Trusts

Reading:
Australian Master Tax Guide 59th edition Chapter 6

1
A brief refresher
• A trust is not a separate legal entity.
• A trust is a relationship between the trustee and beneficiaries.
• Trust deed regulates the relationship.
• The trustee can be an individual or a company.
• The trust owns the property but the trustee cannot deal with it as if it
were its own.
• The beneficiaries are generally entitled to the property of the trust
and any income earned according to the terms of the trust deed.

2
Validly enforceable trust
There are three essential elements for a validly enforceable trust:
• clearly identifiable property capable of being held on trust.
• certainty of beneficiaries.
• a personal obligation on the trustee to deal with the trust property for
the benefit of the beneficiaries.

There is also a general requirement that the trust property be held by

an eligible trustee.

3
Common trusts for tax purposes
Fixed trusts

The class of beneficiaries to whom the income of the trust is to be paid

is fixed.
The share of the income to be received by each beneficiary is fixed.

4
Common trusts for tax purposes
Unit trusts
These are a common form of fixed trust.
The beneficial entitlement to income of the trust is divided into units.
The trust income is paid to whoever holds the units at the specified
distribution date.

5
Common trusts for tax purposes
Discretionary trusts

The trustee has the discretion to choose:

which beneficiaries (from a class of beneficiaries specified in the
trust deed) should receive the income of the trusts, and/or
what amount is to be paid to each beneficiary.

6
Taxing provisions
Div 6 of ITAA36 (ss 95 to 102) deals with the taxation of trusts.
• The trust is not a taxpayer and does not pay tax.
• The tax is paid by either the beneficiaries or the trustee.

7
Taxing provisions
To determine what tax is payable Div 6 requires that:
• You calculate the accounting and the net income of the trust.
• You identify the beneficiaries of the trust and you determine which
beneficiaries are:
• presently entitled,
• resident of Australia and
• not under a legal disability.

8
Accounting income vs net income
• The “accounting income of the trust” is the income available to be
distributed to the income beneficiaries. It is also referred to as the
“distributable income” or “trust income”.
• The “net income” is defined in s 95 as the total assessable income of
the trust estate determined as if the trust was a resident taxpayer less
all allowable deductions. Net income is also referred to as the
“taxable income” or the “s 95 income”.
• A beneficiary’s assessable income is determined by the beneficiary’s
share of the trust’s net income.

9
s 97 of ITAA36
• a resident beneficiary
• who is presently entitled to a share of the accounting income of the trust.
• who is not under a legal disability.
• will include in assessable income their share of the net income of the trust.
• as is attributable to a period when the beneficiary is resident.
• otherwise the trustee is assessable.

10
Main trust provisions
• Section 95 contains definitions of terms used in Div 6 such as:
• “net income”
• the section explains how to calculate the net income (the taxable income) of a trust estate.
• “resident trust estate”.
• Section 95B deems certain beneficiaries not to be under a legal disability.
A beneficiary of a trust
• who is presently entitled to a share of the income of the trust
• in the capacity of a trustee (of another trust)
• shall, for their present entitlement to that share,
• be deemed not to be under a legal disability.

11
Main trust provisions
Section 96 provides that a trustee shall not be liable as trustee to pay income tax upon
the income of the trust except as provided by the ITAA36.
Section 97 contains the general rule that:
• a resident beneficiary
• who is presently entitled to a share of the accounting income of the trust estate and
• is not under a legal disability
• will include in their assessable income
• their share of the net income of the trust estate
• as is attributable to a period when the beneficiary is resident.
• Beneficiaries assessed under s 97 are taxed at their ordinary marginal tax rates.

12
Main trust provisions
Section 98 generally assesses the trustee:
• where beneficiaries have a present entitlement to income but are
under a legal disability- (see next slide regarding s 98(1));
• where a beneficiary (who is not a resident at the end of the income
year) is presently entitled to a share of the trust income.
• The trustee is assessed for the tax under ss 98(3) (read with s 98(2A)).
• The trustee is assessed on the sum of:
• the share of the net income of the trust attributable to the period when the beneficiary is a
resident, and
• the share of the net income of the trust attributable to the period when the beneficiary is not
a resident to the extent that income is attributable to sources in Australia.

13
S 98(1)
(1)  Where a beneficiary of a trust estate
• who is under a legal disability
• is presently entitled to a share of the income of the trust estate,
• the trustee of the trust estate shall be assessed and liable to pay tax for:
(a)  so much of that share of the net income (of the trust estate)
• as is attributable to a period when the beneficiary was a resident; and
(b)  so much of that share of the net income (of the trust estate)
• as is attributable to a period when the beneficiary was not a resident and
• is also attributable to sources in Australia;
as if it were the income of an individual and were not subject to any deduction.

