Show download pdf controls
  • Becoming specifically entitled

    For a beneficiary to be specifically entitled to a capital gain or franked distribution received by a trust, the following two conditions must be met:

    • Entitlement condition: the beneficiary must have received, or reasonably expect to receive, financial benefits that are 'referable to the capital gain' (reduced by any capital losses consistently with the application of capital losses for tax purposes) or franked distribution (reduced by directly relevant expenses).
    • Recording condition: the beneficiary's entitlement to the amount must be 'recorded in its character' as an amount referable to the capital gain or franked distribution in the accounts or records of the trust.

    Entitlement condition

    Received or reasonably expected to receive

    A beneficiary has received an amount if, for instance, it has been credited or distributed to them (including under a reinvestment agreement), or paid or applied on their behalf or for their benefit.

    A beneficiary can reasonably be expected to receive an amount if, for example:

    • they have a present entitlement to the dollar amount
    • they have a present entitlement to the amount as determined using a precise specified methodology
    • the amount has been set aside exclusively for them
    • the trustee has resolved to pay to them the amount of any gain made on an asset under a proposed sale.

    Specific entitlement can only arise under the terms of the trust. For example, where, under the terms of a trust deed, specified beneficiaries are already entitled to trust property and the trustee sells that property making a capital gain, it may not be possible to make other beneficiaries specifically entitled to the capital gain. In this sense, specific entitlement follows the entitlements under trust law (such as set out under the terms of a trust deed).

    Example: no expectation of receiving an amount another beneficiary is already entitled to

    Under the trust deed, the trustee of Wharf Trust must allocate any trust income to its named beneficiaries (the primary beneficiaries) by 30 June in each income year. If the trustee doesn't allocate all or part of the income by that date, other beneficiaries (the default beneficiaries) become entitled to the balance in equal proportions.

    The trust deed defines trust income to include capital gains that are assessable for tax purposes. It also allows the trustee to stream capital gains to particular primary beneficiaries.

    For the 2014-15 income year, the trust's income consists of bank interest and a capital gain. The trustee doesn't allocate any trust income to any of the primary beneficiaries by 30 June 2015.

    Therefore, the default beneficiaries are presently entitled to all the trust income (including the capital gain) for 2014–15. This means the trustee can't make one of the primary beneficiaries specifically entitled to any part of the capital gain after 30 June 2015, as they can have no expectation of receiving what the default beneficiaries are entitled to receive.

    End of example
    Financial benefits from gains or distributions

    A financial benefit is anything of economic value. In the case of a capital gain, the proceeds a trust receives from a capital gains tax (CGT) event constitute a financial benefit. In the case of a franked distribution, the distribution itself is a financial benefit.

    Financial benefits that accrue to a beneficiary as a result of them being entitled to a share of a trust capital gain or franked distribution are referable to the capital gain or franked distribution.

    This would be the case, for instance, if the terms of the trust require the trustee to distribute capital gains to one beneficiary to the exclusion of others. It would also be the case if the trustee exercises a power under the deed to distribute a franked distribution to one beneficiary to the exclusion of others.

    A beneficiary's right to receive financial benefits referable to a trust capital gain or franked distribution may be expressed as a dollar amount. Alternatively, it may be expressed as a methodology for determining the specific dollar amount, even though the result of applying that methodology may not be known until later. For example, a trustee could resolve to distribute to a beneficiary:

    • half of the trust capital gain realised on the sale of an asset (creating an entitlement to half of the amounts referable to the associated capital gain)
    • the balance of the trust capital gain on the sale of an asset after applying $100 of the gain to another beneficiary (creating an entitlement to the amount referable to the gain less $100)
    • 75% of all dividends (including franked distributions) received by the trust (creating an entitlement to three-quarters of the amounts referable to all franked distributions received by the trust)
    • the amount of a franked distribution remaining after the application of directly relevant expenses (creating an entitlement to all of the relevant amounts referable to the franked distribution) – refer to Expenses for franked distributions.
    Capital losses

    The trustee's use of relevant losses can affect the extent to which the amount a beneficiary receives (or expects to receive) is referable to a capital gain. If the trustee applies losses against a capital gain, a beneficiary's entitlement can only be referable to the balance.

