Guide on Trust Funds – Part 24
The importance of identifying how income is defined in the trust deed
As long as trust income calculated under the trust deed does not include a ‘notional’ income amount (or, if it does not exceed the ‘notional’ deductions also included in the calculation of trust income – refer below), the ‘statutory cap’ will not be exceeded.
Therefore, depending on how the trust deed defines income, it may be possible for trustees to calculate trust income so that it does not exceed the ‘statutory cap’.
What if trust income is determined under ‘ordinary concepts’?
This section focuses on the calculation of trust income where an income equalization clause does not apply and the income for trust purposes is determined under ‘ordinary concepts’.
In this regard, the trust deed may contain a ‘hard-wired’ clause requiring income to be determined under ‘ordinary concepts’. Alternatively, the trustee may calculate the income in this way where they have discretion to do so.
Trust income calculated under ‘ordinary concepts’ excludes ‘notional’ income and ‘motional’ deductions. As a result, the trust income will not exceed the ‘statutory cap’. Any differences between trust income and net (taxable) income (e.g., resulting from the treatment of franking credits) are dealt with through the tax reconciliation process.
The recommended position in terms of not breaching the ‘statutory cap’ is to, where possible, simply not include ‘notional’ income amounts in trust income (even where permitted to do so under the trust deed).
If the trustee has a discretion to include such amounts in trust income as per the deed, and chooses to do so, reference should be made to the following section which deals with the application of the ‘statutory cap’.
Calculating trust income where an income equalization clause applies
In the past, there have been doubts as to whether an income equalization clause could effectively achieve its desired outcome where the clause caused ‘notional’ income amounts, such as franking credits, to be included in the calculation of income for trust purposes.
In the regard, based on recent case law, for tax purposes, the ATO were of the view that a trustee could not effectively include a ‘notional income amount in trust income, and nor could a beneficiary be made presently entitled to such an amount.
The release of the draft ruling confirms that, in the ATO’s opinion, income equalization clauses may not, in many circumstances, achieve their desired outcome.
What is the ‘statutory cap’?
In the draft ruling, the ATO seek to place a limit on the role the trust deed can play in the determination of the income of the trust. Specifically, they have introduced ‘statutory cap; whereby the ‘income of the trust estate’ ( as that term is used in s.97 and Division 6 generally) cannot be an amount that exceeds the net accretion to the trust for that year.
The reason for this is that if the income exceeds the ‘statutory cap’ this will be due to ‘notional’ amounts which are not readily available for distribution by the trustee.
Where the trust deed defines income in a way (including where the trustee has a discretion to determine the income) that causes it to exceed the net accretions to the trust (i.e., the ‘statutory cap’) the ATO will only accept that the ‘income of the trust estate; is equal to the statutory cap.