On 13 April 2011, the Assistant Treasurer, Mr Bill Shorten, released an Exposure Draft containing proposed inserts for the Tax Laws Amendment (2011 Measures No. 3) Bill 2011 to enable the streaming of franked distributions and capital gains as well as anti-avoidance measures aimed at ensuring that low-taxed entities, specifically exempt entities, cannot be inappropriately used to reduce the tax payable on the net income of a trust. The proposed changes have been classified as "interim" measures to remedy critical issues prior to the entire set of provisions being updated and re-written into the Income Tax Assessment Act 1997 ("ITAA1997") at a later date.
Summary of the Conceptual Approach
The taxation of a trust's capital gains and franked
distributions will effectively be removed from Division 6 of Part
III of the Income Tax Assessment Act 1936
("ITAA1936") and dealt with under
Subdivisions 115-C and 207-B of the ITAA1997 respectively. This
approach essentially involves 3 steps:
Firstly, as is currently the case, Division 6 will apply to assess beneficiaries on their share of a trust's net income based on their proportionate share of the total trust law income of the trust.
Secondly, Subdivisions 115-C and 207-B as amended will apply to assess the beneficiary on their share of any capital gain made or franked distribution derived by the trustee. The share of these amounts will be determined by having regard to whether the beneficiary is "specifically entitled" to the relevant capital gain or franked distribution (see below).
Thirdly, the new Division 5B will adjust the Step 1 amounts of taxpayers to avoid double taxation.
The intended outcome for the streaming of capital gains and
franked distributions under the conceptual approach is that the
capital gains and franked distributions derived by a trustee to
which beneficiaries are "specifically entitled" will be
"streamed" on a quantum basis to those
beneficiaries, along with their tax attributes (such as franking
credits). Such amounts to which no beneficiary is specifically
entitled will flow proportionately to beneficiaries based on their
share of the total trust law income of the trust, or to the trustee
if there is a part of the total trust law income of the trust to
which no beneficiary is presently entitled.
The following paragraphs highlight a number of the specific mechanics associated with the conceptual approach.
Firstly, the requirements for a specific entitlement vary depending upon whether a capital gain or a franked distribution is desired to be streamed. In the case of a capital gain, a specific entitlement will arise where, under the terms of the trust, the beneficiary has a vested and indefeasible interest in trust property representing the capital gain. In the case of a franked distribution, a specific entitlement will arise where, under the terms of the trust, the distribution has been specifically allocated (in its character as a franked distribution) to the beneficiary. In both cases, the vested and indefeasible interest or the specific allocation, as appropriate, must be recorded in the accounts of the trust. Furthermore, the Exposure Draft makes it clear that, in order to determine whether a specific entitlement exists, regard may be had to the terms of the trust, the exercise of a power conferred by the terms of the trust, and the operation of legislation, the common law and the rules of equity. The explanatory notes to the Exposure Draft states that a specific entitlement will require more than a "notional" allocation for tax purposes, but may not require the beneficiary to be "presently entitled" to the requisite amount. For example, it will be sufficient for the amount to be "earmarked" for the particular beneficiary who, if not presently entitled, will eventually become entitled to it.
"Earmarking" makes sense in terms of the specific allocation requirement for the streaming of franked distributions, however it is questionable whether "earmarking" will be sufficient to give the relevant beneficiary a vested and indefeasible interest in trust property representing the capital gain for the purpose of streaming of capital gains. It appears that the implication made by the explanatory notes, when combined with the family trust example stated therein, is that a resolution by the trustee to distribute any part of a capital gain to a beneficiary may be sufficient to give the beneficiary a specific entitlement to that part of the capital gain.
From a practical perspective, it will be essential for trustees to review their trust deeds before 30 June to determine whether it is possible to create such a specific entitlement.
Secondly, where a beneficiary is made specifically entitled to an amount "attributable" to a capital gain or franked distribution, the associated tax attributes will flow to that beneficiary regardless of whether part or all of the amount is part of the total trust law income of the trust.
