ACCG924 Taxation Law

Lecture Notes Week 9 2018

 Lecture Nine
Taxation of Trust Income

Readings from Australian Taxation Law 2018 for this week’s lecture

Taxation of trust income

Introduction -- W17-000; 17-005 to 17-025
Taxation of trust income -- W17-060 to 17-140

Taxation of minors
W21-010 to 21-050

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 Taxation of trust income
Division 6 Pt III s 95 to 102 ITAA1936

Nature of a trust

Trust is not a separate legal entity -- is a fiduciary obligation imposed on a

person (the trustee) to hold trust property for the benefit of certain persons
(the beneficiaries) or purposes, eg the relief of property or to protect the
environment

Being under a fiduciary obligation means that the trustee must act according to
the terms of the trust and must not personally benefit

A trust is most commonly established by a person (the settlor), but may be

established in other ways, such as by court order

The trustee may hold the legal title to trust property (eg, the trustee’s name is on
the trust bank account), but is compelled in equity to deal with it according to
the terms of the trust – means the beneficiaries may enforce their rights in
court.
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 Taxation of trust income

Types of trusts include:

–  Bare trusts
–  Fixed trusts (eg, unit trusts)
–  Discretionary trusts
–  Constructive trusts.

Trusts may be inter vivos trusts (between living persons) or testamentary trusts
(set up on the death of a person).

Family trusts -- money or property is given to a trusted adviser or professional

trustee who will invest it and deal with it according to the trust deed – trust
deed is a legal document that sets out matters such as the name of the settlor,
the trustee, the beneficiaries (usually family members) and the powers and
duties of the trustee – is usually a discretionary trust because the trustee can
exercise discretion about who, within the nominated beneficiaries, will benefit
from trust income and capital from year to year 4
 Taxation of trust income

Who pays tax on the trust income?

A trust is not a separate taxable entity – is the relationship between the trustee
and the beneficiaries

Generally, it is the beneficiaries who are liable to pay tax on the trust income.
However, the trustee may be liable to pay tax:
-- on behalf of a beneficiary where a beneficiary is under a legal disability or is
not a resident, or
-- where income is accumulated in the trust.

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 Taxation of trust income

Two key concepts

Are two key concepts that must be discussed before the taxation of trust
income can be understood:
-- present entitlement
-- under a legal disability
These concepts determine who pays tax and how much tax.

Present entitlement -- Courts have said that, to be presently entitled, a

beneficiary must have an “indefeasible, absolutely vested, beneficial interest
in possession” in the trust income – basically, the taxpayer has a present
right to demand payment
-- Harmer 1991: money was held in trust by solicitors until a court case
between two parties was settled – High Court said neither party was
presently entitled to the money because each had only a contingent
interest, conditional on who the court finally ruled in favour of.
If the beneficiary is under a legal disability, the interest must be such that the
beneficiary would have been able to demand immediate payment of the
income had there been no disability.

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 Taxation of trust tncome

Deemed present entitlement

Trustee of a discretionary trust must apply the trust income according to the
trust deed but otherwise has a discretion as to how it is distributed – this
means the beneficiaries are not presently entitled because they cannot
demand payment -- they are, however, deemed to be presently entitled
when the trustee exercises the discretion in their favour (s 101)

Under a legal disability

No definition in the legislation, but generally means a person who cannot give a
valid discharge when payment is made to them, and so someone else has
to act on their behalf
Most common:
-- persons aged under 18
-- persons of unsound mind
-- persons who are bankrupt

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 Taxation of trust income

When is a beneficiary liable to pay tax on the trust income?

Section 97 ITAA36: a beneficiary pays tax on trust income if the beneficiary is:
-- presently entitled to the income
-- not under a legal disability, and
-- a resident.

Trustee gives the beneficiary the full amount of trust income to which they are
presently entitled and the beneficiary pays tax on the income at ordinary tax
rates.

Beneficiaries are taxed on the income to which they are presently entitled even
if the trustee has not distributed that income to them by the end of the year
in which it is derived.

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 Taxation of trust income
When is the trustee liable to pay tax on behalf of the beneficiary?

Section 98 ITAA36: the trustee pays tax on behalf of the beneficiary (takes tax
out then gives the beneficiary the amount remaining) in two situations.
1.  where the beneficiary is presently entitled to the income but is under a legal
disability
2.  where the beneficiary is presently entitled to the income but is not a resident

Beneficiary is presently entitled but under a legal disability

Where a trustee pays tax on behalf of a beneficiary who is presently entitled but
under a legal disability, the trustee pays tax at either of two rates:
(i) at the ordinary tax rates for an individual resident taxpayer, with
Medicare levy added if appropriate (W2-300), or
(ii) if the beneficiary is a minor, sometimes at Div 6AA rates (see later
discussion of “Taxation of Minors”).
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 Taxation of trust income

Where a trustee has paid tax on behalf of a beneficiary who is presently

entitled but under a legal disability:
-- a beneficiary with no other income has no further tax liability
-- a beneficiary with other income (eg, from employment) must lodge a
tax return showing their total income (trust income, including the tax
sent to the ATO, and other income) and their tax liability is
calculated on the total amount – beneficiary is then given credit for
the tax already paid on their behalf by the trustee (s 100), so no
double tax.

