Trustees and beneficiaries now have an opportunity to
contribute to the Government's impending rewrite and
modernization of the income tax laws applying to
November 21 saw the Federal Government release its Consultation
Paper, "Modernizing the taxation of trust income". The
paper marks the first step towards a full rewrite and update of the
provisions in the income tax law dealing with trusts that the
Government plans to take effect from 1 July 2013.
The need for reform for taxation of trust income arises from
longstanding failures of the trust provisions in the tax
legislation to keep pace with other changes in the tax law and the
increased use of trusts in commercial contexts. In particular, no
amendments were made to the trust provisions to deal with the
introduction of capital gains tax and the dividend imputation
system more than 25 years ago, leading to uncertainty in how
beneficiaries were taxed on capital gains and could access benefits
such as the CGT discount and franking credits.
The uncertainty peaked after the High Court determined in
Commissioner of Taxation v Bamford  HCA 10 that beneficiaries
were subject to tax on a proportion of the taxable income of the
trust, rather than specific amounts of income. The decision
provoked the Government to introduce stop-gap amendments earlier
this year to facilitate streaming of capital gains and franked
dividends to beneficiaries while promising a broader review of the
taxation of trusts.
The main focus of the proposed amendments is the current
discrepancy between trust and tax law in their treatment of trust
income, such as issues of the distributable income of the trust
versus its taxable income and whether certain types of trust should
be disregarded for tax purposes. The discrepancies can lead to
anomalous and unfair outcomes for taxpayers, as well as being open
to manipulation for tax avoidance purposes.
The Consultation Paper makes clear that the Government wants to
ensure that the current flow-through treatment of trusts
– which aims to tax beneficiaries on their entitlements
to trust amounts – operates appropriately. The Government
is not interested in introducing entity taxation reforms, which
would tax the trust or trustee as a company and which the Howard
Government tried unsuccessfully to introduce.
The Government has also indicated that it is not interested in
making legislative changes to the operation of existing trust
deeds. That is, trustees will not be given powers by the tax
legislation to make decisions or take actions that they do not
currently have under the terms of their trusts.
Aside from these policy limitations, the Consultation Paper
seeks feedback on all aspects of trust taxation, including further
problems taxpayers and their representatives identify, interaction
with other areas of tax law, how different types of trusts should
or could be taxed, transitional issues for applying any new rules
and the scope of potential reforms.
The Consultation Paper also outlines three options for reform,
without expressing a clear preference for any one option or
limiting the potential for other options to develop:
the "patch" model, which would attempt to implement
changes through changes to the definitions currently used in the
legislation but otherwise minimise changes to be made;
the "proportionate within a class" model, which would
operate similarly to the existing provisions but introduce an
additional step into ascertaining classes of income to be subject
to specific tax treatment; and
the "trustee assessment and deduction" model, which
would see the taxable income of the trust assessed in the hands of
the beneficiaries that receive the economic benefit related to that
income, ensuring that amounts retain their character as dividends,
capital gains, etc in the hands of beneficiaries.
All models attempt to reduce the reliance of tax provisions on
trust concepts and specific trust deeds, allowing greater
flexibility in the arrangement of trust structures.
Trustees and beneficiary taxpayers should take this opportunity
to review their trust deeds and identify issues with the current
tax law, as well as making submissions on the changes they would
like to see.
The Government expects the full consultation process to the
introduction of amending legislation to take at least a year.
Submissions on this first aspect of the consultation process close
Friday, 10 February 2012.
Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this bulletin.
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