Bamford v. Commissioner of Taxation:
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.
The decision also raised concerns about how the proportionate approach interacts with other areas of the tax law. In particular, laws that assume or provide for amounts (such as capital gains and franked distributions) to have the same ‘character’ when assessed to a beneficiary as they had in the hands of a trustee.
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.
What has changed
The new law amends the Income Tax Assessment Act 1997, specifically Subdivision 115-C and Subdivision 207-B. 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 on 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. If there is some of this 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 also allows 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 replaces) the choice available to the trustee of a testamentary trust under the law prior to the amendments. 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.
Example 1
A trust has net capital gains of $100,000 for a financial year.
Under the old law, the $100,000 must be distributed in proportion per the trust distribution statement.
Under the new law, the trustee may specifically entitle any beneficiary to all or part of the net capital gain.
If there was no beneficiary entitled to the net capital gain then the trustee may be assessed for tax on the income.
