Various aspects of the tax law relating to trusts have been the subject of long-term uncertainty. Some clarification was provided in the 2010 year High Court decision in the Bamford case, however the Tax Office indicated that the judgement of the court raised further issues, which it outlined in a Decision Impact Statement.
Background: Bamford vs Tax Commissioner
The Bamford decision highlighted the fact that the amounts on which a beneficiary is assessed for tax do not always match the amounts they are entitled to under trust law. This mismatch can result in unfair outcomes and, according to the Tax Office, opportunities for tax manipulation.
In Bamford’s case, the High Court held that ‘income of the trust estate’ is to be determined according to trust law (as opposed to tax law concepts). The key impact of this is that when calculating what constitutes the income of a trust estate, the definition of the term in the trust deed is very important in determining the outcome. Because of this, the phrase ‘taxable income’ of a trust estate does not necessarily equal the ‘income of the trust estate’ — whether it does, or not, depends on the relevant clauses in the deed.
The Bamford case highlighted the importance of the definition of ‘income’ in a trust deed. In particular, it highlighted the problems with the potential mismatch between the definitions ‘income of the trust estate’ (to which the beneficiaries are entitled) and the ‘taxable income’ of the trust (on which the beneficiaries or trustee must pay tax).
The High Court in the Bamford case was not required to consider the issue of ‘streaming’ particular classes of income of the trust estate. However, the Tax Office concluded that the reasoning of the court made it clear that streaming would not be effective for tax purposes based on the law as it was at the time.
Amendments to the law were enacted on June 29, 2011, with effect for the 2010-11 year, to specifically enable capital gains and franked dividends to be streamed provided particular legislative requirements were satisfied.
What the amendments mean
The Tax Office says the legislated amendments have been made to ensure that, where permitted by the trust deed, the trust’s capital gains and franked distributions can be effectively streamed to beneficiaries for tax purposes by making those beneficiaries ‘specifically entitled’ to those amounts. Beneficiaries specifically entitled to franked distributions will, subject to existing integrity rules, also enjoy the benefit of any attached franking credits.
A beneficiary specifically entitled to a capital gain will be assessed on that gain, regardless of whether the benefit they receive is income or capital for trust law purposes. That is, unlike the situation that applied prior to the amendments, a beneficiary may be assessed based on a specific entitlement to a capital gain, even though they do not have a ‘present entitlement’ to income of the trust estate.
Capital gains and franked distributions to which no beneficiary is specifically entitled may be allocated proportionately to beneficiaries based on their present entitlement.
IMPORTANT NOTE: In another change to the distribution rules for trusts, the Tax Office advises that all trustees who make beneficiaries entitled to trust income by way of a resolution (for 2011-12 and thereafter) must do so by the end of the relevant income year, or an earlier date if stipulated in the trust deed. Previously, an administrative concession adopted by the Tax Office allowed trustees to make such resolutions by August 31 after the end of the income year in certain circumstances.
The changes also introduce two specific anti-avoidance rules to address the inappropriate use of exempt entities to ‘shelter’ the taxable income of a trust.
The first, the ‘pay or notify rule’, generally applies where an exempt beneficiary has not been notified of or been paid their present entitlement to income of the trust estate within two months of the end of the income year. In this circumstance, they are treated as not being, and never having been, presently entitled to that income.
The second rule, the ‘benchmark percentage rule’, generally applies where an exempt entity’s share of the income of the trust estate (ignoring any franked distributions and capital gains), exceeds a benchmark percentage. Broadly speaking, this rule applies where the exempt entity’s share is greater than their entitlement to the trust amounts that make up the trust’s taxable income. The benchmark percentage rule is designed to prevent exempt entities being used to inappropriately reduce the amount of tax payable on the taxable income of the trust.
Under both rules, the trustee is assessed on the share of the trust’s taxable income that corresponds to the income ‘to which the exempt beneficiary is taken as not being entitled to’. The Tax Office maintains discretion to not apply the anti-avoidance rules if in the circumstances it would be ‘unreasonable for it to apply’.
Still as status quo, for now
These amendments do not give trustees the power to stream if they do not already have this power under the trust deed. Alternatively, a streaming power may be
implied where the deed confers on the trustee a power to distribute income or capital at the trustee’s absolute discretion and there is nothing further in the deed or trust law in the relevant jurisdiction that fetters that power. It would be prudent to seek professional advice if doubt exists as to the availability of a streaming capability for the trustee.
The existing integrity rules (such as the ‘45-day holding period’) continue to apply in respect of the streaming of franked distributions, particularly to determine whether the beneficiary can receive the benefit of franking credits.
The streaming changes only affect trusts that make a capital gain or that are in receipt of a franked distribution for the 2010-11 or a later income year.
Pre-paying private health insurance
The private health insurance rebate is to be means tested from July 1, 2012, which will see the 30% rebate drop to 20% for singles earning more than $84,000 and families on $168,000. It will then fall to 10% for incomes of $97,000 and $194,000 respectively before dropping to zero at incomes above $130,000 and $260,000.
But a one-off method of extending the full rebate has emerged. Some private health insurance companies are accepting pre-payment of premiums before June 30, 2012. This means that private health fund members can lock in the current 30%krebate by paying their premiums before the means testing regime takes effect.
The Private Health Insurance Ombudsman’s office says that the relevant legislation is worded in such a way to allow for the date when premiums are paid to determine under which financial year eligibility for relevant government rebates or offsets is set.
The Minister for Health, Tanya Plibersek, has confirmed that private health insurance premiums paid before June 30, 2012, will qualify the payer for the level of rebate under existing rules, but that payments made on or after July 1, 2012, will be subject to the new health insurance rebate means test.
The legislation allows health insurance prov)ders to determine if they will allow pre-payment. Many health insurers have done just that, and allow pre- payment for up to 12 months, with some allowing 18 months and one company even providing for up to 30 months pre-payment of premiums.
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