Thirdly, the amount "attributable" to a capital gain is the capital gain actually made by the trustee (ignoring any discounts) reduced by directly relevant expenses. Consistent with the capital gains tax ("CGT") regime, this applies on a "gain by gain" basis. Likewise, the amount "attributable" to a franked distribution is the total franked distribution received by the trustee (excluding franking credits) reduced by directly relevant expenses. Consistent with current policy, if there is no trust law income, it will not be possible to stream franked distributions to a beneficiary.
From a practical perspective, the trustee will be required to prepare and maintain appropriate accounts that indentify the net capital gain and net dividend (that is, after expenses) that is to be streamed and the specific allocation of that amount to beneficiaries.
Fourthly, it will not be possible to deal separately with the taxable component and the discount component of a capital gain. For example, where a trust makes a capital gain of $1000, should the trustee make one beneficiary specifically entitled to the taxable component of $500 and another beneficiary specifically entitled to the discount component of $500, each beneficiary will be treated as having a capital gain of $500. Each beneficiary can then apply any capital losses and, if eligible, the CGT Discount.
Example – Applying the Conceptual Approach
For the purposes of the XYZ Family Trust, "income" is
defined in the trust deed to mean income according to ordinary
In the 2011 income tax year, the XYZ Family Trust derived a capital gain of $400 after expenses, $200 of interest income after expenses, and a gross $70 fully franked dividend (directly related expenses being $20).
Accordingly, the trust law income of the XYZ Family Trust will be $250 whereas the Section 95 net income of the XYZ Family Trust will be $480. The trust law income and the net income of the XYZ Family Trust are shown in the table below.
On 30 June 2011, the trustee resolves to distribute all of the capital gain to Beneficiary X, all of the interest income to Beneficiary Y and the franked dividend to Beneficiary Z. The XYZ Family Trust has held the relevant CGT asset for more than 12 months and Beneficiary X is eligible for the CGT Discount.
The 3 Step Conceptual Approach should be applied as follows:
Under Division 6 of the ITAA1936, Beneficiaries Y and Z would
have an 80% and 20% entitlement respectively to the trust law
income. Under the proportionate approach, Beneficiary Y would be
assessed on 80% of the net income of $480 (that is, $384) whereas
Beneficiary Z would be assessed on 20% of the net income of $480
(that is, $96). Beneficiaries Y and Z would also be entitled to a
franking credit of $24 and $6 respectively.
Beneficiary X would have no assessable income as he does not have a present entitlement to any trust law income.
Given that Beneficiary X is specifically entitled to the whole
net capital gain, Beneficiary X's subsection 115-225(4)
"share" of the $400 capital gain is 100% ($400/$400).
This percentage is then multiplied by $200 (being so much of the
capital gain included in the net income of the trust as worked out
under subsection 115-225(2)). The resulting $200 is grossed up as a
result of paragraph 115-215(3)(b).
Beneficiary Y does not have any Step 2 amounts.
Given that Beneficiary Z is specifically entitled to the franked dividend, Subdivision 207-B would include all of the $80 net taxable dividend income in Beneficiary Z's assessable income. Beneficiary Z would also be entitled to a franking credit of $30.
Division 5B would then apply to remove double taxation. Division 5B should:
- Remove all of the $64 dividend income assessed to Beneficiary Y (that is, 80% x ($50 + $30)) and all of the $160 capital gain assessed to Beneficiary Y (that is, 80% x $200);
- Remove all of the income assessed to Beneficiary Z under Step 1 (that is, $96); and
- Add an additional $40 of interest income to Beneficiary Y.
The result of the 3 Step Conceptual Approach is that Beneficiary X should be taxable on $200 (being the discounted capital gain of $200), Beneficiary Y should be taxable on $200 of interest income, and Beneficiary Z should be taxable on $80 (comprising the cash dividend of $50 and the attached $30 franking credit).
Date of effect
The trust streaming measures contained within the Exposure Draft
are proposed to apply for the 2011 and later income tax
Author: Bobby Acevski. Tax Consulting Manager, MOORE STEPHENS (Gold Coast)
This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2009 Moore Stephens Australia Pty Limited. All rights reserved.