Hello, I’m Robyn Jacobson, Senior Advocate at The Tax Institute. Welcome to Tax Time 2023. In this session, we will cover some of the key changes and often overlooked provisions that practitioners will need to consider this tax time when completing their clients’ trust tax returns.
This year, The Tax Institute has prepared a handy Trust Tax Return checklist. This checklist does not cover every single issue that you may encounter, but serves as a guide on a range of issues that should be considered when preparing trust tax returns.
There have been some significant changes affecting trusts that all tax practitioners need to be aware of and be ready to assist their clients with. Let’s start by reviewing some of these changes.
Section 100A
Following the release at the end of last year of the ATO’s finalised guidance on section 100A, focusing on trust distributions is more important than ever. The final guidance — in the form of Taxation Ruling TR 2022/4 and Practical Compliance Guideline PCG 2022/2 — is a notable improvement from the previous ATO guidance concerning the application of section 100A.
Broadly, section 100A will apply if all the following criteria are satisfied:
- l a beneficiary (who is not under a legal disability) is presently entitled to a share of all or part of the trust income in a particular income year (and they are therefore assessed under section 97 of the ITAA 1936 on that share of the trust’s net income);
- l that present entitlement arises in connection with a reimbursement agreement;
- l the arrangement does not fall into the following two exemptions:
- ¡ the reimbursement agreement was not entered into by at least one of the parties to the agreement with a purpose of reducing or deferring someone’s income tax liability; and
- ¡ the arrangement was entered into in the course of ‘ordinary family or commercial dealing’.
TR 2022/4 explains the ATO’s views on these concepts and requirements. The Tax Institute’s Tax Policy and Advocacy team has written detailed articles which consider the ATO’s view of section 100A and its compliance approach. These are available to our members and can be found on our website, under Insights | Articles.
For those who have relied on the ATO’s July 2014 website guidance, PCG 2022/4 states that the ATO will not dedicate new compliance resources to consider the application of section 100A to arrangements that ended prior to 1 July 2014 unless:
- he ATO is otherwise considering your tax affairs; and
- the arrangement continues before and after 1 July 2014.
PCG 2022/2 also explains two further risk zones that are used by the ATO to delineate the ATO’s perceived risk of a taxpayer’s arrangement. These are the green and red zones.
- If your client’s arrangement falls within the green zone, the ATO will not dedicate compliance resources to consider the application of section 100A to the arrangements, other than to confirm that the features of the relevant scenario are present.
- Arrangements that fall within the red zone are likely to see the ATO allocate compliance resources to consider the application of section 100A as a priority.
Notably, in finalising the PCG, the ATO removed the proposed blue risk zone and introduced additional green zone examples. The additional examples clarify that the following arrangements will fall within the green risk zone:
- Where an individual beneficiary is made presently entitled to a share of trust income, the funds are paid to the beneficiary (including to a joint bank account) and are used for the benefit of the beneficiary — this includes making donations to deductible gift recipients or contributions to the beneficiary’s superannuation fund;
- Where a beneficiary is made presently entitled to a share of trust income and the beneficiary receives their entitlement within two years of becoming presently entitled; and
- Where the trustee retains the funds that the beneficiary would otherwise receive in the satisfaction of their entitlement for one or more of the noted purposes, including using the funds:
- as part of the working capital of the business;
- to repair replace or maintain an asset; or
- for some other commercial activity.
Although the additional examples provide greater certainty, the removal of the blue zone may mean that taxpayers with arrangements that do not fall within either the green or red zone will need to further consider their arrangements.
Importantly, the green and red zones in the PCG do not indicate the likelihood of section 100A applying to the arrangement; rather, they indicate the likelihood of the ATO applying its compliance resource to consider whether section 100A applies to the arrangement.
The ATO has advised that it will update its view in the Ruling following the recent appeal decision by the Full Federal Court in Guardian, and any upcoming cases such as BBlood appeal (also before the Full Federal Court). We hope that these updates will further clarify arrangements that are likely to fall within the green and red zones, assisting you to more readily inform and advise your clients.
