribute the trust income in a certain way. On 15 July, the trustee types the note reflecting the resolution of 29 June and provides a copy to the beneficiaries. We will accept the handwritten or typed notes as evidence of the making of the resolution on 29 June. Example: Corporate trustee The corporate trustees of a larger trust group map out where distributions are to be made, with appropriate percentages. This 'map' is signed by the relevant trustees on 26 June to evidence the resolutions that have been made. On 25 July, the resolutions are recorded in the minutes book maintained by the trustees. We will accept the signed 'map' or minutes book as evidence of the making of the resolutions on 26 June. WARNING The dangers of verbal resolutions The ATO acknowledges that an unwritten decision made by the trustee can create an effective present entitlement at that time. However, from an evidentiary perspective, it is clearly suggested that a written record is preferred as it will likely reduce the capacity for a dispute to arise at a later point in time. The written record need not be sophisticated. The first of the two examples above indicates that a note will be sufficient to record the decisions made by the trustee. The NTAA strongly recommends that trustees do not rely on verbal resolutions alone. There is a higher degree of risk associated with the making of verbal resolutions than ever before, even where the verbal resolution is formally documented by way of a minute of meeting some time later.

11 Example resolution 2 (Streaming) When to use this resolution This resolution is designed to be used where the trustee has derived net franked dividends and/or capital gains, and is seeking to stream either or both of these amounts to one or more particular beneficiaries by making them specifically entitled to them. WARNING Resolution to be signed no later than 30 June 2016 The trustee must ensure that this resolution is signed no later than 30 June Regardless of the number of persons required to sign the resolution, all parties must have signed no later than 30 June Where this does not occur the following will happen: 1. The trustee will not have determined the trust income, thereby causing the default definition in the deed to apply; 2. The trustee s desire to stream any capital gains included in trust income or net franked dividends will be ineffective; and 3. The trustee may not have otherwise distributed the trust income, thereby causing the default distribution clause in the deed to apply. WARNING Minute of meeting may NOT be sufficient for streaming Example resolution 2 must be signed and dated by the trustees/directors no later than 30 June The trustees/directors must not rely on having merely held a meeting by this time and preparing a minute of meeting after year end. You have not been provided with an example minute of meeting where the trustee is seeking to stream capital gains and/or franked dividends. For a beneficiary to be specifically entitled to the net financial benefit attributable to a franked dividend, the amount must be recorded in the accounts or records of the trust no later than the end of 30 June Whilst this includes a trustee s resolution, whatever the recording mechanism, it must be IN WRITING. In relation to capital gains, the entitlement must be recorded in the records or accounts of the trust by 31 August However, where the capital gain is included in trust income, the trustee must deal with it no later than 30 June 2016, or it will be either: - assessed to the beneficiaries presently entitled to the trust income generally; or - subject to a default distribution clause. Example resolution 2 ensures that the beneficiary s specific entitlement to any capital gain is recorded in writing by 30 June If the resolution is not signed and dated by 30 June 2016, only the net capital gain will be included in trust income under the default definition. Further, any attempt to stream it will be ineffective.

12 Whilst it may be technically possible to verbally distribute the capital gain on or before 30 June 2016 and to record it in writing no later than 31 August 2016, Example resolution 2 works on the basis that the distribution of income and the recording of that distribution are carried out no later than 30 June Assumptions made in this resolution This resolution makes the following assumptions that trustees must be aware of: The trust has a corporate trustee; The directors of the trustee will not hold a meeting, but will instead pass the relevant resolution by signing a record of the resolutions; It is appropriate in the circumstances that the trustee determines that the income of the trust for the year ending 30 June 2016 comprises: (i) (ii) (iii) all those amounts that are income for the purposes of the accounting records; less the expenses and outgoings properly attributable to that income for the purposes of the accounting records; plus the gross amount of each capital gain less any unrecouped capital. It is appropriate in the circumstances that only amounts representing income for accounting purposes plus capital gains will be treated as income, and in particular no franking credit attached to any franked dividends received by the trustee will be included in the income of the trust. Apart from capital gains and net franked dividends, the trustee is not seeking to stream any other class of income (e.g., unfranked dividends, interest, foreign income, etc.). The trustee is only seeking to stream capital gains and/or franked dividends in a single class. For example, they are not streaming one capital gain to one beneficiary and another capital gain to a different beneficiary. Do not use this resolution This resolution should not be used in any of the following circumstances: The trustee is seeking to modify income other than only by the inclusion of gross capital gains (as set out in the assumptions above); The trustee wishes to create specific entitlements to capital gain(s) by way of capital distribution(s); and/or Other scenarios in which the effectiveness of the resolution is doubtful, as discussed below. TAX WARNING When not to use Example resolution 2 This resolution should only be used where the trustee has come to the conclusion that the streaming of net franked dividends and/or capital gains will be effective for tax purposes for the 2016 income year. If the trustee has not come to this view or is otherwise unsure, they should consider using Example resolution 1 so as to not risk the resolution not having its intended outcome, even in respect of distributions of other income to beneficiaries. See below for instances where Example resolution 2 may not achieve the trustee s desired outcomes.

