What to do after Bamford?A fundamental decision passed by the High Court of Australia in Bamford v Federal Commissioner of Taxation (Bamford) has implications on way beneficiaries are taxed and the definition of income of the trust.
The Bamford case-
Issue 1 - Proportionate taxation of beneficiaries
Following the Bamford case Beneficiaries are now taxed on their proportionate share of the income of the trust that they are presently entitled to.
Mr and Mrs Bamford were the directors of a corporate Trustee of a trust; the Bamford Trust. The income of the trust totalled $191,701 and was reduced by deductions to $187,530. Mr & Mrs Bamford received distributions from the $187,530 amounting to $33,872 each. Therefore Mr and Mrs Bamford were both presently entitled to approximately 18% of the income of the Trust.
The Australian Taxation Office (ATO) denied the deductions and subsequently taxed Mr & Mrs Bamford according to their proportionate present entitlement of the Trust's income; approximately 18% of $191,701. This increased their tax liability and they were taxed on $34,624 each rather than the amount they each actually received being $33,872. Consequently the Trust held $181,530 but the parties were taxed on the $191,701 according to their proportionate present entitlement of the income of the Trust.
Following the Bamford case beneficiaries are now taxed proportionately according to their proportionate share of the income of the trust which they are presently entitled to. Despite this fundamental change occurring in the 2009/10 tax year the ATO has indicated that it will accept past practice until the 2010/11 tax year.
Issue 2 - Trustee may treat capital as income of the trustA second impact of the Bamford judgement was the ability of a Trustee to determine capital gains as income of the trust. In 2002 the Bamford Trust sold an asset making a capital gain. A term in the Bamford Trust Deed allowed a capital gain to be classified as net income of the trust. This would allow the Trustee to treat a capital gain as income of the trust.
The High Court held the capital profit made by the trust during the year was income of the trust estate because the trustee had a valid power in the Bamford Trust Deed to treat the profit of the sale as income pursuant to the trust deed. Accordingly where the definition of income is drafted in the Trust Deed to include capital and income the Trustee may determine any capital gain is income of the trust.
What action should be taken?Trust Deeds should be reviewed to ensure streaming clauses are up to date and ensure the definition of income of the trust in the Trust Deed comprises capital and ordinary income. This is particularly important where the Trust is likely to make a capital gain in the not too distant future.
This may require amendments to the Trust Deeds which naturally can cause resettlement issues. Coulter Roache Lawyers can assist with amending Trust Deeds in light of the Bamford case and provide resettlement advice.
For further information please contact Nick Amore or Tom White on 5273 5271.