    Application of losses consistent with application for tax purposes

    An entitlement to the balance may be sufficient to create a specific entitlement to the entire capital gain (assuming all other requirements are met). This will only be the case if, in working out the amount of the trust's net capital gain for tax purposes, the corresponding capital losses for tax purposes are used to reduce the amount of that particular capital gain.

    Example: treatment of capital losses

    During 2014–15, Creek Trust sells asset A for a $1,000 gain and asset B for a $2,000 gain. Both gain amounts are the same for trust and tax purposes. Creek Trust also sells a third asset and makes a loss of $300 for tax purposes. However, for trust accounting purposes, the trust made a loss of $500 from the sale of the third asset.

    The trustee resolves to distribute $500 to Sam, recorded as referable to the gain on asset A after being reduced by the loss from the sale of the third asset. For tax purposes, the trustee applies the capital loss of $300 against the gain from asset A in working out the trust's net capital gain.

    Of the $1,000 gain made on the sale of asset A, Sam is only entitled to receive $500. However, applying the loss on the third asset against the gain on asset A is consistent with the treatment of the corresponding capital loss for tax purposes. Therefore, Sam is specifically entitled to the entire gain on asset A for tax purposes.

    Assume the trustee had instead applied the $300 capital loss for tax purposes against the capital gain made on asset B. Sam would still only be entitled to receive $500 in respect of asset A (as, for trust purposes, the $500 accounting loss from the sale of the third asset had been applied against that gain). However, the $1,000 financial benefit referable to the gain on asset A was not reduced. This is because the loss was not applied against that gain for tax purposes. Accordingly, Sam would be specifically entitled to only half of the gain on asset A for tax purposes (as he is entitled only to $500 of the $1,000 financial benefits referable to the gain).

    End of example
    Expenses for franked distributions

    The trustee's treatment of expenses directly relevant to a franked distribution affects the extent to which the amount a beneficiary receives (or expects to receive) is referable to the franked distribution.

    An entitlement to the balance of any distribution remaining after the application of directly relevant expenses is sufficient to create a specific entitlement to the entire franked distribution (assuming all other requirements are met). A beneficiary can only be made entitled to receive this balance if it is a positive amount – that is, if the franked distribution is not entirely offset by directly relevant expenses.

    If expenses are incurred directly for an income producing investment, a rateable proportion of that expense can be a directly relevant expense attributable to each amount of income derived from that investment, including any franked distributions.

    The extent to which an expense is considered directly (rather than indirectly) relevant depends on the facts and circumstances of the particular case.

    General trust expenses, such as accounting fees and trustee fees, would not generally be directly relevant expenses incurred in deriving a franked distribution because there is no direct relationship between these expenses and the franked distribution.

    Pooled distributions

    To overcome the problem of some distributions being entirely offset by directly relevant expenses, all franked distributions received by a trust during an income year may be pooled and treated as a single franked distribution if the trustee has dealt with them all as a single class.

    This allows a beneficiary to be specifically entitled to all, or a share of all, franked distributions, including those fully sheltered by expenses, as long as the total of all franked distributions exceed all directly relevant expenses. This allows the beneficiary to have the benefit of the franking credits that are attached to all franked distributions (subject to integrity rules).

    Example: treatment of expenses referable to franked distributions

    Roma Trust holds a parcel of shares in Best Co and a parcel of shares in Less Co. During the income year ending 30 June 2015, the trustee receives:

    • a franked distribution of $70,000 (with attached franking credits of $30,000) from Best Co
    • a franked distribution of $35,000 (with attached franking credits of $15,000) from Less Co
    • an unfranked distribution of $35,000 from Less Co.