13 CGT small business concessions ( SBCs ) Example resolution 2 may not achieve the desired tax outcomes where a trust is able to reduce its net capital gain to nil using the SBCs. This is explained in more detail later on. Net capital gain and/or franked dividend exceeds net (taxable) income Example resolution 2 may not achieve the desired tax outcomes where the net (taxable) income (excluding franking credits) of the trust is less than the net capital gains plus net franked dividends. For example, a trust may have a net capital gain of $50,000 and a rental property loss of $20,000. In that case, the net (taxable) income of the trust is $30,000, which is less than the net capital gain. A problem will arise where the trustee purports to stream the capital gain. The capital gain is only taken to be streamed to the extent the beneficiaries are entitled to receive the net financial benefit referable to the capital gain. Using the above figures, the net financial benefit is $50,000. However, because the income of the trust is only $30,000 (i.e., $50,000 - $20,000), beneficiaries will be only entitled to $30,000 out of that $50,000 net financial benefit (i.e., 60%). Therefore the beneficiaries will only be assessed on $18,000 (i.e., 60% x $30,000) and the trustee will be assessed on the remaining $12,000 under S.99A. The way to avoid the trustee being assessed in this way is to either: Utilise Example resolution 1 (or the minute) under which the capital gain is not streamed. The beneficiaries will then be assessed based on their proportionate entitlement to the trust income of $30,000, and not based on their entitlement to the net financial benefit attributable to the capital gain; or Continue to use Example resolution 2, but do not attempt to stream any part of the capital gain. Note: the exact same analysis applies above where the net franked dividends (or a net capital gain and the net franked dividends) exceed the net (taxable) income of the trust (excluding franking credits). Notional capital gains Where a capital gain has been calculated under the market value substitution rule, it cannot be streamed. It is taxed to the beneficiaries based on their proportionate entitlement to the other income of the trust. On this basis, it is appropriate to use Example resolution 1. This is discussed in more detail later on. Trust derives capital gain and franked dividends only Where a trust has derived capital gains and franked dividends only, there is a trap if the shares are negatively geared, i.e., there are no net franked dividends. If the trustee streams the capital gain, there is likely to be no income remaining to which the beneficiaries can be presently entitled, which means they cannot benefit from the franking credits. In this situation, it is appropriate to use Example resolution 1 which ensures the capital gain is not streamed. The beneficiaries will be entitled to franking credits based on their proportionate share of trust income (which includes the non-streamed capital gain). Explanations In order to effectively stream capital gains and/or franked dividends there are a number of key concepts that must be understood, as set out below. Net franked dividends A franked dividend is only capable of being streamed to one or more particular beneficiaries if there is a net financial benefit referable to the franked dividends and those beneficiaries are specifically entitled to a share of that net financial benefit.

