Guide on Trust Funds – Part 16
Can trust income include capital gains?
In some instances the trustee may query whether certain amounts can or should form part of trust income. There could be a number of specific reasons why a trustee may wish to include an amount in trust income, such as. for a capital gain – the inclusion of the gross capital gain in trust income allows it to be ‘streamed’ as part of the distribution of trust income.
The trust deed
The first issue the trustee must consider is whether the trust deed allows the amount to be included in trust income. That is, does the deed contain a hard-wired IEC which prevents amounts from being included unless they form part of the net (taxable) income? Alternatively, if the deed contains an income characterisation clause the trustee has the discretion as to whether to include/exclude certain amounts.
If the deed contains neither an IEC nor an income characterisation clause it will be necessary to refer to the specific wording in the deed. If the deed is silent, income takes
its ordinary meaning, and it would not be possible to include capital gains for example.
Including capital gains in trust income
The ATO originally held a view that capital gains could not form part of the S.97 trust income due to the fact they were capital in nature. They believed this was so even if the deed allowed the trustee to so include the capital gain. However, in Bamford v FCT [2010] HCA 10 the High Court concluded the ATO was incorrect and that a clause in the trust deed allowing the trustee to include the capital gain in trust income was valid. This is the case regardless of whether the capital gain is included under an IEC or a trustee discretion.
Why include a capital gain in trust income?
The main reason for including a capital gain in trust income is to simplify the procedure for streaming it. Subdivision 115-C provides that a capital gain is streamed to the extent that the gross capital is distributed. This means that if the capital gain is eligible for one or both of the 50% general discount and/or the 50% active asset reduction, both the taxable and tax-free components must be streamed. If the gross capital gain can be included in trust income, the entire amount can be streamed as part of the income distribution.
Note: To the extent that no part, or the tax-free part, of the capital gain cannot be, or is not, included in trust income, it can still be streamed as a capital distribution.
How does the trust deed define income?
As to whether the trustee can include the gross capital gain in trust income is totally dependent on the trust deed.
If the taxable capital gain is reduced to nil under the CGT small business concessions, ‘streaming’ ceases to be an issue as there is no taxable capital gain left to stream. However, if the deed permits, the trustee may wish to include the gross capital gain in trust income for the purposes of establishing a ‘significant individual’ which is relevant for the 15 year exemption and the retirement exemption. Note that a ‘significant individual’ can be established via a capital distribution however, if an income distribution is also made it is the beneficiary’s lower entitlement that must be at least 20%.
