On 21 November the Government released its Consultation Paper (the "Paper"), Modernising the taxation of trust income – options for reform. This is another step towards the proposed re-write of Division 6 of the Income Tax Assessment Act 1936. Currently, the law governing the taxation of trusts is plagued with uncertainty. The rules are designed to provide greater certainty as to how trust income is taxed to beneficiaries. This is a positive outcome for the many taxpayers who utilise trust structures.
The Government has already taken preliminary steps to reduce some of this uncertainty through enacting legislation that applies from 1 July 2010 that enables the streaming of capital gains and franked distributions to beneficiaries (which was under scrutiny from the ATO as a result of the High Court's decision in Commissioner of Taxation v Bamford). This is the next step in the Government reforms to the taxation of trust income. The proposed reforms will go through various consultation stages before its proposed implementation from 1 July 2013.
What's not covered?
Although we commend the Government for making headway in reforming Division 6, we are still waiting for the Government to release the new tax regime for Managed Investment Trusts which is proposed to apply from 1 July 2012 (it is noted that the Division 6 reforms will not apply to Managed Investment Trusts). Furthermore, the Paper does not provide reforms to the definition of fixed trust for the purpose of the trust loss provisions. This has been an area of concern for taxpayers since the style="font-style: italic;">Colonial First State Investments Ltd v Commissioner of Taxation. It was stated that this will be dealt with through a separate process.
The Paper identifies certain issues as being in need of immediate reform. These include:
- clarifying the scope of entities which will be subject to the new trust tax laws (this will be of particular interest to investors in Investor-directed portfolio services ("IDPS") and other custodian or nominee arrangements).
- better aligning the concepts of distributable income and taxable income to determine the amount to which a beneficiary is taxed on the taxable income of the trust (discussed further below).
- whether trust amounts retain their character in the hand of the beneficiary and the ability to stream classes of income to certain beneficiaries;
- whether trustees should have an extended time to determine beneficiaries entitlement to income. Currently, if trustees do not make this determination by the end of the income year (which is practically difficult to do), there is a risk that the trustee will be taxed.
- how expenses should be allocated against income.
Proposed approaches to the taxation of trust income
Three options are being considered concerning the taxation of trust income. The models identified in the Paper are:
- the "patch" model: Under this approach the Government proposes to retain the current structure of Division 6 but reform the law by defining the term "income of the trust estate". As a result of the consultation process that took place after the release of the Government's consultation paper in March, it was determined that defining income using tax concepts was the preferred approach;
- the "proportionate within class" model: This involves the distributable income of the trust to be divided into different classes of income maintained by the trustee. The taxable income of the trust will be allocated to those classes of income. Beneficiaries will then be taxed on their share to each class of taxable income based on their proportionate entitlement to that class of the trust's distributable income;
- the "trustee assessment and deduction" model: This model is similar to that adopted in the US, Canada and NZ. It broadly provides that the taxable income of the trust is assessed in the hands of the beneficiaries that receive the economic benefits related to that taxable income. This model effectively follows the "quantum approach" rather than the "proportionate approach".
It is also worth mentioning that the Government has ruled out taxing trusts as companies citing that it would be a major departure from current policy.
At this early stage, it is difficult to determine which approach would be most suitable with respect to the proposed approaches to the taxation of trust income and the other reforms suggested. However, given the wide reaching impact of such legislative reform, we encourage taxpayers to be involved in the reform process. You can do so by contacting Moore Stephens who is intending to present a submission which is due by 10 February 2012.
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