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Key watch outs to ensure effective distributions of trust income

Key watch outs to ensure effective distributions of trust income

With 30 June fast approaching and trustees working through year end distribution plans, its timely to reflect on some key issues that should help ensure that decisions made are effective.

First and most important rule?

The first and most important rule when working with trusts is to read the deed, the whole deed, including any amendments thereto. A thorough working knowledge of the requirements of the deed is key to ensuring that decisions by the trustees are valid and effective.

Are intended recipients eligible beneficiaries?

Ensure that the intended recipient of a distribution is within the class of persons who can benefit under the deed from an appointment of trust income (or of trust capital, if you intend to stream a capital gain that is not income of the trust) and not listed as excluded beneficiaries. For example, some trust deeds specifically exclude the trustee of the trust from being a beneficiary. 

In this respect, it will be important to review the effect of changes that exclude potential foreign beneficiaries that were made to avoid state taxes and duties. 

Consideration should also be given to whether a liability to Family Trust Distribution Tax would arise as a result of a family trust or interposed entity election having been made with the intended recipient outside the family group as defined in Schedule 2F to the Income Tax Assessment Act 1936.

Understand how the income of the trust is defined

For taxation purposes, the taxable (net) income of the trust is allocated to beneficiaries based on their proportionate share of the distributable (or deed) income of the trust estate. For example, assume a trust derives $100 of distributable income and distributes $50 to beneficiary A. This would mean that beneficiary A would have a 50% proportionate share of the distributable income of the trust. Accordingly, beneficiary A would be allocated 50% of the taxable (net) income of the trust. Trustees should consider estimating both the distributable income and the taxable income of the trust before making distributions to understand the potential tax implications of such distributions. 

Where the trust deed defines income to mean the taxable (net) income of the trust, ensure that notional amounts (e.g. franking credits) are not included in the distributable income. 

Ensure decision making rules in the trust deed are satisfied

The trust deed may contain rules prescribing how and when distributions decisions are to be made by the trustees. For example, it may require resolutions to be prepared by a certain date; that they be in writing; that the resolution be approved (e.g. by the guardian or the appointor). If such rules are not complied with, the distribution may be ineffective and thus other parties (such as a balance beneficiary, the trustee, or a default beneficiary) may be taxable on the income of the trust.  

In addition to the rules in the trust deed, where the trustee is a company, rules contained in the company’s constitution prescribing how decisions the company to be made, will also need to be satisfied for the decision to be effective. 

Is a distribution resolution required to be made by 30 June?

The answer is yes if the trust deed requires that a written resolution be made by 30 June (or other earlier date) for the distribution to be effective. 

Where the deed is silent on whether a written resolution is required by 30 June, it is still important that distribution decisions are made by 30 June. In this respect, the ATO will accept that distributions are valid if there is other evidence of a decision having been made by 30 June. For example, such evidence might take the form of a “mud map” of where distributions are to be made and in what amounts or percentages that is signed by the trustees by 30 June1. 

Additional requirements for corporate trustees

Where the trustee is a company, all proceedings and resolutions of members’ and directors’ meetings, and resolutions passed, and declarations made, without meetings, are required to be recorded in the company’s minute books within one month and each minute is required to be signed within a reasonable time after the resolution was made or meeting held2. If that requirement is satisfied, it will be easier for a trustee to substantiate that the resolutions are valid and effective.  

What are the next steps?

It is critical that clients document decisions regarding the distribution of trust income and do so in a way that complies with any rules in the trust deed and constitution of the corporate trustee (as applicable) by 30 June.

1.  Refer https://www.ato.gov.au/general/trusts/in-detail/trust-tax-time-toolkit/resolutions-checklist/#_Will_records_created.
2. Corporations Act 2001 (Cth) s 251A(1).
This content is general commentary only and does not constitute advice. Before making any decision or taking any action in relation to the content, you should consult your professional advisor. To the maximum extent permitted by law, neither Pitcher Partners or its affiliated entities, nor any of our employees will be liable for any loss, damage, liability or claim whatsoever suffered or incurred arising directly or indirectly out of the use or reliance on the material contained in this content. Pitcher Partners is an association of independent firms. Pitcher Partners is a member of the global network of Baker Tilly International Limited, the members of which are separate and independent legal entities. Liability limited by a scheme approved under professional standards legislation.

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