Recent court decisions, legislative changes (both passed and proposed) together with a potentially reinvigorated will on the part of the ATO to test and apply black letter legal concepts, serve as a reminder for trustees and responsible entities that their trusts/schemes are governed not only by regulatory laws but also by general trust law. 

Many tax consequences for trusts and their beneficiaries turn on the application of general trust law principles. Accordingly, ignoring those trust law principles carries with it the risk of unexpected tax outcomes and the prospect of claims by beneficiaries for non-compliance with trust duties, including where the non-compliance has produced an unwelcome tax result for beneficiaries.

The prominent court decisions are the decision of Stone, J in the Federal Court in Colonial First State Investments Limited (2011) and the decision of the High Court in Bamford (2010).  The legislative change was the passing of the Act (in June 2011) that included express provisions for streaming capital gains, franked dividends and franking credits to beneficiaries of a trust or scheme.  The proposed legislative change is the so called “MIT regime” (ie managed investment trusts) to allow for a new attribution method of allocating the taxable income of a trust between beneficiaries (and, if appropriate, the trustee) in respect of trust income.

The Colonial and Bamford decisions, together with the streaming rules are relevant for all forms of trust other than those taxed as companies under specific provisions.  Hence, family discretionary trusts and private and public unit trusts are covered, including registered managed investment schemes (noting that under the Corporations Act, the responsible entity holds scheme property on trust for scheme members).

Trust law 101

Many duties have been developed for trustees through the general law (drawn from cases over several centuries).  They are duties that a trustee owes to its beneficiaries.  Beneficiaries can seek redress through the courts either to prevent a prospective breach of duty or to seek redress for a breach that has occurred.  The duties very much reflect concepts of morality and fairness, in recognition of the fact that a trustee is looking after someone else’s money and so the law will hold the trustee accountable to a high standard, reflecting the expectations of society.

In that vein, duties that are engaged (virtually without exception) when it comes to trust distributions for large trusts/managed funds are:

  • a trustee must know its trust deed/constitution;
  • a trustee must obey/follow its trust deed/constitution.  The existence and scope of beneficiaries’ rights and interests are expressed through the trust deed/constitution (in addition to statutory rights, where applicable).  Accordingly, a trustee must not merely follow the trust deed/constitution in general terms.  It must obey every provision and thereby protect and defend the rights and entitlements of the beneficiaries;
  • a trustee has a duty of care and prudence.  This is commonly expressed as being to exercise the same skill and care as an ordinary prudent person of business would exercise if looking after their own property.  An alternative expression through some cases is that a trustee must exercise the same degree of care and prudence that a person would excercise if looking after property for someone for whom the trustee was morally bound to provide.  Again, an exacting duty;
  • a duty to act personally.  Expressed another way, this is a duty not to delegate.  However, delegation is allowed where specifically permitted by the trust deed/constitution or by statute.  In modern deeds, it is common for a trustee/RE to have the power to delegate.  Even so, the existence of this duty underscores the importance of making sure that trustees/REs have properly resolved to delegate and have clearly identified the delegates.  

When exercising a power (such as the common requirement in deeds to determine what is included in income for distribution), a trustee must act in good faith, take into account all relevant considerations and disregard irrelevant considerations and act only for a proper purpose.

As a fiduciary, a trustee has a duty of loyalty so that it must act without any conflict of duty and interest or duty and duty (unless the persons to whom the duties are owed have given their fully informed consent) and must not receive unauthorised profits.

The cases, streaming and the MIT regime

The cases, streaming and, it seems likely, the MIT regime all bring into play the above concepts.  That is because, in various ways, they turn on identifying a beneficiary’s entitlements or determining what is included in income or both and when those entitlements arise.  In so doing, a trustee/RE must look to its deed/constitution, probably exercise certain powers, probably delegate certain powers, do so without conflict and make sure all of those things are done in a timely way.

What to think about…

The following might be asked of the typical trustee/RE in relation to trust distributions:

  • are you considering each trust/scheme separately?  General policies across a range of trust/schemes can be risky, even where the deeds/constitutions are the same or similar, because there can often be other considerations that must be taken into account and those considerations may vary from trust to trust.
  • what is trust income under the deed/constitution?
  • does determining trust income involve any discretion or power on the part of the trustee/RE?
  • what are the relevant considerations in the exercise of that power?  This includes how will the beneficiaries be affected by the exercise of the power; both in terms of cash distribution and taxable income.
  • does the trustee/RE or any of its directors have any conflict?
  • when does the power need to be exercised?  Normally, this will need to be done before financial year end, a point that was emphasised in Colonial;
  • who is going to exercise that power?
  • have appropriate resolutions been passed to delegate power to that person or persons?
  • what were the relevant considerations taken into account in exercising the power to delegate?
  • does the trust deed/constitution allow for streaming of capital gains or franked dividends?  If not, the new streaming rules would not be available.
  • are the rights and entitlements of beneficiaries “clearly defined”?  It seems that this concept will be a feature of the new MIT regime so as to allow for attribution.  Whether there is relief for registered schemes remains to be seen.
  • under the MIT regime, how will the trustee/RE attribute taxable income between beneficiaries?  There seems to be a reasonable prospect that this will involve an exercise of power.  Hence, a decision on attribution might not only be tested by the ATO but also by beneficiaries.  

The list could go on.  There is a lot for trustees/REs to absorb and apply over the coming months.