Pay or notify rule
If a tax-exempt beneficiary is not made aware of their present entitlement to trust income within two months of the end of the income year, the trustee will generally be taxed on a corresponding share of the trust's net income.
When the rule applies
The pay or notify rule applies to a trustee if:
- an exempt beneficiary is presently entitled to an amount of trust income
- the exempt beneficiary is not an exempt Australian Government agency
- the trust is not a managed investment trust (or treated like one for the purposes of Division 275 of the ITAA 1997)
- the trustee has not notified the exempt beneficiary in writing of their present entitlement or paid the entitlement to the beneficiary within two months of the end of the relevant income year.
The written notice doesn’t have to specify the dollar amount of the present entitlement. It's sufficient if it sets out how the entitlement is calculated – for example, as a percentage of trust income.
How the rule is applied
If the pay or notify rule applies, for tax purposes the exempt beneficiary is treated as not being – and never having been – presently entitled to the affected amount of trust income. Instead, the trustee is taxed on a corresponding share of the net income of the trust (generally under section 99A of the ITAA 1936), unless we exercise our discretion not to apply the rule.
Example: how the rule is applied
In 2014–15, Daley Trust generates $100,000 of rental income. The trust has no other revenue or expenses so its income and net income is $100,000.
The trustee of Daley Trust makes the trustee of Philips Trust (which is a charity and therefore a tax-exempt entity) presently entitled to all of the trust income. However, the trustee of Daley Trust does not provide the trustee of Philips Trust with written notice of its entitlement before 31 August 2015 and makes a payment of only $30,000 to the trustee of Philips Trust before that date.
Without the anti-avoidance rule, the trustee of Philips Trust would be notionally assessed on all of the trust's $100,000 net income. (Because of the Philips Trust’s charitable status, the assessment is ‘notional’ in the sense that the income is exempt).
Under the anti-avoidance rule (and assuming our discretion is not exercised) the trustee of Philips Trust is treated, for tax purposes, as not presently entitled to the other $70,000 of trust income because it is unaware that it is presently entitled to this amount. The trustee of Daley Trust is then taxed on this $70,000 under section 99A of the ITAA 1936.
End of example
We have discretion to disregard a trustee's failure to pay or notify an exempt beneficiary within two months. We can exercise the discretion if the consequences of applying the anti-avoidance rule would be unreasonable.
To exercise the discretion, we must consider the following factors:
- the circumstances that led to the trustee failing to pay or notify
- the extent to which the trustee tried to correct the failure and, if so, how quickly that happened
- whether we have previously exercised this discretion for the trustee and, if so, the circumstances in which this occurred
- any other relevant matters.
Example: exercising the Commissioner's discretion
Continuing the previous example, the trustee of Daley Trust is initially unaware that Philips Trust is an exempt entity (because it is not publicly known to be a charity) and, therefore, does not ensure that Philips Trust is informed of its entitlement before 31 August 2015.
The trustee of Daley Trust prepares its accounts on 30 September 2015 and it's only then that it becomes aware Philips Trust is an exempt entity. The trustee of Daley Trust promptly takes steps to notify Philips Trust of its entitlement.
As Daley Trust has taken immediate action to notify Philips Trust of its entitlement on becoming aware of its tax-exempt status, and it was not unreasonable for Daley Trust to be unaware of Philips Trust's likely tax exempt status, we exercised the discretion to disregard the failure of the trustee of Daley Trust to comply with section 100AA of the ITAA 1936.
Consequently, Philips Trust is notionally assessed on all of Daley Trust's net income of $100,000. No amount is assessed to the trustee.
End of example