The ATO is warning that their compliance activities often identify mistakes in this area because trust deeds are not being appropriately considered before income is appointed. To that end, the ATO has released an article suggesting the following key things which should be considered when making trust distributions:
- Conduct a review of the trust deed and any amendments to ensure trustees are making decisions consistent with the terms of the deed;
- Check that the trust hasn’t vested as this may impact distribution decisions;
- Check who the intended beneficiaries are, but also keep in mind that some beneficiaries might have different entitlements to income and capital under the trust deed;
- Check the deed for any conditions and requirements around the making of trustee resolutions, including the need to have the resolution in writing and the timing of when it’s required to be made, for example, the deed might require trustees to take certain actions before 30 June;
- If the trustee is looking to stream capital gains or franked distributions to certain beneficiaries, check the trust deed doesn’t prevent this and the requirements around streaming have been met.
It is also important to check if the trust has made a family trust election or interposed entity election. A family trust election helps wrap the workings of the trust around a specific individual’s family group. These elections can help protect trust losses, company losses, and franking credits but can also cause significant tax problems if they are used incorrectly. An interposed entity election makes an entity a member of the family group of an individual.
Where these elections are in place, it is essential that trustees understand the implications before making any decisions on distributions. Distributions of trust income outside the specified individual’s family group will trigger family trust distribution tax at penalty rates.
For clients with trusts in their group structure, the key message is that it is important to review the trust deed to ensure any proposed distributions of trust income are valid. This is because if trust distributions are found to be invalid, the ramifications from a tax perspective can be quite significant and it is clear that the ATO are finding fundamental errors being made in this area.
The ATO is also on the lookout for arrangements where amounts are allocated or appointed to beneficiaries, but they don’t receive the real financial benefit of the distribution. If the arrangement has the effect of reducing the overall tax paid on the income of the trust, then this will normally increase the level of risk involved and attract the ATO’s attention.
CHANGES TO THE TAX RETURNS FOR TRUSTS AND BENEFICIARIES
Changes have been made to capture more information on the tax return about how trusts distribute income. These include:
- For trustees, four new capital gains tax (CGT) labels have been added in the statement of distribution section of the trust tax return; and
- For beneficiaries, the ATO has introduced a new trust income schedule that all beneficiaries receiving trust distributions will be required to lodge.
To assist with preparing their tax return and reduce the risk of errors, the ATO recommends that beneficiaries are provided with a copy of the trust’s statement of distribution as it relates to their own distributions. This is because the new trust income schedule for beneficiaries is designed to align with the statement of distribution in the trust’s tax return.
Trusts can be an excellent vehicle for many reasons including the flexibility to determine how income is distributed. The cost of that flexibility is strong controls and compliance.
The ATO is increasingly strident about how trusts are distributing income, and the tax impact of those distributions. It’s important for trustees to get it right because if trust distributions are found to be invalid, the tax ramifications can be significant.