Taxation of Trusts

Time to review the operation of your family discretionary trusts.

The Australian Taxation Office has recently released guidance explaining their attitude to the use of trusts including the non-payment of accrued loan accounts in trusts and the use of income distributed for tax purposes to children over 18years.

These are important announcements and must be considered by all trustees of discretionary or family trusts.

It is common for trust income to be “distributed” by book entry making beneficiaries making presently entitled to trust income.

Sometimes (though much less commonly), a beneficiary's present entitlement to a share of trust income arises out of, or in connection with, an arrangement:

  • involving a benefit being provided to another person
  • intended to have the result of reducing someone's tax liability, and
  • entered into outside the course of ordinary family or commercial dealing.

In these cases, section 100A of the Income Tax Assessment Act 1936 generally applies to make the trustee, rather than the presently entitled beneficiary, liable to tax at the top marginal rate.

In simple terms it is important that income distributed to beneficiaries is paid to or applied for the purposes of those beneficiaries.

A more common example occurs when children reaching the age of 18 years are used to share trust income of the parents after paying tax at their generally lower marginal tax rate. The Tax Office is concerned that taxpayers are entering into arrangements to avoid tax on the net income of the trust by utilising the lower marginal tax rate applying to the children in circumstances where the benefit from these arrangements is, in substance, enjoyed by the parents by:

  • the Children incurring amounts for expenses against their present entitlements that would ordinarily be met by their Parents, or
  • the Children's entitlements otherwise being applied for the benefit of the Parents either directly, or by the charging of excessive amounts, and/or
  • elements of contrivance.

A review of these arrangements by the Tax Office considers that the following consequences may arise:

  • the purported entitlement of the Children to trust income may be a sham or otherwise ineffective for trust law purposes
  • the arrangement may constitute a reimbursement agreement under section 100A of the Income Tax Assessment Act 1936 (ITAA 1936)
  • subsections 95A(1) and 97(1) of the ITAA 1936 may apply to treat the Parents as presently entitled where the means by which the trustee permits the use of the funds evidences the exercise of a discretion to pay or apply those amounts to the Parents (notwithstanding that the appointments are recorded as 'beneficiary loans'), or
  • the general anti-avoidance provisions in Part IVA of the ITAA 1936 could apply.

While the Tax Office alert specifically considers arrangements involving the children of controlling individuals, they are also concerned about similar arrangements involving other family members of controlling individuals that would have lower marginal tax rates than those of the controlling individuals.

Our team will review the application of these announcements to client family trusts and it is strongly recommended that trustees or directors of trustee companies clearly understand their obligations in regards to these new requirements in particular.

Please contact your MVAB Team person if you would like to discuss the application of these announcements to your particular circumstances.