14
S 100
Section 100 applies where
• a beneficiary is presently entitled to income of a trust estate
• but is under a legal disability;
• or is deemed to be presently entitled to income by s 95A;
• and where the trustee (and not the beneficiary) is assessable under s 98.
• Where such a beneficiary is a beneficiary in more than one trust estate,
• or derives income from any other source,
• the section essentially provides that the beneficiary is to pay tax on the
income
• but can get a credit for tax paid or payable by the trustee in respect of the
same income.

15
S 98(3)
A trustee to whom this subsection applies for an amount of net income
is to be assessed and is liable to pay tax:
(a)  if the beneficiary is not a company—for the amount of net income
as if it were the income of an individual and were not subject to any
deduction; or
(b)  if the beneficiary is a company—for the amount of net income at
the rate declared by the Parliament for the purposes of this paragraph.

16
To Sum Up
Non-resident beneficiary presently entitled:
• taxable in the hands of the trustee at the non-resident rates of tax.
The trust income is also included in assessable income of the non-
resident and a credit allowed for the tax paid by the trustee (see ss
98, 98A).
Beneficiary presently entitled but under a legal disability:
• taxable in the hands of the trustee on behalf of the beneficiary at the
beneficiary’s marginal rates. (see s 98)(see also s 100).

17
Main trust provisions
• Tax assessed to a trustee for a non-resident beneficiary is generally
not a final tax.
• If the trustee is assessed under s 98(3) for an individual or company
beneficiary, those beneficiaries are assessed under s 98A(1) and
allowed a credit under s 98A(2) for tax paid by the trustee.
• Special rules apply for income subject to withholding tax.

18
Main trust provisions
• Section 99 assesses the unallocated portion of trust net income to the trustee at
ordinary marginal rates.
• Section 99 only applies if the Commissioner determines not to apply s 99A.

• Section 99A provides that a special rate of tax will apply to certain trust income. The
special rate of tax will apply to a share of trust income to which no beneficiary is
presently entitled.
• The applicable tax rate is the highest marginal rate of tax for resident individuals.
• However there are exceptions. For example, s 99A(2)(a)(i) provides that the special
rate of tax will not apply to a trust estate that resulted from a will if the
Commissioner is of the opinion that it would be unreasonable for the special rate of
tax to apply to that trust income.
19
Main trust provisions
• If the Commissioner is of the opinion that it would be unreasonable
for the special rate of tax to apply to the trust income, then more
concessional rates of tax will apply under s 99.
• In forming the opinion, the Commissioner must have regard to the
matters listed in s 99A(3).
• These matters include situations where an attempt has been made to
increase the assets of the trust by, for example, granting of special
rights or privileges to the trust, the transfer of the property to it, or
the making of loans to it.

20
Main trust provisions
• Section 99B includes an amount of trust property paid to or applied
for the benefit of a beneficiary in the beneficiary’s assessable income.
• Section 99C explains when property is applied for the benefit of a
beneficiary.

21
Main trust provisions
Section 100A is an anti-avoidance provision.
• It provides that
• where a beneficiary of a trust estate
• who is not under a legal disability,
• is presently entitled to trust income, and
• that present entitlement is
• linked either directly or indirectly to a reimbursement agreement,
• the beneficiary is deemed not to be presently entitled to the income.
• Trust distributions which fall within s 100A are assessed to the
trustee under s 99A.
22
Main trust provisions
Section 101 states that
• where a trustee has a discretion to pay or apply income of a trust
estate to or for the benefit of specified beneficiaries
• a beneficiary in whose favour the trustee exercises their discretion
• shall be deemed to be presently entitled to the amount paid to them
or applied for their benefit by the trustee in the exercise of that
discretion.

23
Division 6AA ITAA36

• Division 6AA of ITAA36 contains special rules regarding the

assessment of unearned income earned by a minor (a person under
18) directly or through a trust.
• It ensures that special rates of tax and a lower tax-free threshold
apply in determining the basic income tax liability of minors unless
certain exceptions apply.

24
Division 6AA ITAA36
• Minors are beneficiaries under a legal disability.
• Where they are presently entitled to a share of the net income of the
trust, the tax will be payable by the trustee for them at the
beneficiary’s marginal rates, that is - Div 6AA rates unless one of the
exceptions applies!

25
Legal disability

Not defined in the income tax legislation.

The following categories of people are regarded as being under a legal
disability:
• infants/minors (under 18 years);
• mentally incompetent persons;
• undischarged bankrupts;
• felons.

