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AJML Accountants Update – November 2016

Guide on Trust Funds – Part 23

Can trust income include capital gains, franking credits or revaluations, etc.?

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. Streaming capital gains is discussed in a later segment of this trust section of the seminar notes.
  • For franked dividends – where a trust otherwise has a loss, the benefit of the franking credits is lost hence the trustee may seek to include further amounts in trust income to generate a trust profit.

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.

Including other amounts in trust income

In most cases, there is no incentive for a trustee to include ‘notional amounts’ such as franking credits in trust income. The same may also be said in relation to including an unrealised gain as trust income.

Preventing the loss of franking credits

However, there is one specific circumstance in which a trustee may seek to include an amount as part of trust income. Where the trust has derived franked dividends and there is no trust income (e.g., there is a loss0 the benefits of the franking credits are permanently lost. Accordingly, trustees will try to avoid finding themselves in this situation. To the extent the trust deed permits trustees may seek to turn the loss into a profit, for example, by:

  • Including franking credits in trust income;
  • Including a gross capital gain in trust income;
  • Recognising an unrealised capital gain on a capital asset as trust income;
  • Treating an amount of pre-existing trust capital as income (e.g., an amount held in a CGT discount reserve at the commencement of the year); and
  • In the case of trading stock – valuing closing stock at market selling value instead of cost.

Alternatively, a trustee may seek to reduce the expenses taken into account when calculating trust income so as to turn the loss into a profit. The expense, or part of it, would be taken up as a reduction of trust capital. For example, any interest deductions in the trust (related to a geared asset for example) would not be offset against the income generated by that asset.