The new rules allowing streaming of capital gains and franked distributions was introduced into Parliament on 2 June 2011.
The Tax Laws Amendment (2011 Measures No. 5) Bill 2011 (Cth) (Bill) has now been passed by both Houses of Parliament and is waiting royal assent before it is enacted and becomes law.
On 30 March 2010, the High Court handed down its decision in Commissioner of Taxation v Bamford (2010) 240 CLR 481.
This decision highlighted a number of longstanding problems with the taxation of trusts, particularly where the amounts on which a beneficiary is assessed do not always match the amounts that they are entitled to under trust law.
Accordingly, on 16 December 2010, in recognition of these longstanding issues with the taxation of trusts, the Government announced a public consultation process as the first step towards updating the trust income tax provisions.
After obtaining advice from the Board of Taxation, the Government announced that it would:
- better align the concept of “income of the trust estate” with “net income of the trust estate”; and
- enable the “streaming” of capital gains and franked distributions.
The Government subsequently released a discussion paper, Improving the taxation of trust income for public consultation on the options to implement the Board of Taxation’s recommendations.
After public consultation the Government decided to prioritise the streaming issues and defer its consideration of the trust income vs tax income definitional issues to a broader review of the trust income tax provisions later this year.
On 13 April 2011, an Exposure Draft was released which contained the proposed inserts for the Bill to enable the streaming of capital gains and franked distributions.
The Bill was then introduced into Parliament on 2 June 2001 and passed by both Houses on 23 June 2011.
How the streaming amendments will work
The primary purpose of the amendments is to ensure that, where permitted by a trust deed, the ‘streaming’ of capital gains and franked distributions to beneficiaries is effective for tax purposes.
The amendment will broadly work as follows:
- Through a new legislative process set out in new Division 6E, the taxation of capital gains and franked distributions will be backed out of Division 6 of the Income Tax Assessment Act 1936 (Cth) and dealt with in Subdivisions 115-C (capital gains) and 207-B (franked distributions) of the Income Tax Assessment Act 1997 (Cth).
- Capital gains or franked distributions that are not effectively streamed will continue to be taxed to the beneficiaries under Division 6 of the ITAA36.
- To effectively stream a capital gain and/or a franked dividend, the trustee must make a beneficiary 'specifically entitled' to the amount of the capital gain or franked distribution.
- The terms of the trust deed must allow the trustee to make a beneficiary 'specifically entitled' to a capital gain and/or a franked dividend and the specific entitlement must be reflected in the trust's accounts or records.
It is important to note that the streaming amendments do not give the trustee a power to stream capital gains or franked distributions where they do not already have the power to do so in the trust deed.
Accordingly, trust deeds should be reviewed to ensure that the trustee can create a 'specific entitlement' in favour of a beneficiary as required by the legislation.
What is “specifically entitled”?
To effectively stream of capital gains and franked distributions, beneficiaries must be “specifically entitled” to the capital gain are franked distribution.
To be “specifically entitled” under the new legislation:
- a beneficiary must receive, or reasonably be expected to receive, an amount equal to the “net financial benefit” referable to the capital gain or franked distribution; and
the entitlement must be recorded in its character in the accounts or records of the trust no later than:
- two months after year end in the case of a capital gain; and
- the end of the income year in the case of franked distributions
“Recorded in its character”
A key issue for trustees under the new specific entitlement provisions is the timing requirements and the method for “correctly” recording a beneficiary’s entitlement in the accounts or records of the trust.
30 June 2011 considerations
We recommend the following before 30 June 2011:
- Reviewing trust deeds to identify whether the trust deed contains the relevant powers to allow streaming (e.g. a power to allow the trustee to classify income and account for income separately according to its source).
- Preparing the necessary resolutions to ensure that any intended specific entitlements to franked distributions will be effective under the new legislation.
31 August 2011 considerations
We recommend the before 31 August 2011, and only if the trust deed allows, and if relying on the ATO’s administrative practice (set out in IT 328), that more detailed appointment resolutions should be prepared that comply with the new legislation and deal with all other income, capital gains, primary production income etc.