On 2 June 2011 legislation to enable the streaming of franked dividends and capital gains from trusts for tax purposes, as well as targeted anti-avoidance rules with relation to trust law, was introduced into parliament. It is important that all trustees are made aware of this as they may need to act immediately, in order to comply with the potential new laws. These likely changes have come as a result of the Bamford case last year, which raised questions about the ability for trusts to stream capital gains and franking credits to beneficiaries in a tax-effective way.
The proposed law changes are intended to apply to the 2010-11 and later income years. However the changes are not certain to receive royal assent before 30 June 2011, making it somewhat difficult for those who may be affected. Not all trust deeds allow the trustee to stream income, however many do and this can potentially result in penalties.
Which trusts are affected by the proposed changes?
The proposed streaming changes will only affect trusts that make a capital gain or that are in receipt of a franked distribution for the 2010-11 or a later income year. If your trust makes no capital gains or receives no franked distributions for the current income year, the streaming changes will not affect how the tax law applies to the trust this year. If your trust makes capital gains or receives franked distributions but no beneficiary is made specifically entitled to any capital gain or franked distribution, the changes should produce a similar result to the existing law. The proposed changes will set out when a beneficiary is taken to be ‘specifically entitled’ to a capital gain or franked distribution.
The proposed new anti-avoidance rules may apply where an exempt entity, other than an exempt Australian government agency, is a beneficiary of a trust and is entitled to income of the trust. The Bill also provides the trustee of managed investment trusts with a choice as to whether to apply the streaming changes for the 2010-11 and 2011-12 income years. Regardless of this choice the proposed anti-avoidance rules will not apply to managed investment trusts.
Proposed ‘streaming’ changes
Currently the taxation of capital gains and franked distributions (like other amounts included in the taxable income of a trust) depends on the extent to which beneficiaries are presently entitled to the income of a trust (determined in accordance with trust law). The changes are intended to ensure that where a trustee exercises a power to ‘stream’ capital gains and/or franked distributions to specific beneficiaries the ‘streaming’ is effective for tax purposes (subject to relevant integrity rules in respect of franking credits).
For streaming to be effective, a beneficiary must be ‘specifically entitled’ to the capital gain or franked distribution. Under the Bill, it is proposed that a beneficiary will be so entitled to the extent they receive or can reasonably be expected to receive a financial benefit referable to the gain or franked distribution.
The treatment for a specifically entitled beneficiary may occur regardless of whether the benefit they receive or are expected to receive is income or capital of the trust. That is, unlike the current rules, under the proposed changes in the Bill, a beneficiary may be assessed based on a specific entitlement to a capital gain or franked distribution of the trust, even though they do not have a present entitlement to income of the trust estate.
Capital gains and/or franked distributions to which no beneficiary is specifically entitled are proposed to be allocated proportionately to beneficiaries based on their present entitlement to income of the trust estate (excluding amounts to which any beneficiary is specifically entitled).
Proposed anti-avoidance rules
Proposed anti-avoidance rules in the Bill will target the use of exempt entities to inappropriately reduce the tax otherwise payable on the taxable income of a trust. The first rule will, as proposed, treat an exempt beneficiary that has not been notified of or paid their present entitlement to income of the trust estate, within two months of the end of the income year, as not being, and never having been presently entitled to that income.
The second rule will, as proposed, apply where an exempt entity’s adjusted share of the income of the trust estate exceeds a prescribed benchmark percentage. Where this occurs the exempt beneficiary will be treated as not being, and never having been, presently entitled to the amount of the income of the trust estate that exceeds the benchmark percentage. Under both rules as proposed, the trustee will be assessed on the share of the trust’s taxable income that corresponds to the income to which the exempt beneficiary is taken as not being entitled to.
Trustees should be aware that the changes will not allow for trustee resolutions made on or before 30 June 2011 to be amended to take account of the law as finally enacted after that date. Therefore in framing a resolution, a trustee may like to consider its tax effect should the law not be enacted or not be enacted as proposed.
If you chose to apply the existing law
If a taxpayer lodges a return on time and in accordance with the existing law at the time of lodgment, and an amendment is needed because the law is amended retrospectively which results in an increase in tax liability then:
• no tax shortfall penalties will apply
• any interest attributable to a shortfall will be remitted to nil up to the date of enactment of the new law. Interest will also be remitted for taxpayers who actively seek an appropriate amendment within a reasonable time after the enactment of the new law.
If the taxpayer does not lodge an amendment request within a reasonable time, then full interest may apply from the date of enactment. The ATO will consider what is a reasonable time on a case by case basis.
If you chose to apply the proposed new law and it is not enacted as introduced
If a taxpayer lodges a return on the basis of the anticipated changes to the law, and an amendment is needed because those changes are not enacted as anticipated (for example, because amendments were made during the Parliamentary process) which results in an increase in tax liability then:
• no tax shortfall penalties will apply on the basis that it was reasonable for the taxpayer to follow an announced government policy, and that the existence of the announcement represents special circumstances for remission
• any interest accrued in respect of the amendment will be remitted to the base interest rate up to the date of enactment of the new legislative measure. In addition, the interest, in excess of the base rate, will be remitted for taxpayers who actively seek an appropriate amendment within a reasonable time after the enactment of the new law.
If the taxpayer does not lodge an amendment request within a reasonable time then any interest may revert to the full rate from the date of enactment. This approach will be conditional on the taxpayer having acted reasonably when lodging the original return or activity statement.
If you chose to apply the proposed new law and it is not enacted
If a taxpayer lodges a return on the basis of the anticipated changes to the law and an amendment is needed because those changes are not ultimately enacted which results in an increase in tax liability then:
• no tax shortfall penalties will be applied
• any interest accrued in respect of an amendment will be remitted to the base interest rate if the sole reason for the amendment is the measure not going ahead. The remittance is for a reasonable period of time following the public announcement by the ATO (on this webpage) that the measure is not going ahead.
In all three scenarios, where the amendment results in a reduction in tax liabilities, interest will be paid by the ATO on the overpayment of tax made by the taxpayer.
We will be keeping you up to date with all of these new changes as information comes to hand. If you expect your trust will make a capital gain or that will be in receipt of a franked distribution for the 2010-11 or a later income year then it is important that you seek professional advice immediately to discuss whether changes to your trust deed will be required.
Here at The Quinn Group, our experienced team of accountants, lawyers and tax agents can assist you in making any changes required to your trust deed. For more information regarding the new laws submit an online enquiry or call us on 1300 QUINNS (784 667) or on +61 2 9223 9166 to book an appointment.