The interaction between trust law and tax law has long been a
source of ongoing confusion for those who use family discretionary
trusts to protect their assets. The Assistant Treasurer, Bill
Shorten, hasproposed new legislation to clarify the way
discretionary trusts are taxed. If the rules are changed, the many
hundreds of thousands of Australians who use family discretionary
trusts may need to update their trust deeds to reflect the new
Below, Special Counsel Damian O'Connor and Solicitor Julian
Wright outline the changes proposed and the process from here.
Why are changes being proposed?
The proposed legislation, to be enacted by the Federal
Government, was announced on 4 March 2011, and will apply from the
current income year 2010-2011. It focuses on two issues:
Who pays the tax where the taxable income of the trust is
different from the income of the trust that is available for
distribution under the trust deed. For a variety of reasons,
including differences between accounting and tax rules, a
beneficiary may be taxed on a greater proportion of the trust
income than they actually get.
Whether it is possible for different beneficiaries to receive
different types of income (such as discount capital gains), or
whether they will be taxed as if they receive an 'undissected
share' of all the taxable income of the trust.
In recent times, the law relating to the taxation of trusts and
beneficiaries has been plagued by uncertainty. In Bamford v
Commissioner of Taxation (March 2010), the High Court of
Australia questioned established practices used by taxpayers and
their advisers in dealing with trusts, without providing the
pathway forward that many had hoped for.
The decision in Bamford determined that the correct approach to
use in determining how beneficiaries are taxed is the
'proportionate approach'. The following example illustrates
how the proportionate approach presently works:
If John is entitled to the trust's income of $10 and Steve
is entitled to the trust's capital gain of $100, it may be
that, depending on the terms of the trust deed, John will be taxed
on all the trust's taxable income of $110, including the
capital gain of $100. This may be the case even though John is not
entitled to the capital gains under the trust deed, and this
outcome arises because the trust's taxable income is different
from the income that is available for distribution under the trust
Treasury discussion paper
The Treasury has released a discussion paper that contains the
Board of Taxation's advice on how to deal with the issues that
have given rise to this uncertainty in the way trusts are taxed,
such as those outlined in the example above. The discussion paper
considers the various ways clarity might be achieved, and whatever
decision the Government makes on the new legislation, it is likely
to have important consequences for the way in which family trusts
The next steps
While the Government's proposal addresses only two aspects
of the problematic area of taxation of trusts, taxpayers and their
advisers can at least look forward to gaining some certainty around
these two aspects. The final details of the legislation will, of
course, be critical.
Any changes that are made to trust deeds must be carefully
considered to ensure they achieve the desired result, while not
triggering any adverse outcomes (such as trust resettlements).
The Federal Government has called for comments and feedback on
the proposals contained in the discussion paper by close of
business on Friday 18 March 2011.
For more information on the proposed changes, please contact
HopgoodGanim's Taxation and Revenue practice, who are also
available to help channel your comments on the proposals so that
you can make your voice heard on this critical area of tax
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