Our useful trust tax time checklist has further details and links to useful resources.
ATO’s treatment of UPEs
Late last year, the ATO revised its position regarding the treatment of unpaid present entitlements (UPEs). The updated view is contained in Taxation Determination TD 2022/11, and applies to trust entitlements arising on or after 1 July 2022.
The updated guidance replaces the previous view set out in Practice Statement PS LA 2010/4, which can be still be relied on in relation to trust entitlements that arose on or before 30 June 2022.
A private company is taken to provide a loan for Division 7A purposes where it provides financial accommodation to a shareholder, or an associate of a shareholder. Broadly, TD 2022/11 states explains that a company is taken to provide financial accommodation for Division 7A purposes to its a shareholder//associate of a shareholder, where:
- the company is made presently entitled to an amount of trust income;
- that amount is set aside by the trustee and held on sub-trust; and
- the company consents to those funds being used by the shareholder/associate.
The UPE will need to be managed as a complying Division 7A loan, or paid in full by lodgment day, otherwise a deemed dividend will arise for the shareholder/associate.
Sub-trusts
The ATO’s view on evidencing the existence of a sub-trust is set out at Issue No. 7.1 of the Public advice and guidance compendium (Compendium) accompanying the Determination. The ATO’s view is that most sub-trusts will be a ‘Transparent Trust’ as described in PS LA 2000/2.
A ‘Transparent Trust’ is one in which the beneficiary of the trust estate has an absolute, indefeasible entitlement to the capital and the income of the trust. As the beneficiary has an absolute entitlement to the income of the trust, the beneficiary rather than the trustee, will be taxed on the proportionate share of the trust’s net income. For further guidance on the ATO’s view on absolute entitlement, refer to draft Taxation Ruling TR 2004/D25.
If the sub-trust is a Transparent Trust, income derived by the sub-trustee in that capacity will be included by the corporate beneficiary in its assessable income.
If the sub-trust is not a Transparent Trust, whether the sub-trustee is required to lodge tax returns will depend upon the respective legislative instrument for each year. Ordinarily, a trust that is not a Transparent Trust will be required to lodge tax returns (unless another exemption applies).
Our Tax Time resources and in-depth guides provide you with further tools and tips to help you during tax time this year.
The impact of the Carter decision
In 2022, the High Court handed down its decision in Commissioner of Taxation v Carter [2022] HCA 10. The question for the High Court was whether the default beneficiaries who were entitled to trust Income under the deed remained liable to tax under section 97 of the ITAA 1936, despite validly disclaiming their right to those gains after the end of the income year.
The High Court’s decision in Carter raises three key principles:
- the disclaimer must reject the entirety of the beneficiary’s interest;
- the disclaimer must be executed prior to the end of the accounting period to be effective for that accounting period — this means that the beneficiary cannot retrospectively expunge or alter the rights that existed just before midnight on 30 June of the relevant income year; and
- a valid distribution does not require the assent of the beneficiary. However the creation of beneficiary entitlements can occur without a beneficiary’s knowledge.
In reconciling the Carter decision with the Ramsden decision, Carter does not displace the precedent established in Ramsden that a beneficiary can validly disclaim their interest in a share of trust income after the end of the income year, but this is only for trust law purposes. Carter confirms that, once a present entitlement to a share of trust income is conferred on a beneficiary for an income year, nothing can prevent the beneficiary’s liability to income tax under tax law based on the beneficiary’s their proportionate share of the trust’s net income — even if they have subsequently disclaimed their interest under trust law.
Some other points to consider are that:
- Section 97 assesses a beneficiary based on their present entitlement to trust income and is concerned with the beneficiary’s right to receive income, not their actual receipt of the income; and
- beneficiaries are assessed on their share of the trust’s net (taxable) income based on their present entitlement to a share of the trust income immediately before the end of the relevant income year.
So what does this mean? From a practical perspective, there are a number of things you need to consider when advising your clients about disclaiming their trust interests.