26
Division 6E ITAA36

• introduced as a response to Bamford’s impact on a trust’s ability to

stream trust income, to isolate franked dividends, franking credits and
capital gains.

27
Division 6E ITAA36
Section 102UW sets out when Div 6E will apply:
This Division applies if:
(a) the net income of a trust estate exceeds nil; and
(b) any of the following things are taken into account in working out the net income
of the trust estate:
(i) a capital gain
1. (to the extent that an amount of the capital gain remained after applying steps 1 to 4 of the method
statement in subsection 102-5(1) of the Income Tax Assessment Act 1997 );
(ii) a franked distribution
2. (to the extent that an amount of the franked distribution remained after reducing it by deductions that
were directly relevant to it);
(iii) a franking credit.
28
Division 6E ITAA36
• Accordingly,
• if a trust has a positive net income and
• the net income includes any of the three items of assessable income,
• the Div 6E requires an adjustment to be made to:
• the trust’s income;
• the trust’s net income; and
• the s 97 present entitlement representing the beneficiary’s share of
the trust’s income.

29
Accounting income vs net income
• The “accounting income of the trust” is the income available to be
distributed to the income beneficiaries.
• It is also referred to as the “distributable income” or “trust income”.
• The “net income” is defined in s 95 as the total assessable income of the
trust estate determined as if the trust was a resident taxpayer less all
allowable deductions.
• Net income is also referred to as the “taxable income” or the “s 95 income”.
• A beneficiary’s assessable income is determined by the beneficiary’s share
of the trust’s net income.
• A trust is generally entitled to the 50% discount on capital gains made on the
disposal of assets held for more than 12 months.
30
Bamford & Ors v FCT (2010) 240 CLR 481
• The High Court confirmed that a trust’s accounting income for the
purpose of determining who is to be assessed on its s 95 net income
is to be determined
• by reference to the trust deed or,
• in the absence of a definition, the general law of trusts.
• So, the trust deed can define accounting income or empower the
trustee to determine what is accounting income.

31
S 95 clause
• In the absence of a definition of “income” in the trust deed (or a trustee’s
discretion)
• the trust’s accounting income will be determined under ordinary concepts,
• which does not include “statutory income” items such as capital gains.
• Most modern trust deeds however have what is referred to as a “s 95
clause”.
• This has the effect that the accounting income will be the same as the taxable
income of the trust.

Note Forrest v FCT (2010) ATC 20-163 -

http://law.ato.gov.au/atolaw/view.htm?docid=LIT/ICD/WAD101of2008/00001
32
Example

• A trust has made a capital gain of $100,000 which is discounted to $50,000

as the asset has been held for more than 12 months.
• If there is no definition of accounting income in the trust deed and no
discretion in the trustee to re-characterise capital amounts as income, then
the accounting income will be $0. Any amounts provided to beneficiaries
will have to be distributed as capital amounts.
• If there is a s 95 clause in the trust deed, the accounting income will be
$50,000.
• Where the trust deed gives the trustee discretion to recharacterise capital
amounts as income, the accounting income could be $0, $50,000 or
$100,000.
33
Forrest v FCT [2010] FCAFC 6; 2010 ATC
20-163
• Forrest was a shareholder and Chief Executive Officer of Anaconda Nickel Ltd, an
ASX listed company ("Anaconda").
• He was also a unit holder in the Minderoo Trust ("the Trust") that held a large
number of shares in Anaconda.
• He had borrowed money to acquire the units and claimed interest expenses in
relation to the loans.
• The Trust was a 'hybrid' trust in that it was to be in receipt of revenue income
that was to be distributed to the unit holders and also capital gains that were to
be distributed to the discretionary beneficiaries at the discretion of the trustee.
• However, one of the provisions of the deed indicated the trustee could treat any
income as income of any type.
• It appeared that it could treat fixed income as discretionary income and vice
versa.

34
Forrest v FCT [2010] FCAFC 6; 2010 ATC
20-163
• Forrest claimed that the Trust was a fixed trust and that he was entitled to the
income of the trust in proportion to the units that he held.
• He also claimed that, even if it were found that the trust was discretionary, it
was the intention of the trustees to distribute the income to him and therefore
the interest expenses were deductible.