14 Generally, the net financial benefit will be the gross amount of the franked dividends (i.e., the cash dividend) less the expenses relevant to the franked dividends which is likely to be interest on moneys borrowed to acquire the shares in respect of which the franked dividends are derived. The amount left after the application of the relevant expenses is referred to as the net franked dividends. If there are no net franked dividends, then there is no amount to which a beneficiary can be specifically entitled. That is, there is no amount that can be streamed. However, the franking credits will still potentially flow to the beneficiaries based on their proportionate entitlement to the other income of the trust, as illustrated in the example below. EXAMPLE Treatment of franking credits where trust has no net franked dividends During the 2016 income year, the Acme Discretionary Trust ( ADT ) derived the following amounts: Business Income $100,000 Franked dividends $ 7,000 ($3,000 franking credits) $107,000 ($ 17,000) (directly relevant dividend expenses) Trust income $ 90,000 The net (taxable) income is $93,000 (i.e., $90,000 + $3,000 franking credit). Can ADT stream the franked dividend to one or more beneficiaries? No. As the directly relevant expenses exceed the franked dividends, there is no net franked dividends (i.e., no net financial benefit referable to the franked dividends) available for streaming. Who obtains the benefit of the franking credits? Each beneficiary will be entitled to a proportion of the franking credits based on the proportion of the trust income they are presently entitled to. (Technically, the franking credit entitlement is based on the beneficiary s adjusted Division 6 percentage ). However, where there are no net franked dividends, this percentage is the same as the percentage of trust income they are presently entitled to. Assume the $90,000 of trust income is distributed as follows: Ted: the first $1,000 Felix: the next $9,000 Joan: the next $30,000 Kate: the balance (i.e., $50,000) The amount of trust income to which each beneficiary is presently entitled is converted to a percentage and then applied to the total franking credits, as follows: % of income Share of credits Ted: 1.11 $ 33 Felix: $ 300 Joan: $1,000 Kate: $1,667 calculated as: income presently entitled to / $90,000 calculated as: % of income x $3,000

15 TAX TIP Use Example resolution 1 if the trust has no net franked dividends Where a trust has no net franked dividends and has not derived a capital gain (or does not seek to stream it if it has) there is no need to use Example resolution 2. Example resolution 1 will allow the beneficiaries to benefit from any franking credits based on their proportionate present entitlement to trust income. What if a trust has an overall loss? Where a trust has received franked dividends, irrespective of whether there are any net franked dividends, there must be some trust income to which beneficiaries can be made presently entitled in order for those beneficiaries to be entitled to the franking credits. If there is no trust income, then it is not possible for a beneficiary to have an adjusted Division 6 percentage other than nil. As it is this percentage that determines their entitlement to the franking credits, no entitlement exists. Despite the trust having no income, the trust may still have a net (taxable) income due to the inclusion of the franking credits in its assessable income. To the extent the trustee is assessed under S.99A, they are entitled to offset the tax payable with the franking credits, but are not entitled to a refund for any excess credits. EXAMPLE Trust is in a loss position During the 2016 income year, the Beta Discretionary Trust ( BDT ) derived the following amounts: Business loss ($16,000) Franked dividends $14,000 ($6,000 franking credits) ($ 2,000) ($10,000) (directly relevant dividend expenses) Trust income ($12,000) The net (taxable) loss is $6,000 (i.e., ($12,000) + $6,000 franking credits). Can BDT stream the franked dividend to one or more beneficiaries? No. As the trust is in an overall loss, there is no net franked dividends (i.e., no net financial benefit referable to the franked dividends) available for streaming. Can any beneficiary have an entitlement to the franking credits? No. As there is no trust income to which a beneficiary can be presently entitled, it is not possible to have other than a nil adjusted Division 6 percentage. If a beneficiary does not have a share of the franked dividends they cannot be entitled to any franking credits. Accordingly, the $6,000 of franking credits are permanently lost. What if the business loss was $8,000? In this case, there would still be a trust loss of $4,000 but the trust would have a net (taxable) income of $2,000 due to the inclusion of the franking credits in its assessable income. Whilst the franking credits would fully offset any tax assessed to the trustee under S.99A, the excess would be permanently lost.

