Publications / Taxation
With the introduction into Federal Parliament on 2 June 2011 of the promised ‘temporary’ amendments to the law dealing with the taxation of income from trusts, it is apparent that steps will need to be taken by 30 June 2011 - and then by 31 August 2011 - to continue to receive the full taxation benefits of the ‘flow through’ treatment of capital gains, income and franking credits via discretionary trusts.
Also, even if no other steps are taken in respect of the ATO’s controversial views about unpaid present entitlements (UPEs) owed by trusts to companies by year end, 30 June 2011 is a critical date to ensure that ‘investment agreements’ are in place for UPEs arising in the year ended 30 June 2010 (on or after 16 December 2009) under options 1 and 2 of the ATO’s Practice Statement Law Administration PS LA 2010/4. Otherwise, those 2010 UPEs will be taken by the ATO to be loans arising in the 2011 income year for which section 109N agreements are needed by the lodgement date of the 2011 income tax return of the company. (For UPEs arising in the year ended 30 June 2011, there will be time up to lodgement date of the 2011 income tax return of the company to take action on these UPEs.)
This article does not seek to fully explain these issues but flags what should be urgently considered and implemented:
- by 30 June 2011, and
- by 31 August 2011.
By 30 June 2011
- Trust deeds should have been reviewed to identify relevant powers - and if necessary, have been amended - to be able to operate effectively under the proposed new law.
Note that, consistent with our previous views, a simple approach of equating trust law income with net taxable income (i.e. a ‘section 95 clause’) will not be sufficient - but may be workable if there are separate powers to reclassify amounts into and out of income. Other typical suggested ‘minimal’ changes include removal of any requirement that distribution determinations be strictly made by 30 June and insertion (if needed) of a power to stream specific types of income (i.e. an attribution clause).
- The necessary resolution or determination should be made by the trustee, in accordance with the proposed new law, to ensure that any intended specific entitlements to franked dividends will be effective. (It may be possible to make these decisions about the distribution of franked dividends by 30 June, without also needing to do the full detailed modelling of the overall taxation effects for all beneficiaries, as noted below for action by 31 August 2011.)
- Wider trust resolutions or determinations should be made when required by year end under the trust deed. Only if not required under the trust deed can a decision be made to seek to rely on the ATO’s administrative practice in Income Tax Ruling IT 328 for such resolutions or determinations to be accepted by the ATO, when made by 31 August after the 30 June year end.
- Investment agreements under options 1 and 2 of PS LA 2010/4 should be considered and, if chosen, put in place for UPEs arising in the year ended 30 June 2010 (on or after 16 December 2009).
By 31 August 2011
- If relying on the ATO’s administrative practice in IT 328, wider trust resolutions dealing with all capital gains and income should be made.
- Included in those resolutions or determinations, should be the necessary steps to ensure any intended specific entitlement to capital gains in accordance with the proposed new law.
- Making decisions on these resolutions or determinations would ideally involve detailed modelling of the estimated taxation effects for each beneficiary under the proposed new law.
A fundamental change in the operation of trusts is required under the proposed new law - the practice of a trustee determining the distributions of franked dividends or capital gains after 30 June or 31 August, as applicable, will no longer be sustainable in the context of creating ‘specific entitlements’ under the new law. There is also the wider risk that the the ATO may now seek to more actively question the timing of resolutions or determinations generally.
In taking any of the above steps, care is also needed to ensure that nothing is implemented which will cause difficulties if the proposed changes to the law are not, in fact, implemented - although it is considered likely that the proposals will become law.
McCullough Robertson is currently refining its trust deed review checklist and approach and drafting ‘high level’ example trust minutes to assist with these issues.
For interested practitioners, we expect to shortly extend invitations to participate in a seminar on these year end matters, to be held next week. Practitioners who would prefer an in-house session for their firm should contact us to make urgent arrangements.
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.