Government to Fix some Problems with Taxation of Trusts
The Federal Government has released a Treasury Discussion Paper entitled “Improving the taxation of trust income”.
The Government is proposing interim amendments to the tax law as a stop-gap attempt to deal with the problems caused by the High Court’s Bamford decision. These amendments would apply retrospectively from 1 July 2010. These interim measures will be later followed by a total update of the tax law for trusts with a rewrite into the Income Tax Assessment Act 1997 (ITAA 1997), as announced by the Assistant Treasurer on 16 December 2010.
The discussion paper identifies the following two stop-gap amendments:
Better align the ‘income of the trust estate’ with the taxable income of the trust to ensure that only the beneficiaries who are entitled to the income and gains of the trust are taxed on that income and /or gains; and
Ensure capital gains and franking offsets can be streamed to specific beneficiaries for tax purposes (where the trust deed allows streaming of the distributions).
The High Court’s Bamford decision and some other recent trust tax law cases highlighted the problems with the taxation of trust estates. In particular what constitutes ‘distributable income’ of the trust estate for the purposes of section 97 of the ITAA 1936, and on what basis the beneficiaries are to be taxed on that income.
In Bamford, the High Court clarified that:
‘Income of the trust estate’ is distributable income as determined by trust law; and
Beneficiaries are taxed on a share of the trusts taxable income in the same proportion as their ‘share’ of the distributable trust income to which they are beneficially entitled.
This decision created or highlighted the following problems with the current law for taxing trusts:
Mismatch between assessable and trust income – By adopting the proportionate approach, there may be a mismatch between amounts beneficiaries are entitled to receive under trust law and amounts they are ultimately taxed on i.e. they may be taxed on amounts they do not in fact receive in a trust distribution. It also creates opportunities to manipulate tax liabilities.
Problems with Streaming – Where trust income is comprised of different types or categories, e.g. foreign income, capital gains and franked dividends, can they be distributed or ‘streamed’ to certain beneficiaries at the expense of others for tax purposes? The Bamford decision has effectively brought to an end the ability to stream most types of trust income.
To partially fix these problems, the Government will amend the law to:
Better align the key concept of ‘income of the trust estate’ (i.e. distributable income) with the tax law concept of ‘net income of the trust estate’ (taxable income) so as to reduce anomalous outcomes and opportunities to manipulate tax liabilities; and
Ensure capital gains and franked distributions (including the attached franking credits) can be streamed to particular beneficiaries.
The proposed amendments will apply for the 2010-2011 tax year and future tax years i.e. from 1 July 2010.
Aligning trust income with taxable income
The Government is proposing ways to better align the trust law concept of distributable income with the tax law concept of ‘taxable income’ to remove the problems of the wrong beneficiaries being taxed or not taxed on the share of the income or capital gains they are entitled to.
The Government proposes to legislate a definition of the phrase ‘income of the trust estate’ (distributable income) for the purposes of Division 6 ITAA 1936.
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