16 What if a trustee wishes to stream individual franked dividends? Example resolution 2 allows the trustee to stream franked dividends in a single class which is possible as long as there is at least some net franked dividends and at least $1 of trust income. However, if there are no net franked dividends overall, the trustee can still stream those individual franked dividends (and their attached franking credits) where the directly relevant expenses are less than the franked dividend they relate to. Where the trustee wishes to take this course of action, the resolution will need to specifically nominate those franked dividends that are being streamed. As a consequence, the trustee will need to know (no later than 30 June 2016): whether there are any net franked dividends ; and if not, which franked dividends are still capable of being streamed. It may be necessary for the trustee to prepare a separate schedule to be attached to the resolution (whereby such schedule would be noted as forming part of the resolution). In the distribution of income segment of the resolution, the trustee may refer to an attached schedule. Note that there will be no standard format for such a schedule. What is crucial is that the net franked dividends in relation to each share can be identified as having been distributed to one or more beneficiaries. Such a schedule (which includes only shares where the franked dividend exceed the directly relevant expenses) may be formatted, for example, along the following lines: Example Schedule of franked dividends Company Franked dividend Expenses Net dividend BHP $ 7,000 $4,000 $3,000 WES $ 1,500 $1,000 $ 500 RIO $ 6,000 $2,000 $4,000 $14,500 $7,000 $7,500 The total of the net franked dividend amounts of each of the above named shares are distributed to: Mr. Smith: 50% Mrs. Smith: 50% or Mr. Smith: the first $5,000 Mrs. Smith: the balance Does the trustee need to know the exact amounts at 30 June 2016? As long as the trustee is aware of the shares that are showing a profit, it will be sufficient for the trustee to identify the shares in the schedule and to specify the amount or percentage to which each beneficiary is entitled. For example: The total of the franked dividends from shares held by the trustee in BHP, WES and RIO (less the total of the directly relevant expenses in relation to each of them respectively) are distributed to: Jnr. Johnson: 20% Mrs. Johnson: 30% Mr. Johnson: 50%

17 In relation to the other franked dividends (which were fully offset by directly relevant expenses), the franking credits will flow to the beneficiaries who are presently entitled to the other income of the trust on a proportionate basis (i.e., based on their adjusted Division 6 percentage ). Capital gains A reference to a capital gain in the resolutions is a reference to the gross capital gain. This is the amount of the capital gain before it is reduced by any of the following (if applicable): The 50% CGT general discount; and Any of the CGT small business concessions (e.g., the 50% active asset reduction). Also, the gross capital gain (i.e., the net financial benefit attributable to the gross capital gain) is only reduced by capital losses applied by the trustee for accounting purposes, but only to the extent the capital losses are offset in the same way for tax purposes. Under the legislative definition of net financial benefit, to the extent there is a mismatch between the accounting and tax treatment of capital losses, the gross capital gain will not be reduced by these capital losses. In relation to capital gains, the streaming rules identify those beneficiaries that are specifically entitled to the net financial benefit attributable to the gross capital gain. That is, if the trustee wishes for a beneficiary to be assessed on 50% of the net capital gain (i.e., the taxable part of the gain), they must stream 50% of the gross capital gain to that beneficiary. TAX WARNING Gross capital gain needs to be streamed Prior to the streaming changes becoming law (effective from the 2011 income year), it was generally understood that the trustee was only required to stream the taxable part of the capital gain. For example, if a capital gain of $20,000 was reduced to $10,000 by applying the 50% discount, the trustee could simply stream the $10,000 in order for the beneficiary to be assessed on that same amount. However, streaming only the taxable part of the capital gain is no longer effective for tax purposes. Example resolution 2 ensures that the gross capital gain (less any unrecouped capital losses) is included in trust income. This results in the beneficiaries being specifically entitled to the full net financial benefit referable to the capital gain. Care should be taken to ensure that the trust s tax return applies capital losses against capital gains in a manner consistent with the trustee s accounting treatment. EXAMPLE Streaming gross capital gains The Monterey Discretionary Trust ( MDT ) derived the following amounts during the 2016 income year: Rental income $12,000 Business income $48,000 Capital gain $40,000 (eligible for discount) Trust income = $100,000 (includes gross capital gain of $40,000) Net (taxable) income = $80,000 (includes net capital gain of $20,000) How can MDT stream the capital gain to one or more beneficiaries? Because MDT has included the gross capital gain (i.e., $40,000) in trust income, beneficiaries can be made specifically entitled to 100% of the net financial benefit referable to the capital gain.

