The final income tax ruling on the taxation of family trust distributions was released on 8 December 2022. It is ruling TR 2022/4 and should be read in conjunction with Practical Compliance Guideline PCG 2022/2. TR 2022/4 is a ruling of huge importance and has been more eagerly awaited than the Harry and Meghan Netflix documentary. As usual the ruling is complicated and will take some time to analyse. This is the ATO summary.
“What this Ruling is about
1. It is common for trust beneficiaries to be made presently entitled to trust income.
2. Sometimes (though much less commonly), a beneficiary’s present entitlement to a share of trust income arises out of, or in connection with, an arrangement:
• involving a benefit being provided to another person
• intended to have the result of reducing someone’s tax liability, and
• entered into outside the course of ordinary family or commercial dealing.
3. In these cases, section 100A of the Income Tax Assessment Act 1936 (ITAA 1936) generally applies to make the trustee, rather than the presently entitled beneficiary, liable to tax at the top marginal rate”
For decades it has been commonplace for discretionary trusts to distribute income to beneficiaries who do not pay tax or who pay tax at low rates. However, the “everybody’s doing it” defence will no longer wash. This is made clear in the ruling.
“What is commonplace is not the test. An arrangement that is commonplace, but which does not achieve family or commercial objectives, is not entered into in the course of ordinary family or commercial dealing.
An agreement entered into between family members and the entities they control is not entered into in the course of ordinary family or commercial dealing where the dealing and the steps that comprise it do not have the quality of achieving any family or commercial objectives.”
Despite this, I think that we can now give some level of comfort to trustees in a three common situations.
Trust distributions to spouses
The ATO is unlikely to question trust distributions to spouses who have little or no other income. Here are the words in the ruling -
Trust distributions to spouses who generally have shared financial responsibilities and who ultimately enjoy the shared benefits of the distribution would usually be capable of explanation as achieving ordinary family objectives. On these facts, the organisation of financial affairs between spouses would likely be entered into in the course of ordinary family or commercial dealing.
Unpaid entitlements of a family member
Unpaid trust distributions to a family member might be acceptable even where the distribution results in less tax payable on the income of the trust. Here is an example used in the ruling –
“From time to time, the trustee of the Davidson Family Trust makes John, who is a family member, presently entitled to a share of trust income. John's entitlement is determined so his taxable income will not exceed certain marginal tax rate thresholds. John is a full-time student and does not have income from other sources. John has indicated to the trustee that he will not call for the payment of the amount of his entitlements until such time as he purchases a home or makes a similar investment. Nonetheless, John is at liberty to enforce his rights as beneficiary to recover those amounts at any time. John's tax-free threshold reduces the overall tax on the trust net income. However, in the absence of additional factors, the arrangement that involves John simply delaying the time when he would realise the benefit of his original trust entitlement would likely be entered into in the course of ordinary dealing.”
On the other hand, there is a clear message here that trust distributions made with no intention of ever paying the beneficiary are likely to result in the trust being assessed on the distributions at the top marginal rate.
Gifts from parents to a child
Sometimes parents are retired but remain beneficiaries of a family trust. Their child, who is also a beneficiary, is in a high income tax bracket. A common strategy in this case has been to distribute income of the trust to the parents who then gift the money to the child. The ruling suggests that if this is done once (or at least not too often) it might be acceptable. However, this might change if the parents repeatedly gift money received from a trust AND one or more of the following factors was present –
· The parents have a lower marginal tax rate
· The parents have lesser financial means than the child, or
· The adult child is also capable of benefitting from the trust in his or her own right.
The three circumstances above probably account for most of the trust distributions in Australia. This new ruling offers some clarity and a degree of cautious comfort to the relevant trustees. There are other circumstances addressed in the ruling but these require further analysis and investigation before I can provide any useful information.
This is general information only and is not advice. Seek advice tailored to your own circumstances.
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