Australia: Trust Tax Reform: One step closer, but is it any clearer?

Last Updated: 7 November 2012
Article by Andrew Cromb, Nick Zanikos and Ian Kearney

The reform of the taxation of trusts took an incremental step closer toward fruition on 24 October 2012, when the Assistant Treasurer released a policy options paper: Taxing trust income – options for reform (the Options Paper). The Options Paper contains few surprises, but is also fairly light on the detail of proposals discussed. Given the amount of detail still to work through, the proposed commencement date of 1 July 2014 seems quite ambitious.

The proposals discussed in the Options Paper will impact a wide range of taxpayers, ranging from fund managers to privately held groups. All affected taxpayers should monitor how the proposals develop over the coming months.

What's happened so far?

The Options Paper follows the Discussion Paper titled Modernising the Taxation of Trust Income – Options for Reform released in November 2011 (the 2011 Discussion Paper). You can read about that Discussion Paper here.

The Options Paper notes that the submissions received in respect of the 2011 Discussion Paper reflected a desire for more information about two of the proposed models – the 'trustee assessment and deduction model' and the 'proportionate within a class model'. The Options Paper addresses this request while also clarifying the core features required of any new model for taxing trust income.

The Options Paper does not comment further on the 'patch model' raised in the 2011 Discussion Paper. Under the patch model, the Government proposed to retain the current structure of Division 6 but introduce refinements such as a new definition for the term "income of the trust estate" to be based on tax concepts. The patch model's absence from the Options Paper seems to suggest that the Government favours more substantial reforms, but there is no indication that the Government has abandoned the patch model altogether.

Core Features of a new model for taxing trust income

The Options Paper proposes that any new model for taxing trust income should have the features described below:

  • Character retention - all amounts distributed by a trust should retain their character in the hands of beneficiaries, unless specific tax rules prevent this occurring. So, for example, foreign income derived by a trust will continue to be treated as foreign income when it is distributed to beneficiaries. Similarly, it appears that tax preferred income (e.g. tax deferred distributions) will also retain their character.
  • Streaming - trustees will be able to stream all different classes of income, rather than just capital gains and franked distributions. This ability will exist regardless of whether there is an express streaming power in the trust deed. This marks a return to the position most taxpayers believed existed prior to the 2011 income year, when taxpayers generally understood that streamed of different types of income was possible. This practice came to an end following the decisions in Bamford and Greenhatch, though amendments permitted the streaming of capital gains and franked distributions only from the 2011 income year.
  • Allocation of expenses - new rules may be introduced to specify how deductions are to be allocated against different types of income. The Options Paper appears to suggest that deductions will need to be allocated on a "fair and reasonable basis". The basis of allocation is important as it will have the potential to reduce the amount of different classes of income, thereby achieving different tax outcomes than if deductions were applied proportionally across all classes of income.
  • Timing of trustee resolutions - trustees will no longer need to make beneficiaries presently entitled to income (i.e. determine distributions) by 30 June each year. Instead, the time for determining a beneficiary's entitlement is proposed to be extended, potentially to 31 August each year (though possibly longer in certain cases). It is important to remember that this proposal will not effect any requirements to determine income by 30 June which might exist in the trust deed. For example, the trust deed might include a 'default beneficiary' clause stipulating that a particular beneficiary is entitled to all the trust's income if no other determination is made prior to 30 June. It is not possible for Federal tax law to change this.
  • Tax rate on accumulated income to remain 46.5% - the tax rate paid by trustees on income that is not distributed to beneficiaries will probably remain at 46.5%. The Government is concerned that any attempts to lower this rate will see taxpayers leave income in the trust to shelter it from high marginal rates. It believes integrity rules similar to those in Division 7A would be required to ensure this income is not later accessed by beneficiaries tax-free. As a result the Options Paper seems disinclined towards any rate cut.
  • Transitional rules for resettlement - transitional rules may be introduced to ensure trust deed amendments made as a consequence of introducing the new regime do not trigger a resettlement for income tax purposes. It is unclear whether such a measure is strictly necessary following the decision in Clark. However, in any event, Federal legislation will be unable to mitigate the risk of resettlement for stamp duty purposes. One hopes State governments work with the Federal Government to achieve an appropriate outcome.
  • Tax treatment of bare trusts - bare trusts, such as custodians and investor directed portfolio services, will not be subject to any new regime. These trusts are proposed to be disregarded for income tax purposes. This is a sensible development, which reflects current industry practice.

Further information in respect of proposed models

The Options Paper provides further information in respect of two models dealt with in the 2011 Discussion Paper:

  • the economics benefits model (EBM), which was referred to as the trustee assessment and deduction model in the 2011 Discussion Paper; and
  • the proportionate assessment model (PAM), which was referred to as the proportionate within class model in the 2011 Discussion Paper.

Under the EBM, trustees would apportion tax liabilities for a year by allocating or distributing the trust's taxable income to beneficiaries. In other words, each beneficiary's tax liability would depend on the amount of taxable income allocated or distributed to them. It would not depend on any distribution of the trust's 'income'. Further, while not explicitly stated, it appears that the EBM will not rely upon the concept of present entitlement used in the current trust tax rules.

The assessment process for this model would essentially work as follows:

  1. Calculate the trust's taxable income as if the trust were a resident taxpayer.
  2. Identify the components of the trust's taxable income.
  3. Distribute and allocate amounts representing taxable income.
  4. Beneficiaries would be assessed on amounts distributed/allocated to them.
  5. The trustee would be assessed on the remaining taxable income.

By contrast, the PAM approach would assess beneficiaries by reference to their proportionate share of the 'trust profits' of a relevant class. This model bears some similarity to the current trust tax rules, which assesses beneficiaries by reference to their share of trust income. However, it is clear that trust profit will be a broader concept than income, and will expressly include capital receipts. It is still unclear what different classes trust profit will be (or will be able to be) divided into.

Under the PAM, the assessment process would essentially work as follows:

  1. Calculate the trust profit.
  2. Determine the different classes of trust profit and calculate the class amounts.
  3. Determine the proportions of the class amounts to which beneficiaries were presently entitled.
  4. Calculate the taxable income of the trust as if the trust were a resident taxpayer.
  5. Allocate the trust's taxable income to the classes maintained by the trustee (if applicable).
  6. The trustee is assessed on the remaining taxable income.

Where to from here?

In addition to receiving formal submissions, Treasury is engaging in a number of meetings with stakeholders and Moore Stephens will be represented in this dialogue. Treasury have previously indicated that they are looking to release Exposure Draft legislation in February 2013, with a view to introducing legislation into the House of Representatives in the Winter sittings of 2013. The Government have previously announced that the new reforms are to take effect from 1 July 2014. As noted above, the timeline for these future steps appears challenging.

What can you do?

Taxpayers with an interest in the proposals can make a submission prior to 3 December 2012. If you have any particular issue or concern that you would like raised by us in discussions with Treasury, we encourage you to get involved and contact us.

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 © 2011 Moore Stephens Australia Pty Limited. All rights reserved.

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