    Roma Trust incurred interest expenses of $80,000 during the year for money borrowed to acquire the shares in Less Co.

    Under the terms of Roma Trust, Greg is entitled to all net dividend income (including franked distributions).

    The interest expenses that are directly relevant to the franked distributions received from Less Co are based on the percentage the franked distributions are of the total Less Co distributions, that is:

      $35,000
    $35,000 + $35,000

    x 100 = 50%

    Therefore, the interest expenses directly relevant to the franked distributions are $40,000 (50% of $80,000), which exceeds the amount of those franked distributions ($35,000).

    However, the trustee is distributing all the franked distributions to Greg in a single class (as Roma Trust's net dividend income), which means the franked distributions from Best Co will be pooled with the franked distributions from Less Co and treated as a single franked distribution. As that single franked distribution ($105,000) exceeds the directly relevant expenses ($40,000), Greg can be made specifically entitled to all of the franked distributions received (including that received from Less Co). Therefore, he might also have the benefit of the franking credits that are attached to those franked distributions (subject to integrity rules).

    End of example

    Recording condition

    The beneficiary's entitlement to the amount must also be 'recorded in its character' as referable to the capital gain or franked distribution in the trust's accounts or records.

    Recorded in its character

    A beneficiary's entitlement to an amount will be recorded in its character as referable to a capital gain or franked distribution in a trust's records or accounts if, for example, the:

    • beneficiary is entitled, under the trust deed, to all of the capital gains of a trust
    • trustee, in a valid exercise of a power under the deed, resolves to distribute all franked distributions received by the trust to the beneficiary
    • trustee, in a valid exercise of a power under the deed, resolves to distribute all the profits from a proposed sale of a particular asset to the beneficiary.

    A beneficiary's entitlement to an amount may also be recorded in its character as referable to a capital gain or franked distribution by a notation in the trust accounts, provided it is:

    • clear
    • consistent with the terms of the trust and
    • not inconsistent with any other record made by the trustee.

    Example: records of the trust

    The Cabernet Trust deed defines income to include capital gains that are assessable for tax purposes.

    For 2014–15, the income of Cabernet Trust was $150,000, consisting of $100,000 rent and a $50,000 capital gain from the sale of one of the trust's rental properties. For tax purposes, the capital gain is a non-discount gain.

    On 30 June 2015, the trustee made a resolution allocating trust income equally between two named beneficiaries, Bill and Ben.

    On 31 August 2015, the trustee drew up the trust accounts, which clearly showed that of the $75,000 appointed to Bill, $50,000 was referable to the capital gain. This was done by separately adding $50,000 and $25,000 to Bill's beneficiary account and noting the character of these amounts as referable to the capital gain and rent (respectively).

    When the trustee resolution and the accounts are viewed together it can be concluded that Bill was entitled to an amount referable to the whole of the capital gain, and this amount has been recorded in its character as referable to the capital gain.

    End of example
    Time limit to record the entitlement

    For a capital gain, a beneficiary's entitlement must be recorded (in that character) in the trust's accounts or records no later than two months after the end of the income year in which the capital gain is made.

    For a franked distribution, a beneficiary's entitlement must be recorded (in that character) in the trust's accounts or records by the end of the income year in which the distribution is received.

    Entitlement to unspecified income is not a specific entitlement

    A beneficiary who is presently entitled to some or all of the total trust income (that is, 'blended' income from several sources) may expect to receive some or all of the benefits referable to any trust capital gain or franked distribution included in that income – particularly if the trust income only includes capital gains and franked distributions.

    However, this alone won't create a relevant specific entitlement, because it doesn't, of itself, meet the second condition for specific entitlement. Expressing the entitlement as being to 'some or all' of the total trust income is not a record of the entitlement in its character of an amount referable to the capital gain or franked distribution.

      Last modified: 22 Apr 2016QC 24534