The High Court decision in the case of Commissioner of Taxation v Bamford on 30 March 2010 did not once and for all resolve the uncertainty regarding the taxation of trusts. It is likely that only legislative reform will be able to achieve this difficult task. Although legislative reform of the taxation of trusts was one of the recommendations of the Henry review, there is no immediate prospect of this occurring. Therefore, the continuing complexity and uncertainty must be managed.
Do existing trusts require amendments? What provisions should new trust deeds contain? In this article we summarise the key considerations following the Bamford decision and the issue of Practice Statement PSLA 2010/1 on 2 June 2010 by the Australian Taxation Office.
Speaking generally, the rules regarding the taxation of trusts seek to ensure that, between the trustee of the trust and the beneficiaries of the trust, 100 per cent of the assessable income of the trust is subject to taxation.
"Net Income" and "Income of the Trust" – same same but different?
The main difficulties arise due to the use of two different terms in the legislation governing the taxation of trusts:
- the "net income" of a trust. This is accepted to mean the income of the trust calculated under the Income Tax Assessment Act 1936 and Income Tax Assessment Act 1997 (together the Tax Act). Accordingly, the "net income" of a trust includes capital gains, and
- the "income of the trust estate". This is generally accepted to mean the income of the trust calculated according to trust law and accounting principles. Generally this would not include capital gains. However, the High Court in Bamford clarified that, in determining the "income of the trust estate", the trust deed plays a critical role. The trust deed can define the "income of the trust estate" to be the same as the "net income" of the trust calculated under the Tax Act. In addition, the trust deed can allow the trustee to determine that a capital receipt is to be treated as income.
Review of trust deeds
Trust deeds should be reviewed to determine whether the "income of the trust" is defined, and whether the definition is adequate. Ideally, the trustee should be afforded flexibility in the method employed to calculate the "income of the trust".
While flexibility is the ideal, it means that thought must be given each financial year to the calculation of the income of the trust, and which method will ensure that no beneficiary is left with an unfunded taxation bill and, on a more positive note, that the tax position of the trust and beneficiaries is optimised.
If a trust deed is to be amended, it is worthwhile considering the insertion of provisions to:
- allow the streaming and matching of income and expenses (a practice that has received further support from the decision of the Queensland Supreme Court in the case of Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417 (Supreme Court of Qld, Applegarth J, 11 November 2010), and
- to govern who ultimately controls the trust, and ensure there is an adequate mechanism for that control to be passed on.
Trust resettlements
Amendments to a trust deed raise the issue of "resettlement" of the trust, discussed in the ATO's "Statement of Principles". The Statement of Principles focuses on when changes to a trust deed will in substance amount to the creation of a new trust, with potential capital gains tax, stamp duty and GST consequences.
Normally we would not expect changes to the way in which the trust defines "income" and the ability of the trustee to characterise income and capital receipts to be seen as so fundamental that a new trust is created. However, each case must be considered on its merits. Where such changes affect the underlying entitlements of beneficiaries, particularly where there is a distinction between "income" and "capital" beneficiaries, a resettlement may arise.
Finally, trustee resolutions should not be overlooked as these played a critical role in the Bamford decision. Trustee resolutions need to accord with the way in which the trust deed defines "income of the trust" and relate to the specific trust given the types of income and expenditure it has in the relevant year of income.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