18 Assume the trustee distributes the capital gain as follows: Mary: 70% Gordon: 30% Mary is entitled to $28,000 of the capital gain (i.e., 70% x $40,000) and will be assessed on $14,000 of the net capital gain (i.e., 70% x $20,000). Gordon is entitled to $12,000 of the capital gain (i.e., 30% x $40,000) and will be assessed on $6,000 of the net capital gain (i.e., 30% x $20,000). What if MDT had a capital loss of $10,000? In that case, the net financial benefit referable to the capital gain would be $30,000 (i.e., $40,000 $30,000). Mary is entitled to $21,000 of the capital gain (i.e., 70% x $30,000) and will be assessed on $10,500 of the net capital gain (i.e., 70% x $15,000). Gordon is entitled to $9,000 of the capital gain (i.e., 30% x $30,000) and will be assessed on $4,500 of the net capital gain (i.e., 30% x $15,000). The market value substitution rule Where a capital gain has been increased due the operation of the market value substitution rule ( MVSR ), that increase cannot be streamed. It will be assessed to the other income beneficiaries based on their adjusted Division 6 percentage. The reason for this is that there will be no net financial benefit referable to that part of the gain that resulted from the MVSR. For example: An asset with a cost base of $10,000 was sold for $13,000 but it has a market value of $22,000. The MVSR deems a capital gain of $12,000. However, the net financial benefit referable to the capital gain is only $3,000. As such, the trustee can stream the $3,000, but the additional $9,000 (being the part of the capital gain attributable to the MVSR) cannot be streamed, and is assessed to the other income beneficiaries based on their adjusted Division 6 percentage. Dealing with multiple capital gains Where a trust derives more than one capital gain in the 2016 income year, it needs to decide whether it will distribute the total capital gain or whether it wants to stream each capital gain independently. For example: (a) If the trust has a mix of discount and non-discount capital gains, it may wish to ensure that none of the discount capital gains are streamed to a company; or (b) If the trust only has discount or non-discount capital gains it may be indifferent as to which beneficiaries the capital gains are streamed, or how unrecouped capital losses are to be applied. Example resolution 2 has been designed based on the premise that the trustee is indifferent as to how each capital is streamed. For example, a trust derives a $10,000 discount capital gain and a $5,000 non-discount capital gain. Rather than streaming each capital gain separately, the trustee simply resolves to distribute 70% of all the capital gains to Mr A and 30% of all the capital gains to Mr. B. As such, Mr. A is entitled to 70% of each capital gain (i.e., 70% of the discount capital gain and 70% of the non-discount capital gain). The same applies to Mr B, but to the extent of 30%. Further, unrecouped capital losses are assumed to be applied proportionately against discount and non-discount capital gains. However, if the trustee does not wish to stream capital gains on a global basis or wishes to apply capital losses against non-discount capital gains only, it will be necessary for the trustee to prepare a separate schedule to be attached to the resolution (whereby such schedule would be noted as forming part of the resolution). In the distribution of income segment of the resolution, the trustee may refer to an attached schedule. Note that there will no standard format for such a

19 schedule. What is crucial is that there is a defined category of capital gains that can be identified as having been distributed to one or more beneficiaries. Such a schedule may be formatted, for example, along the following lines: Example Schedule of capital gains The total amount of the capital gains that are discount capital gains is distributed as follows: Mr. Jackson: 50% Mrs. Jackson: 50% or Mr. Jackson: the first $5,000 Mrs. Jackson: the balance The total amount of the capital gains that are non-discount capital gains is distributed as follows: Peter: the first $416 Mary: the next $416 Heath: the next $20,000 Murphy Co: the balance Does the trustee need to know the exact amounts at 30 June 2016? It is not necessary for the trustee to be aware of the exact amount of the capital gains at 30 June It will be sufficient for the trustee to identify the different categories of capital gains in the schedule and to specify the amount or percentage to which each beneficiary is entitled. Obviously, the more information the trustee has in relation to the amount of the capital gains as well as the tax profiles of the beneficiaries, the more tax-effective the distributions will be. Dealing with capital losses Where a trust derives one or more capital gains and also has capital losses (whether current year or prior year) extra care must be taken when streaming the capital gains. The reason for this is that the net financial benefit referable to a capital gain takes into account capital losses, but only to the extent they are applied in the same way for tax purposes. Where a trust makes only a capital loss in a year, it may choose to offset this amount against trust income. However, given that capital losses can only be offset against capital gains for tax purposes, the trustee should instead ensure the capital loss is carried forward so it can be offset against a capital gain included in trust income, which should coincide with its tax treatment for the relevant year. If a capital loss were offset against trust income in a year, it would not be available to reduce the net financial benefit attributable to a gross capital gain in a later year. TAX WARNING Offsetting a capital loss against trust income Where a trust makes a capital loss in a year prior to the 2016 income year, the preferred treatment for trust purposes is to carry it forward in the balance sheet and offset it against gross capital gains derived in a later income year. The reason for this is to align the accounting treatment of the capital loss with its tax treatment.