35
Forrest v FCT [2010] FCAFC 6; 2010 ATC
20-163
• It was accepted that the trust was discretionary as to capital distributions.
• However, one of the issues for decision was whether the trust was fixed or discretionary in
respect of income.
• In the opinion of the Court,
• the power conferred by clause 12 of the deed
• could not be exercised by the trustee wrongly
• to classify a receipt as a capital gain, when the receipt was, in truth, income.
• The clause is not an unlimited power to be exercised in the trustee's unconfined discretion.
• In the Court's judgment, the terms of the deed demonstrate the settlor's and trustee's
objective intention that
• the income other than capital gains was to be held on a fixed trust for the Unit Holders and
• capital gains were to be held on a discretionary trust

36
Forrest v FCT [2010] FCAFC 6; 2010 ATC
20-163
• Relevantly, the Court was of the view that
• the settlor's intention of creating a fixed trust of income other than capital
gains
• would have been defeated
• if the power had been construed as a discretionary power of re-
characterisation.
• There may be other cases in which such a power would not be
inconsistent with the settlor's objective intention.

37
Present entitlement
A beneficiary is “presently entitled” to a share of the income of the
trust estate if, but only if:
(a) the beneficiary has an interest in the income which is both
(a) vested in interest and
(b) vested in possession; and
(b) the beneficiary has a present legal right to demand and receive
payment of the income,
(a) whether or not the precise entitlement can be ascertained before the end
of the relevant income year and
(b) whether or not the trustee has the funds available for immediate payment.

38
Present entitlement
“Present entitlement” means:
• entitled to immediate payment of a share in the trust: see FCT v
Whiting (1943) 68 CLR 99
• a right to demand payment from the trustee or require that the
trustee properly reinvest, accumulate or capitalise those funds in the
trust: see FCT v Whiting (1943) 68 CLR 99
• the enjoyment of a right to demand and receive payment: see Harmer
v FCT 89 ATC 5180.
• the beneficiary's interest is non-contingent.

39
Present entitlement

• Subsection 95A(1) provides that

• a presently entitled beneficiary
• remains presently entitled to their allocated income
• even after it has been paid or applied.
• Subsection 95A(2)
• makes a beneficiary presently entitled to trust income
• where the beneficiary has
• a vested and indefeasible interest in the income of a trust estate
• but no present entitlement to that income.

40
UPE
• It is a common occurrence that a trust distribution to a beneficiary is
unpaid.
• The unpaid amount is referred to as an unpaid present entitlement
(UPE).
• The fact that the amount has not been paid does not impact whether
the amount is assessable to the beneficiary.
• In law, an unpaid present entitlement is an equitable obligation that
requires the trustee to pay the amount on demand by the beneficiary.

41
Tax administration
• Trusts file annual tax returns?
• Lodgement dates?

42
Trust income less than net income
• The excess of taxable income (net income) over trust income
(distributable income) will be assessable because Div 6 assesses the
“net income”.
• The problem is who is liable to the tax on it.
• Is it the trustee because no beneficiary is presently entitled to the
excess, or are the beneficiaries assessable?
• Two views:
• the quantum view and
• the proportionate view

43
Quantum view
• The quantum view is as follows:
• The beneficiary is assessed only on the distributable income which they are
presently entitled to receive.
• The trustee is assessed under ss 99 or 99A on any excess of net income over
distributable income.

44
The proportionate view
• The beneficiary is assessed on a proportion of the net income.
• The proportion equals the percentage proportion of the distributable
(accounting) income the beneficiary is presently entitled to receive.
• If the beneficiaries are entitled to the whole of the distributable
income, the whole of the net income will be distributed
proportionally to the beneficiaries and no amount will be assessed to
the trustee.

45
Example
• Accounting income is $4,000 and net income is $5,000 and there are
two beneficiaries presently entitled to 50% each.
• The quantum view means what?

46
Example
• Accounting income is $4,000 and net income is $5,000 and there are
two beneficiaries presently entitled to 50% each.
• The proportionate view means what?

47
FCT v Bamford (2010) 240 CLR 481
• The High Court in FCT v Bamford (2010) 240 CLR 481 found that the
proportion is based on percentage entitlement, confirming that the
proportionate view is the method to be used.
• The High Court said that the words “income of the trust estate” in the
opening part of s 97(1) refer to distributable income, ie income
ascertained by the trustee according to appropriate accounting
principles and the trust instrument.
• Once the share of the distributable income to which the beneficiary is
presently entitled is worked out, the beneficiary is to be taxed on that
percentage share (or proportion) of the net income of the trust estate.

