Guide on Trust Funds – Part 27
High Court case – Bamford 3
|Tax laws have been changed to address a number of uncertainties and longstanding problems with the taxation of trusts, some of which were highlighted by the High Court decision in the Bamford case, effective from 29 June 2011.
The amendments enable the streaming of capital gains and franked distributions to beneficiaries for tax purposes and introduce targeted anti-avoidance rules.
These amendments do not give trustees a power to stream if they do not already have this power under the trust deed. The existing integrity rules (such as the ’45-day holding period’) continue to apply in respect of the streaming of franked distributions – particularly to determine whether the beneficiary can receive the benefit of franking credits.
A beneficiary will have an entitlement to an amount referable to a capital gain or franked distribution if they are entitled to a share of that amount. Their share may be expressed as a dollar amount or as a precise methodology for determining the dollar amount, even if the result of applying the methodology is not known until later. Examples of beneficiaries not being specifically entitled:
A beneficiary cannot be specifically entitled to an amount of a capital gain or franked distribution if there is no amount referable to the capital gain or distribution remaining in the trust. For example, because the gain or distribution has been reduced to zero by expenses.
Discount capital gains that are treated as income
In order for the beneficiary to be made specifically entitled to the entire capital gain, the beneficiary would need to receive (or become entitled to receive) an additional amount from the trustee (typically out of trust capital) to ensure that their entitlement equalled the amount of the capital gain, before the 50% capital gains discount has taken place.
A beneficiary cannot be made specifically entitled to franking credits. The treatment of franking credits will be based on the beneficiary’s share (including any specific entitlement) of the relevant franked distributions. Accordingly, it is not possible to stream franked distributions and franking credits separately
The changes also introduce two specific anti-avoidance rules to address the inappropriate use of exempt entities to ‘shelter’ the taxable income of a trust.
The first rule applies where an exempt beneficiary has not been notified of or paid their present entitlement to income of the trust estate within two months of the end of the income year. In this circumstance, they are treated as not being – and never having been – presently entitled to that income.
The second rule applies where an exempt entity’s entitlement to the income of the trust estate (ignoring any franked distributions and capital gains to which any beneficiary is specifically entitled), expressed as a percentage, exceeds a benchmark percentage, which is the exempt entity’s entitlement of the trust’s taxable income expressed as a percentage. Where the exempt beneficiary’s entitlement expressed as a percentage exceeds the benchmark percentage, the beneficiary is treated as not being – and never having been – presently entitled to the percentage share of the income of the trust estate that exceeds the benchmark percentage.
Under both rules, the trustee is assessed on the share of the trust’s taxable income that corresponds to the income to which the exempt beneficiary is taken as not being entitled to.