IN SHORTEN WE TRUST? Trust taxation changes

A new discussion paper has recently been released by the Assistant Treasurer to address some of the hysteria surrounding the trust taxation regime. These issues have plagued taxpayers and tax

practitioners alike for decades and the raft of recent case law has exacerbated the conundrums surrounding trust taxation. Whilst the discussion paper is not an attempt to resolve all of the issues that Division 6 of the Income Tax Assessment Act 1936 (“Division 6”) have posed, it is seen as a catalyst by Treasury to help in redrafting Division 6. A more detailed process has been foreshadowed by Treasury; however in the meantime the more pressing item on

Treasury‟s agenda is to provide some form of certainty to taxpayers for the 2010/11 income tax year in relation to the following:

Broadly, clarifying the net distributable income

concept for Division 6 purposes; and

Allowing capital gains and franked dividends

streaming.

Statutorily defining net distributable income The concept of net distributable income (or as it is referred in Division 6 - „income of a trust estate‟) is primordial in determining where the tax liability in relation to the income of the trust should rest for a particular income year. Broadly, beneficiaries are assessed on their share of the taxable income of the trust in proportion to the net distributable income that they are presently entitled to receive. Where the whole of the net distributable income is not flushed out to the beneficiaries of the trust for a particular income year that undistributed amount will be subject to tax in the trustee‟s hands at punitive rate. The net distributable income concept has proven to be an abstract concept, which has led to different interpretations and uncertainties as to whether the right amount is being distributed to prevent trustee tax liability from applying. To resolve this issue, Treasury is proposing to impute a statutory definition to net distributable income. The three alternative definitions are as follows: 1) Aligning net distributable income with taxable

income. This would be done by defining net

distributable income to broadly mean taxable

income but adjusted for relevant amounts (for

instance inclusion of capital gains but excluding

notional items).

“..THE ACCOUNTING AND LEGAL

PROFESSIONS ARE JUST A PHONE

CALL AWAY TO ASSIST BUT THE ONUS

IS ON THE TRUSTEE TO DETERMINE

THE NET DISTRIBUTABLE INCOME..”

Machel Advisory Services 9 March 2011

ON NOTICE

LABOUR HIRE ARRANGEMENTS UNDER ATTACK The Australian Taxation Office (“ATO”) has announced that labour hire arrangements using a discretionary trust

structure to split income will come under scrutiny. The ATO is concerned that, inter-alia, some of these

arrangements are either a sham, subject to alienation of personal services income or may be subject to Part IVA.

Whilst there are merits in adopting this approach, the practicalities of adopting this method are not realistic. Calculating taxable income can prove to be an arduous exercise and this process may not necessarily be completed, for a myriad of reasons, by the time that the trustee is required to exercise its discretion to distribute an amount. This is an administrative issue that will need to be addressed as part of this process. This approach makes the assumption that trustees have the necessary tax knowledge and therefore can work out the taxable income and the necessary adjustments to determine net distributable income. No doubt the accounting and legal professions are just a phone call away to assist but the onus is on the trustee to determine the net distributable income and the amount that the trustee wants to distribute should not necessarily be a tax driven concept. The list of adjustments is not known yet but it is safe to assume that the list will be an extensive one and this will undoubtedly add a layer of complexity to year end distribution. This approach may not necessarily suit trusts that distribute on a basis other than year end. This may require trustees in some instance to perform notional tax calculations for interim distributions where a final catch-up distribution is not expected to occur. This would be the case for cash-strapped trusts (other than managed investment trusts). This approach will also impede on the trustee discretion to appoint income. Aligning net distributable income with taxable income means that in some circumstances more income will need to be distributed to prevent trustee tax liability. For instance where substantial capital gains has been realised and the cash is needed to pay down debt funding, the trustee will nevertheless need to make beneficiaries presently entitled to the realised capital gain under the proposed approach to prevent punitive tax from applying.

2) Aligning net distributable income with accounting

concepts. This would be done by defining net

distributable income to broadly mean accounting

profit. It is being proposed that this would be

accounting profit as calculated in accordance with

the generally acceptable accounting principles

(“GAAPs”).

We are of the view that this approach will be hard to implement because the bulk of discretionary trusts may not necessarily use GAAPs and

therefore should not be compelled to do so solely for tax reasons. In addition, GAAP accounting profit may contain notional amounts embedded in it and therefore these amounts may not be able to be distributed.

3) Maintaining the current approach but including

capital gains. Whilst this will require significant

resourcing from the Australian Taxation Office

(“ATO”) to administratively police because of the

subjective nature of net distributable income, we

are of the view that this may bring a more

reasonable outcome (at least in the short term)

because this will allow trustees to retain discretion

as to the amount they want to distribute without

being impeded by the tax legislature.

We echo the proposal made by Treasury that the appropriate anti-avoidance provisions should be developed to target any abuse of this approach to shelter income from being subject to tax.

Streaming of capital gains and franked dividends The other measures proposed by the discussion paper are to enable the streaming of capital gains and franked dividends. The decision in Bamford and the stance taken by the ATO have cast doubt as to whether capital gains and franked dividends could be streamed. A strict interpretation of the law when applying the proportionate approach would mean that the beneficiaries would be assessed on a share of the overall taxable income irrespective of what class of income they are presently entitled to. This would limit the possibility of streaming classes of income. To facilitate streaming of capital gains and franked dividends, Treasury has proposed amendments to the respective tax provisions. The above proposed amendments are long time overdue and have been well received by the tax community. However, it is too early to proclaim victory given the complexities associated with the current trust taxation regime and we can only trust that Treasury and the ATO will keep an open dialogue during the drafting of the new tax regime and its subsequent implementation. Machel Advisory Services will be making a submission on the newly released discussion paper. If you want to discuss this article or contribute to our submission, please contact Yanese Chellapen of our office.

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