48
Example
• Why can beneficiaries end up paying tax on amounts they have not
received?

49
Trust income greater than net income
• Where distributable (trust) income exceeds net income, the
beneficiary is assessed only on their proportionate share of the net
income.
• The ATO does not treat the excess as being assessable to the
beneficiary, either in the year derived or when distributed to the
beneficiary, or assessable to the trustee.
• However, this non-assessable amount distributed to the beneficiary
will reduce the cost base of any fixed trust interests held by the
beneficiary (eg units in a unit trust) where CGT event E4 applies –
Layala Enterprises Pty Ltd (in liq) v FC of T 98 ATC 4858.

50
No trust income
• It appears there must be trust income before a beneficiary can be
assessed on any net income.
• If there is no accounting income, but there is net income, it will be
assessed to the trustee under either s 99 or s 99A (as applicable).

51
Example
• Assume a trustee of a discretionary trust has exercised its discretion
to apply the whole of the net income, if any, of the trust for the
benefit of one beneficiary, A. “Net income” is not defined in the trust
deed. There is no capital gains component in the net income.
• What is the income distribution in each of the following cases?

52
Example

53
Trusts and CGT
• Trusts generally can claim the 50% discount on capital gains made on
the disposals of assets that have been held for more than 12 months
– s 115-100 and Subdiv 115-C of ITAA97.
• Complying superannuation funds are only allowed a 33 and 1⁄3%
discount on any capital gain made in relation to assets.
• Companies do not qualify for the CGT discount.
• Capital losses are applied against capital gains before applying the
CGT discount.

54
Trusts and CGT
• It is now clear from Bamford that where the net income of a trust (as defined
in s 95 of ITAA36) includes a net capital gain made by the trustee, it would
have been taxed proportionately to the beneficiaries presently entitled to the
income of the trust estate (whether they are entitled to the capital gain or
not).
• However, Division 6E ITAA36 and subdivision 115-C change that approach.
• The changes introduce a new concept of “specifically entitled” (see s 115-228).
• A beneficiary is specifically entitled to a capital gain made by a trust to the
extent that, in accordance with the terms of the trust, the beneficiary has a
vested and indefeasible interest in trust property representing the capital gain,
and that interest is recorded in the accounts of the trust.

55
Schedule 2F ITAA36

• Schedule 2F contains special rules which restrict the circumstances in

which prior year and current year losses can be utilised by trusts.

56
Trust losses
• Beneficiaries in trusts do not share in trust losses.
• Losses incurred by trusts are “trapped” in the trust and are carried
forward and, subject to the trust loss rules, may be offset against
future trust income.
• The trust loss rules are contained in Sch 2F of ITAA36.
• For trust loss provisions there are eight different types of trusts and
six different tests for the carry forward of losses.

57
Trust losses - tests
• The income injection test: an outsider to a loss trust injects income in an attempt to
take advantage of the losses (see s 270-10 of ITAA36).
• The pattern of distributions test: looks to previous years to ensure the same
individuals received more than 50% of the distributions of income and capital in each
year (see ss 267- 20, 267-30, 269-60 ITAA of 1936).
• Two 50% stake tests: require the same individuals to continue to have fixed
entitlements to more than 50% of income/capital of the trust (see ss 267-40, 269-50,
269-55 of ITAA36).
• Control test: a group must not begin to control the trust during the test period (see s
267- 45 of ITAA36).
• The same business test: similar to company test and relates to widely held trusts (see
s 269- 100 of ITAA36).
58
Tests for deductibility of losses

59
Question 1
• A trust earned $110,000 sales income (all Australian source) and had $10,000
expenses relating to the income. This is all its income. The trust has 3
beneficiaries, each with a 20% share in the trust income. The beneficiaries have
the following profiles:
• Beneficiary A Presently entitled, not under legal disability.
• Beneficiary B Presently entitled, under legal disability (eg under 18 years old).
• Beneficiary C Has vested and indefeasible interest and therefore deemed to
be presently entitled under s 95A(2).
• Calculate the amount of the distribution payable to each beneficiary and
comment on the tax rate that is applicable and who is responsible for paying
income tax.

60
Question 2
• Piotr and Depardieu have 4 children. They set up a trust with Edvard
(a family friend) as the trustee. The only beneficiaries of the trust will
be their children. They want to make a family trust election for the
trust, with Piotr as the specified individual.
• How does this arrangement impact on the family control test?

61
Question 2 - answer
• The trust will be able to make the election because it passes the
family control test. Even though a family member does not control
the trust, the only beneficiaries under the trust are Piotr’s family.
• Alternatively, Piotr sets up a discretionary trust with Marcus as the
trustee. Marcus is Piotr’s financial adviser. The trust will be able to
make the family trust election because a financial adviser to Piotr
controls the trust as a trustee and causes it to pass the family control
test. The family’s financial adviser – Marcus, controls the trust as the
trustee.

62