Guide on Trust Funds – Part 25
High Court case – Bamford 1
|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.
Why were the changes made?
The Bamford decision highlighted the fact that the amounts on which a beneficiary is assessed for tax do not always match the amounts they are entitled to under trust law. This mismatch can result in unfair outcomes, as well as opportunities for tax manipulation.
Under the proportionate approach, the amount included in a beneficiary’s assessable income is the proportion of the income of the trust estate to which the beneficiary is ‘presently entitled’, applied against the whole of the trust’s taxable income.
The result of this approach is that a beneficiary includes in their assessable income a ‘blended’ amount of all of the different types of income and capital gains included in the trust’s taxable income.
Streaming of capital gains and franked distributions
The new law amends the Income Tax Assessment Act 1997 (ITAA 1997). The amendments ensure that, where permitted by the trust deed, the trust’s capital gains and franked distributions can be effectively streamed to beneficiaries for tax purposes by making those beneficiaries ‘specifically entitled’ to those amounts. Beneficiaries specifically entitled to franked distributions will, subject to existing integrity rules, also enjoy the benefit of any attached franking credits.
A beneficiary specifically entitled to a capital gain will generally be assessed for that gain, regardless of whether the benefit they receive or are expected to receive is income or capital of the trust. That is, unlike the situation that applied prior to the amendments, a beneficiary may be assessed based on a specific entitlement to a capital gain of the trust, even though they do not have a ‘present entitlement’ to income of the trust estate.
Capital gains and franked distributions to which no beneficiary is specifically entitled will be allocated proportionately to beneficiaries based on their present entitlement to income of the trust estate (excluding amounts to which any beneficiary is specifically entitled). If there is some income to which no beneficiary is entitled (apart from capital gains and franked distributions to which any entity is specifically entitled), the trustee may be assessed for tax on that income under section 99 or 99A of the ITAA 1936.
The new law will also allow the trustee of a resident trust to choose to be assessed on a capital gain, provided no beneficiary has received or benefitted from any amount relating to the gain during the income year, or within two months of the end of the income year. This is similar to (and will replace) the choice available to the trustee of a testamentary trust under the law prior to the amendments, but is not limited to those trustees. This change to the law allows a trustee to choose to pay tax on behalf of a beneficiary that is unable to immediately benefit from the gain.