- First, and foremost, it is important that beneficiaries understand their rights under a trust deed and disclaim as soon as practicable after being made aware of their entitlement. This includes understanding the extent to which the trustee seeks to stream any capital gains or franked distributions to particular beneficiaries, if the trust deed allows it, in line with the principles established in Bamford.
- Remember, Carter means that disclaimers made after 30 June cannot avert the beneficiary’s tax liability. If the beneficiary is a default beneficiary, amendments to the trust deed may be necessary if the beneficiary genuinely intends to disclaim their interest. Beneficiaries should also be aware vigilant in of the understanding any actual and potential trust income entitlementstrust’s expected income and their entitlements to be in a better position to make this assessment.
Section 100A
The High Court’s decision in Carter could have some inadvertent consequences for arrangements that may fall within the scope of section 100A.
Where an adult child beneficiary has unknowingly become presently entitled to a distribution in an income year, they may be unable to effectively disclaim their entitlement from a tax law perspective. They may raise the prospect whether:
- their present entitlement arose in connection with a reimbursement agreement;
- at least one of the parties to the agreement had a purpose of reducing tax; and
- the arrangement was an ordinary family or commercial dealing.
If all the conditions of section 100A are satisfied, the beneficiary — who would otherwise be saddled with a tax liability — may contend that the trustee should instead be assessed under section 100A, instead rather than of the beneficiary being assessed under section 97(1).
Trust losses
Now, let’s chat about some of the usual considerations you may need to turn your mind to.
If your client’s trust has made tax losses, or seeks to recoup a prior year tax loss, special rules may need to be considered. A tax loss of a trust can be carried forward and used to reduce the trust’s net income in a later income year, subject to certain tests. These tests, called the trust loss provisions, are contained in Schedule 2F to the ITAA 1936.
Different tests may apply, depending on the circumstances and the type of trust. The tests broadly focus on any change in the ownership of the trust, as well as potential income injection arrangements.
The 50% stake test, pattern of distributions test and control test may apply in circumstances where there has been a change in the ownership or control of the trust. If the relevant conditions are not satisfied, the trust loss provisions may apply to:
- prevent a trust from deducting its tax losses from earlier income years;
- require a trust to work out its net income and tax loss for the current income year in a special way; or
- prevented a trust from deducting certain amounts in respect of debts (for example, bad debts) incurred in the current or an earlier income year.
You may also need to consider the income injection test if income (this is very widely defined for this purpose) is ‘injected’ into the trust, or other trusts, to reduce trust income or access tax losses.
Remember, the trust loss provisions don’t apply to capital losses. Also, where a trust has validly elected to be a family trust, it has to satisfy only with the exception of the income injection test, not only do the trust loss provisions generally not apply to trusts that have validly elected to be a family trust, and but further, the income injection test is easier to satisfy when a trust makes a family trust election.
Family trust elections
A family trust for tax purposes is one whose trustee has made a valid family trust election (FTE), specifying an individual who is used to determine the ‘family group’. Transactions can then be made between members of that family group without adverse tax consequences.
To make an FTE family trust election, the relevant tests some eligibility conditions need to be satisfied. An FTE needs to must be made in the approved form; simply declaring that the trust is a family trust will not be effective. If an FTE is made, or the information relating to that election is changed or revoked, remember to complete the relevant items in the information section of the trust tax return.
For more information about trust losses and FTEs, refer to our tax time checklists, member-only resources and the ATO website.
Trustee reporting obligations
Trustees have numerous reporting obligations, that they may need your assistance with throughout the year. We will briefly discuss some of the regular reporting obligations.
TFN reporting
Trustees of a closely held trust are required to complete a TFN report containing the TFN and other personal details of the beneficiaries of the trust. This report is due by the last day of the month following the end of the quarter in which the TFN was quoted by the beneficiary (or within such further time as the Commissioner allows). Where a distribution is made to a beneficiary for the first time at the end of an income year, the TFN reportis is therefore generally due on 31 July. Remember, trustees need to lodge a report only for a quarter in which they have information to report.
Where a beneficiary becomes presently entitled to an amount of trust income for the first time and the beneficiary has not provided their TFN details to the trustee before that present entitlement arises, further reporting and withholding obligations may arise.