20 What are the consequences where a capital loss is offset against income? Assume a trust makes a $10,000 capital loss in the 2015 year and offsets it against the trust income. In the 2016 income year, the trust makes a gross capital gain of $50,000. Because the capital loss has been expensed in the 2015 income year, it cannot reduce the net financial benefit attributable to the $50,000 gross capital gain derived in In order for the trustee to fully stream the capital gain derived in the 2016 income year, it must make beneficiaries specifically entitled to the $50,000 (and not $40,000). What are the consequences where a capital loss is carried forward for trust purposes? If the trustee carries forward the $10,000 capital loss in its accounts (i.e., it does not offset it against the trust income in the 2015 income year), the net financial benefit attributable to the capital gain derived in 2016 will be $40,000 (i.e., $50,000 $10,000) In order for the trustee to fully stream the capital gain derived in the 2016 income year, it must make beneficiaries specifically entitled to the $40,000 net financial benefit. What are the tax consequences of the treatment of the capital loss? Using the numbers above, regardless of how the trustee treats the capital loss for trust purposes, the net (taxable) capital gain will be $40,000. The treatment of the capital loss for trust purposes does not affect the trustee s ability to utilise the capital loss for tax purposes. However, what is affected is the amount of the gross capital gain that must be streamed to achieve the desired tax outcomes. If the trustee were to expense the capital loss in the 2015 year for trust purposes, and then were to only stream $40,000 in the 2016 income year, they would have only streamed 80% (i.e., $40,000 / $50,000) of the net financial benefit. Those beneficiaries specifically entitled to the $40,000 would only be assessed on 80% of the net capital gain, being $32,000 (i.e., 80% x $40,000) Where a trust has one or more capital gains and one or more capital losses, the trustee may be indifferent as to which capital gains the capital losses offset. This may be especially so if the trust only has non-discount capital gains. EXAMPLE Offsetting capital losses indifferently The Capo Family Trust ( CFT ) made a capital loss of $20,000 in the 2015 income year. It did not offset the capital loss against the income of the trust and held it in a capital reserve account in the balance sheet In the 2016 income year, CFT made three non-discount capital gains of $10,000, $15,000 and $25,000 respectively. For tax purposes, the trustee is indifferent as to which capital gain/s will be offset by the capital loss. Accordingly, under Example resolution 2, the trustee will distribute an overall net financial benefit of $30,000 (i.e., ($10,000 + $15,000 + $25,000) $20,000). As the trustee has not specifically allocated the capital loss to any particular capital gain, it is arguable the capital loss will be offset against each of the capital gains on a pro rata basis. That is, as the $10,000 capital gain represents 20% of the total capital gains (i.e., $10,000 / $50,000) it will be offset by 20% of the $20,000 capital loss, i.e., $4,000, resulting in a net financial benefit referable to that capital gain of $6,000 (i.e., $10,000 $4,000). The crucial aspect of this is that the trustee must be consistent for both trust and tax purposes. If the trustee, when preparing the 2016 tax return, decides to offset the capital loss against the $25,000 capital gain this will affect the amount of the net financial benefit attributable to each of the capital gains for streaming purposes.