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13 Jun 12
Discretionary trusts - health check

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On 30 March 2010, the High Court of Australia handed down the long-awaited decision in Commissioner of Taxation v Bamford; Bamford v Commissioner of Taxation (Bamford).

Following this case, the tax law in relation to trusts has been changing, and is likely to continue to change as new legislation affecting the taxation of trusts is developed.

As a result, trust deeds should be regularly reviewed to ensure they align with the constantly evolving legal requirements.

As part of a general ‘health check’ of a discretionary trust deed, set out below are some of the key issues to consider.

Key issues

Vesting day of the trust

Although discretionary trust deeds typically provide for the vesting of the trust 80 years from its creation, it would be wrong to assume that all deeds make such provision. Some deeds have, as an example, 30 or 40 year vesting periods. At the time of drafting the deed, this shorter life may have seemed sufficient. However, as these trusts were established in the late 1960s and early 1970s, it is important to be aware of trusts vesting unexpectedly now or may have already vested.

The consequences could be serious in circumstances where the trust vested automatically and the default beneficiary was subject to an existing claim. An alternative scenario is that a trust may have reached its vesting date, but unaware of this, the trustee has continued to make distributions on a discretionary basis.  

It is therefore important for trustees to be vigilant of the vesting day, and of the circumstances of the beneficiaries, to ensure that the assets of the trust do not become unnecessarily exposed to claims against those beneficiaries.

Default beneficiaries of the trust

Most discretionary trust deeds contain a default provision for the distribution of income annually. Discretionary trust deeds should generally also contain a default, or ‘gift-over’ provision, on the ultimate vesting of the trust.

A valid trust requires ‘certainty of objects’. In the absence of default beneficiaries, there is a risk that the trust could be invalid for uncertainty.

The day by which trust distribution resolutions must be made

A trust deed should always be reviewed to determine when resolutions must be made. For example, some trusts actually set out the date (e.g. 30 June each year), while others provide that resolutions may be made at ‘such later time as may be allowed by the Commissioner of Taxation’.

The definition and meaning of trust income (i.e. what will be taken to be ‘income of the trust estate’, however described)

Trust deeds should be reviewed to determine whether the provisions give trustees sufficient flexibility to determine trust income.

It may not be necessary to update every deed, but a review is recommended. An important issue raised in Bamford is how income is defined under the deed. As income of the trust estate is to be determined in accordance with trust law, ideally, the deed should define income as widely and flexibly as possible.

Powers to alter the meaning of the trust income (e.g. by determining what receipts are capital or income)

The distinction between capital and income is also important. It determines whether the taxpayer can distribute capital gains as part of the ‘income of trust estate’.

The proportionate approach to distributions continues to apply.  Advisers should be aware that further allocations may be implied based on a beneficiary’s present entitlements. This proportionate approach can also apply to stream different classes of income (such as capital gains or franked distributions).

Powers to amend the deed

If the ability to amend the deed is too narrowly defined, it may be that certain variations to the deed cannot be achieved.

Prior year losses

It’s important to understand how these are dealt with under the deed. For example, whether they can be offset against capital or be able to be recouped from current year trust income.

Other issues to look for

  • Powers to allocate expenses and costs against particular income or gains.
  • Powers to attribute particular types of income to particular beneficiaries.
  • The ability to hold amounts on separate sub-trusts for beneficiaries or permit those funds to be intermingled with the trust funds.
  • Attribution and streaming powers.

Summary

All trust deeds should be reviewed before 30 June 2012 to ensure they allow sufficient flexibility in determining trust income, consistent with the approach in Bamford and legislative changes introduced following that decision. Specialist advice may be required to confirm whether any amendments are necessary.

We do not expect that it will be necessary to update every deed, but we do recommend that every trust deed be reviewed before the trust minutes for the 2011/2012 income year are prepared and implemented.

For further information or enquiries please telephone 1800 353 425 or email adviserservices@mccullough.com.au.

 

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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