From Leigh Adams Business Lawyers comes this handy guide to the hazardous area of the taxation of trusts and their beneficiaries. The taxation effect substantially differs depending on the terms of the trust deed, and the status of trustees and beneficiaries.
6 categories of trust taxation
Trust taxing methods are summarised according to the following 6 circumstances:
- a beneficiary not under legal disability, and presently entitled
- beneficiary is under a legal disability, and presently entitled (includes special taxing provisions for minors)
- beneficiary is an individual, not legally disabled, and deemed to be presently entitled under s95A(2) – present entitlement.
- beneficiary is a non-resident, and presently entitled to trust income
- no presently entitled beneficiaries
- revocable trusts, or a trust where the settlor’s children are both under 18 and presently entitled
Crucial trust taxation terminology
- What is a ‘present entitlement’? (Answer: it’s a ‘right to present enjoyment’)
- Who has a ‘legal disability’? (Answer: minors, mentally incompetent, criminals, bankrupts)
- When is a trust an ‘Australian resident trust’ (Answer: look to the location of the Trustees or of the trusts management and control)
There are a number of potential problems in recognising the correct taxing position.
- distributable income of a trust is not the same as net income – rules determine how much taxable income is included in assessable income
- streaming of different types of income to selected beneficiaries – rules determine how this can be ‘safely’ done for tax purposes. A statutory mechanism was introduced in 2011.
Being treated as a ‘family trust’ is optional (by making an election), but carries advantages and disadvantages. Getting this wrong, can result in punitive tax rates, because tax at normal rates on distributions by a family trust only applies to a restricted set of beneficiaries.
The author notes that discretionary trusts generally elect to be family trusts where:
- There are prior year losses.
- Franked dividends have been derived from shares acquired after 31/12/1997