The ATO has warned that it is looking closely at how trusts distribute income and to who.
In recent years, how trusts distribute income has come under intense scrutiny. Trust distribution arrangements need to be carefully considered by trustees before they appoint or distribute income to beneficiaries.
What does your trust deed say?
An area of concern is that trustees do not consider the trust deed before income is appointed. The answer to what the trust can do, who it can allocate income to and how, is normally in the trust deed. This should be your first point of call.
Review your deed
- Conduct a review of the trust deed and any amendments to ensure trustees are making decisions consistent with the terms of the deed;
- Check the trust vesting date. The trust deed will specify what happens when the trust vests. If the trust vests, the trustees might be directed to distribute the income and property of the trust to particular beneficiaries. The trustee may no longer have the discretion to decide who to appoint income or capital to;
- Check who the intended beneficiaries are, and also keep in mind that some beneficiaries might have different entitlements to income and capital under the trust deed;
- Timing and requirements for resolutions – Check the deed for any conditions and requirements for trustee resolutions, including the need to have the resolution in writing and when it must be made. For example, the deed might require trustees to take certain actions before 30 June;
- If you want to stream capital gains or franked distributions to certain beneficiaries, check the trust deed doesn’t prevent this and the streaming requirements have been met.
Family trust and interposed entity elections
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 misused.
An interposed entity election makes an entity a member of the family group of an individual.
Where these elections are in place, trustees must 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.
Who receives the benefit?
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 reduces the overall tax paid on the trust’s income, this will normally increase the level of risk involved and attract the ATO’s attention.
Increased reporting on tax returns
Changes have been made to capture more information on the tax return about how trusts distribute income. These include:
- Trust tax return – four new capital gains tax labels have been added. This information should be provided to beneficiaries to match what is reported in their returns.
- Beneficiaries – all trust income beneficiaries must lodge a new trust income schedule. This schedule should align with your distributions as set out in the trust’s statement of distribution.
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 distribute income and the tax impact of those distributions. Trustees need to get it right because the tax ramifications can be significant if trust distributions are invalid.