Thursday, 28 July 2011

Changes Discretionary Trust new tax year 2011-2012

William Buck
June 2011
National Newsletter
Be Informed
The Winter Edition 

01 - Trusting times

2011 Is a big year for trusts. Over the last financial year a number of substantial changes have impacted on the application and interpretation of Australian tax laws in relation to the use of trusts.

In particular, in 2010 the High Court’s much awaited decision on the Bamford Case has affected the way in which a trust calculates and distributes its income which in turn has ramifications for the assessment of a beneficiary’s income.

Later in the year, the Australian Tax Office (ATO) finalised its position on unpaid present entitlements which may now be subject to Division 7A.  This new stance provides a restriction on the previously common use of company beneficiaries to limit the tax on trust profits to 30%.

In the year ahead, it is expected that the Government will introduce new laws on how capital gains and franked dividends are dealt with by trusts and the 2011 Federal Budget announced changes which will affect distributions to minor beneficiaries.

All of these developments mean that 2011 has shaped up to be a critical year for trusts.  Some of the key changes are reviewed below.

Distributions >
Corporate beneficiaries >
Streaming >
Minors >




Trusts are still dealing with the repercussions of the Bamford decision and the ATO’s subsequent position which have had a major impact of how the “income” of the trust estate is defined.
The High Court deemed that the “income” that is distributed to its beneficiaries each year is determined by the terms of the trust deed rather than accounting principles, trust law or tax law.  As such, the trust deed is critical and the concept of “income” may differ from trust to trust.

If a trust receives amounts of income such as franked dividends, foreign income from which tax has been deducted, or discounted or concessionally taxed capital gains, the trust deed will need to be carefully reviewed to ensure the trust can actually distribute the income to the beneficiaries to which it intends.  Otherwise the amount may be assessed to the trustee and taxed at the top marginal tax rate, or the wrong beneficiary may be assessed.

The Court also decided that a beneficiary’s assessable income for tax purposes should include the same percentage of the trust’s net (taxable) income as is received for trust purposes. For example, if a beneficiary received 10% of the “income” of the trust estate (calculated in accordance with the trust deed), then the beneficiary would be assessed for tax purposes on 10% of the trust’s net (taxable) income.  This can create issues where different definitions of income are used for tax and trust purposes and where tax adjustments occur in later years.

Consequently, great care is needed when planning where trust distributions will be made this year and effectively documenting this decision.

Corporate beneficiaries

The ATO has now finalised its position on unpaid present entitlements (UPEs) owing from a trust to a private company where the two entities are part of the same family group. 

Unpaid present entitlements are essentially trust distributions that have been determined by the trust but have not been physically paid.

Private company beneficiaries are often used to limit the effective tax rate on trust profits to 30%.  This strategy generally involves the trust distributing income to the private company, without physically paying some or all of the distribution to the company beneficiary (i.e. a UPE is created).  The income distributed is taxed at 30% within the company, while the funds representing that distribution remain within the trust.  The trust may then use those “company owned” funds for its own purpose (e.g. to purchase assets, retire debt, etc).

The ATO will now take the view that the UPE is a loan for Division 7A purposes.  Unless specific actions are taken, this can mean that a deemed dividend will arise for the trust.

Before 30 June 2011 trusts will need to review existing unpaid present entitlements (UPEs) to:

1. Identify UPEs which have been converted to loans
2. Determine if any UPEs created before 16 December 2009 satisfy the requirement to be grandfathered.

For UPEs created after 15 December 2009 (essentially those relating to 2010 distributions), trusts will need to decide if the amounts will be paid out, converted to complying loans, administered under one of the ATO safe harbour options, or if an alternative approach will be applied to prevent a deemed dividend arising.

For current year (2011) distributions, the use of a corporate beneficiary strategy needs to be re-evaluated.  For trusts conducting a business or building an investment portfolio, using a corporate beneficiary and the ATO’s 7 or 10 year loan safe harbour options could be a viable approach, however this will require ongoing management over the coming years.  Trusts looking to adopt one of these approaches should contact their local William Buck advisor.


One of the historical advantages of a discretionary trust has been the ability to stream particular types of income to particular beneficiaries.  For example, capital gains could be distributed to individuals to utilise the 50% discount concessions and franked dividends could be distributed to a corporate beneficiary (to cap the tax at 30% and allow the franking credit to offset against the tax payable) or to a beneficiary on a low marginal tax rate (to achieve a refund of excess franking credits).

Late last year the decision in the Bamford Case put the viability of this strategy into question because all beneficiaries are required to be assessed on the overall percentage of their share of the income.  The subsequent ATO position further suggested that streaming would not work post 2010.

The Government has now released draft legislation that is intended to restore the ability of discretionary trusts to stream capital gains and franked dividends.  This change is intended to apply for the 2011 year.

For trusts intending to utilise the streaming strategy for 2011, a more detailed consideration of the application of the new streaming laws (once enacted) to the situation of the trust will be required.


In the 2011 Budget the Federal Government announced that, with limited exceptions, minors will no longer be eligible for the Low Income Tax Offset.  This will affect the amount of distributions made from trusts to minors from 1 July 2011 (so for the 2012 year).

Historically minors could receive $416 in income tax free.  Above this amount, penalty rates of tax applied, creating an effective tax rate equal to the top marginal rate.  With the introduction of the Low Income Tax Offset, the tax free amount was increased to $3,333 for the 2011 year.  The tax free amount is even higher if franked dividends can be distributed to the minor.

2011 will be the last year that this strategy can be applied.  From the 2012 year onwards, the historical $416 limit will once again apply.

The changes outlined above make 2011 a momentous year for Trusts and will require careful consideration.  If you have any queries about any of the issues raised in this article please contact your local William Buck advisor.