Statement of distribution
Trustees are required to complete the distribution statement at item 57 of the trust tax return. The information provided can include a range of factors, including the amount of primary production income, the amount of franked distributions, the amount of net capital gains or attributed foreign income.
In particular, where the trust is distributing to another trust that is not excluded from the trustee beneficiary reporting rules, remember to accurately complete labels P and Q of this item, which relate deal to with the tax preferred amounts or the untaxed part of the share of the trust’s net income.
FTEs or IEEs
If the trust has made a valid family trust election or an interposed entity election, remember to double check the entities to which the trust has distributed. This is important to determine, because if the trustee has made a distribution outside the family group of the test individual nominated in the FTE, the trustee may be liable for family trust distribution tax may be payable. The current tax rate is set at 47%. Be careful, because the meaning of ‘distribution’ for this purpose is very broad.
FTDT does not result in double taxation but it is a penal rate of tax.
Given the penal rate of tax payablethis, your clients may benefit from regular reminders of which entities are within, or fall outside, the family group of the test individual nominated in the FTE.
Personal services income
If an individual provides their personal services to third parties via the trust, you will need to consider whether the PSI rules apply. Broadly, the PSI rules will apply if more than 50% of the income received under a contract is for an individual’s personal efforts or skills.
If a trust derives income that is the PSI of one of more individuals, this must be indicated at Item 30 of the trust tax return will need to indicate this, and further relevant information will need to be provided. If the trust receives PSI and does not promptly pay it to the individual as salary and wages:
- the net amount of PSI is attributed to the individual for tax purposes and is not assessable to the trustee;
- the trustee has PAYG withholding obligations (typically monthly); and
- certain related expenses are not deductible under these special rules.
Importantly, the PSI rules do not deem the individual to be an employee of the entity nor treat the entity as if it is not carrying on a business. Also, SG contributions are not payable by the entity in respect of attributed PSI.
HoweverI, if the trust satisfies at least one of the tests, or obtains a PSB determination from the Commissioner, it will be treated as is conducting a personal services business (PSB). In this case, , these three consequences mentioned before will not arise. However, even if the at least one of the tests is are passed and the trust is conducting a PSB, the trust still cannot split the income because it is personal exertion income — if the income isd split, Part IVA may apply to the arrangement.
Remember, that trustees holding a PSB determination in respect of an individual will need to indicate this at label D of Item 30.
For more information about the PSI rules and PSBs, refer to Taxation Ruling TR 2022/3 and our tax time resources.
Rental propertiesy held in trusts
Rental properties are y is commonly held in a trusts for a variety of reasons, such as asset protection and flexibility with distributions. If your client’s trust has a rental property, several sections of the trust tax return will need to be completed. These include:
- Item 9 ‘Rent’, including the Partnerships and trusts rental property schedule 2022; and
- if the trust is carrying on a business:
- Item 1 ‘Description of main business activity’; and
- Item 5 ‘business expenses’ – especially those items relating to rent.
Remember that the benefits of negative gearing concessions generally don’t apply are not available for investment properties held in trusts. If the trust is making net losses from the a property, the trust loss provisions may need to be considered, and the losses cannot be distributed to the beneficiaries.
There may also be other tax implications that taxpayers need to consider, including stamp duty (especially foreign surcharges for some discretionary trusts) and the availability of land-tax free thresholds.
FBT considerations
Where assets of the trust are used for private purposes by employees, or associates of employees of the trust, consider whether there are any FBT implications if the benefit has been provided in respect of the employment of any a person. Depending on the type of fringe benefit provided, certain exemptions may be available.
For example, the trust may be eligible for the small business entity FBT car parking exemption or the FBT work-related devices exemption.
Refer to appendix 13 of the trust tax return for further information about the small business entity concessions.
Conclusion
The topics that we have covered in this session and the accompanying checklist are not an exhaustive list of tax provisions that you will encounter with all your trust clients. The checklists and this recording serve as a reminder of some of the traps that practitioners and taxpayers may encounter when preparing the 2023 trust tax return.