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 Taxation of trust income

Beneficiary is presently entitled but is not a resident

Trustee pays tax on behalf of a beneficiary who is presently entitled to
the trust income but is not a resident at the end of the year of
income (s 98(3) and (4)).
-- the trustee pays tax at non-resident rates and gives the
beneficiary the amount that is left
-- the beneficiary is also assessed on the same amount and given
credit for the tax already taken out (s 98A) – is entitled to a refund if
the tax paid by the trustee on behalf of the beneficiary exceeds the
tax payable by the beneficiary.

Example at W17-120

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 Taxation of trust income

Trustee is liable to pay tax on income to which no beneficiary is presently

entitled -- eg trust income for the year is $100,000, trustee decides to give
$75,000 to one beneficiary and the remaining $25,000 is accumulated in the
trust, so no one is presently entitled to that amount.

Trustee pays tax on the income to which no beneficiary is presently entitled:

-- under s 99 at ordinary tax rates, or
-- under s 99A at flat rate of 45% (W2-140).
Medicare levy is added in both cases if the income amount is appropriate.

Section 99 applies only if s 99A does not apply.

Section 99A does not apply:

(a) to a trust created by will, on the death of a person, or
(b) to a trust of certain property, such as damages relating to personal injury or
disease, workers’ compensation damages or a public fund to support
certain persons, or where the Commissioner considers it unreasonable for s
99A to apply: s 99A(2) and (3).
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 Taxation of trust income
Calculation of net income of a trust estate

A trust is not a taxable entity – its net income is simply determined for calculating
the tax liability of the beneficiaries or the trustee.

The net income of a trust is the total assessable income of the trust calculated as
if the trustee were a resident taxpayer in respect of that income, less all
allowable deductions (s 95(1)).

The calculation requires both Australian and foreign-source income and related
deductions to be taken into account.

Resident beneficiary is assessable on trust income from Australian and foreign

sources.

A non-resident beneficiary is only assessable on Australian-source trust income

and is not liable to tax on net income from non-Australian sources. The foreign
source income to which a non-resident beneficiary is entitled is not subject to
Australian tax.
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 Trust losses

Losses incurred by a trust estate are not distributed to beneficiaries.

Losses may be carried forward and offset against the assessable income of the
trust estate in the following year of income – but only if the trust loss tests in
Sch 2F ITAA36 are satisfied. The trust loss tests are not examinable.

If the trust loss tests are not satisfied, the losses are trapped in the trust.

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 Taxation of income of minors

Division 6AA ITAA36

Anti-avoidance rules to take away the tax advantages of diverting income
to children

Division 6AA ITAA36 (s 102AA to 102AJ) applies to the “unearned income” of

minors – trust income, dividends, royalties and rent

Who is affected? – “prescribed persons”: s 102AC

-- a person who is aged less than 18 years on the last day of the year
– unless the person is engaged in full-time work on the last day of the year,
or for at least three months during the year

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 Taxation of income of minors

What income is affected? – “eligible taxable income”

– all income of a prescribed person unless is “excepted assessable income”: s
102AE

Excepted assessable income

•  Employment income
•  Business income, as defined in s 102AF
•  Income from investment of certain property (including when held in trust), eg
damages relating to personal injury or disease, workers’ compensation,
property in a public fund
•  Income from a trust created under a will.

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 Taxation of income of minors

Tax rates on income of a minor

Excepted assessable income is taxed at ordinary tax rates.

Eligible taxable income is taxed as follows:

•  if eligible taxable income is $416 or less – no tax
•  if eligible taxable income is more than $416 and less than $1,308, tax is
generally 68% of the excess over $416
•  if eligible taxable income exceeds $1,307, tax is payable on the whole of the
eligible taxable income at 45% (plus Medicare levy).

The low income offset cannot reduce tax on eligible taxable income, but can
reduce tax on excepted assessable income.

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 Taxation of income of minors

Example of taxation of trust income received by a minor

Milo is a 17 year old full-time school student who works 10 hours a week at a
supermarket. Milo is also beneficiary of a discretionary trust set up by his
grandparents who are still alive.
During 2017/18, Milo (a “prescribed person” ) earns $8,000 from his supermarket work
(“excepted assessable income”) and is presently entitled to $30,000 from the trust
(‘eligible assessable income”).
The trustee of the trust pays tax on behalf of Milo (s 98) at Div 6AA rates – the trustee
takes $13,500 ([$30,000 x 45%] + $600 [$30,000 x 2% Medicare levy]) from Milo’s
$30,000, sends it to the ATO and gives Milo the $15,900 that’s left.
Milo lodges a tax return showing the $8,000 employment income plus the full $30,000 of
trust income.
The tax liability is calculated on the basis that:
-- the $8.000 is taxed at ordinary rates – means no tax liability because is below the
$18,200 threshold
-- the $30,000 is taxed at Div 6AA rates -- but there is credit for the tax already paid
by the trustee – so no additional tax.
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