Trusts have received a lot of attention from the government, Australian Taxation Office (ATO) and in the media recently. A number of changes have made the job of being a trustee even trickier than it already was. However, with the right guidance and advice it doesn’t have to be too hard to do the right thing by yourself and the beneficiaries.
If you have any questions, or any doubts as to what you should do before 30 June 2012, contact Value Beyond and get the help you need to keep your trust up to date.
These tips can be found in a downloadable PDF here: [wp_lightbox_special_anchor_text_pdf link=”http://valuebeyond.com.au/wp-content/uploads/2012/06/Trust-Resolutions-to-distribute-income-for-30-June-2012.pdf” width=”600″ height=”800″ title=”Trusts: What needs to be done before 30 June 2012″ text=”Click here to open the PDF file”]
Trust Resolutions
While much has been written about the changes to the tax laws relating to trust distributions, and the recent change by the ATO removing their administrative policy allowing trustees until 31 August to prepare their resolutions distributing trust income, there is still a lot of confusion as to what this all means for trusts. Practical advice is outlined further below.
TFN Withholding In addition, TFN withholding rules have been put into place so that trusts also now have to notify the ATO of the Tax File Number of each beneficiary who receives a present entitlement from the trust. Failure to do so will result in the trust having to withhold 46.5% of the distribution and pay that amount to the ATO. The beneficiary will get a credit for the amount withheld when they lodge their tax return.
Trusts are required to notify the beneficiary’s TFN by the last day of the month after the end of the quarter. This means those reports are due 28 July 2012 for the quarter ending 30 June 2012.
Where that beneficiary has received a distribution in the 2010 year and 2011 year and their TFN was included in the distribution section of the trust’s tax return, this is sufficient for that beneficiary’s TFN to have been reported.
Trust Resolutions
The changes mean that for the 2012 financial/income year a trust must have resolved how it is going to distribute its income by 30 June 2012. If no resolution is made, then the income of the trust will be distributed according to the trust deed. This may result in the default beneficiaries receiving the income in equal proportions, or the trustee will be assessed on the income where no beneficiary is specifically entitled. Neither of these outcomes may be desirable.
TIPS –The top tips when considering how to distribute a trust’s income as trustee:
- Read the trust deed. This should be the first step for any trustee or adviser, as it contains the rules for that particular trust.
- Read the ATO’s rulings and guidance found on their website.
- Get advice. This area of tax and trust law is extremely complex, and this has not been made any easier by the recent changes
- If in any doubt regarding the different types of income, distribute the whole of the trust’s income on a percentage basis to the beneficiaries.
This fourth option leaves the least amount of room for error, and particularly avoids the undesirable outcome of the trustee being taxed on income to which no beneficiary is specifically entitled to. It may not provide the optimum tax outcome however.
How to deal with Trust Income
Following the changes in legislation, the resolution must deal with the distribution of 3 key types of income:
- Franked distributions
- Net Capital Gains
- All other income
Franked distributions and net capital gains have specific tax laws relating to how those types of income are dealt with in the context of the overall distribution of income.
In dealing with the trust income and the different classes, it becomes vitally important that trustees refer back to the trust deed to ensure they have the power to stream different classes of income, and that they adequately deal with all the income of the trust.
No split into different classes of income
If a trustee does not stream different classes of income (or does not have the power to do so in the trust deed) to different beneficiaries, then each beneficiary will be entitled to each type of income on a proportionate basis according to the percentage that their share of the income represents of the trust’s total income. If a beneficiary is entitled to a specific amount, then that specific amount is converted to a percentage to determine their share of each class of income.
Example – The XYZ trust derives franked distributions of $70,000 (plus $30,000 franking credits), $100,000 capital gain and $50,000 interest income. The trustee resolves to distribute the income 50% to John, and 50% to Mary. John’s entitlement and the amount he will include in his tax return as a trust distribution will be $35,000 of franked income plus $15,000 franking credits, $50,000 capital gain and $25,000 interest income. Mary will include the same.
Example– Using the example above, if the trustee had resolved to distribute $55,000 of income to John and the remainder to Mary, then the distribution would be worked out as follows: Total income of the trust is $70,000 + $100,000 + $50,000 = $220,000. John’s share is $55,000/$220,000 = 25%. Therefore John would be entitled to $17,500 of franked distribution (plus $7,500 of franking credits), $25,000 of the capital gain, and $12,500 of interest income. Mary would be entitled to the balance of the income.
Stream different classes of income
Where beneficiaries are distributed specific types of income (e.g. franked dividends, capital gains, interest income), it is very important that the trustees follow the rules specifically so that the resolution results in the intended distributions being effective for tax purposes.
Franked dividends/distribution
Where a trust has received a franked dividend or franked distribution, then the beneficiary’s entitlement to that franked distribution is worked out using their percentage share of the franked distribution. The beneficiary’s entitlement to the franking credits attaching to that distribution is also worked out using their percentage share of the distribution.
Complexity arises where a beneficiary is entitled to a specified dollar figure of the franked distribution, rather than a percentage of the franked distributions. If the total of the specified amounts are not equal to the total franked distribution derived by the trust, then the amount left over will be distributed according to each beneficiary’s share of the other remaining income of the trust.
Example – The XYZ trust receives a franked distribution of $50,000 (plus plus interest income of $100,000. The trustee resolves that John is entitled to $40,000 of the franked distribution and 25% of the remaining income of the trust. Mary is entitled to 75% of the remaining income of the trust. As not all of the franked distribution has been specifically distributed, the remaining $10,000 ($50,000 – $40,000) is then split according to the beneficiaries share of the remaining income. This would then result in the $10,000 being split $2,500 to John and $7,500 to Mary.
This results in the total franked distribution being distributed 85% or $42,500 to John ($40,000 specific entitlement plus $2,500) and 15% or $7,500 to Mary. The franking credits would accordingly be split 85%/15% to John and Mary respectively.
This situation become even further complicated where there are expenses that are specifically attributable to a class of income, and even more so where those expenses are greater than the amount of income in that class.
Capital Gains
Much like the discussion above relating to franked distributions, a beneficiary’s share of a trust’s capital gains is based on their percentage entitlement to the capital gains of the trust where capital gains are specifically distributed. This is relatively straightforward where the trustee resolves to distribute to beneficiaries based on percentages, but becomes more complex where a beneficiary is entitled to a specific amount that does not equal the total of the capital gains of the trust.
Where capital gains are not dealt with specifically by the trustee as a separate class of income, then they will be distributed in accordance with each beneficiaries percentage share of the income of the trust generally
Conclusion
Distributing a trust’s income can be quite a complex task, particularly if the trustee seeks to distribute the different classes of income in different percentage or dollar amount entitlements to other classes of income.
In summary, the tips at the beginning of this analysis provide a simple summary of the steps to take when trustees are considering how to distribute the trust’s income:
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- Read the trust deed. This should be the first step for any trustee or adviser, as it contains the rules for that particular trust.
- Read the ATO’s rulings and guidance found on their website.
- Get advice. This area of tax and trust law is extremely complex, and this has not been made any easier by the recent changes
- If in any doubt regarding the different types of income, distribute the whole of the trust’s income on a percentage basis to the beneficiaries.
Particularly if you remain unsure, then follow step 2 – get advice! As the saying goes, an ounce or prevention is worth a pound of cure.