Edited version of your private ruling

Authorisation Number: 1012600067870

Ruling

Subject: Income Tax assessable income trust income - beneficiaries

Question 1

Can section 101 of the Income Tax Assessment Act 1936 (ITAA 1936) operate to deem The Corporate Beneficiary presently entitled to distributions of income made by the Discretionary Trust?

Answer

Yes

Question 2

Does the assessable income of The Corporate Beneficiary include its share of the net income of the Discretionary Trust when it becomes presently entitled to income of that trust?

Answer

Yes

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

The scheme commences on:

1 July 2012

Relevant facts and circumstances

1. The Discretionary Trust deed provides The Trustee with wide discretionary powers to periodically distribute income to beneficiaries or in any financial year accumulate income at its absolute discretion.

2. The Discretionary Trust deed provides for the application of trust income in financial years where The Trustee's discretion has not been exercised to default beneficiaries.

3. The default beneficiaries are natural persons.

4. The Corporate Beneficiary is included in the class of beneficiaries for The Discretionary Trust.

5. Distributions from The Discretionary Trust made to The Corporate Beneficiary usually remain unpaid by The Discretionary Trust.

6. The Discretionary Trust and The Corporate Beneficiary are both Australian residents for taxation purposes.

7. The Corporate Beneficiary is not under a legal disability.

Relevant legislative provisions

Income Tax Assessment Act 1936, section 101

Income Tax Assessment Act 1936, section 97

Income Tax Assessment Act 1936, section 98

Reasons for decision

Issue 1

Question 1

Summary

Section 101 of the ITAA 1936 deems income which has been paid to or applied for the benefit of a specified beneficiary of a discretionary trust as a present entitlement of that beneficiary. Thus, in circumstances where a beneficiary is not regarded as presently entitled, within the ordinary meaning of the expression, section 101 of the ITAA 1936 provides a statutory extension of the term which may operate to make the beneficiary presently entitled.

For all practical purposes it will not matter whether a beneficiary is made presently entitled under the ordinary meaning of the expression or as a result of the statutory extension. Either way the beneficiary will be made presently entitled to the income of the trust for the purposes of section 97 of the ITAA 1936.

Detailed reasoning

Section 97 of the ITAA 1936 relies on present entitlement of a share of the income of the trust estate to determine the related share of the net income of the trust to be periodically included in the assessable income of the beneficiary.

The ordinary meaning of present entitlement has been determined over time by the courts (Harmer v. FCT [2001] FCA 51; FCT v. Bamford [2010] HCA 10; Colonial First State Investments Pty Ltd v. FCT [2011] FCA 16), a beneficiary will be presently entitled to income of a trust estate if:

n the beneficiary has an interest in the income which is both vested in interest and vested in possession, and

n the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant income year and whether or not the trustee has funds available for immediate payment.

Section 101 of the ITAA 1936 is a statutory extension to the ordinary meaning of presently entitled. Hill J provides an explanation in East Finchley Pty Ltd v. Federal Commissioner of Taxation 89 ATR 5280 at 5296:

The dichotomy between cases involving sec. 100A(1) and those involving sec. 100A(2) reflects the dichotomy in Div. 6 between present entitlement arising under sec. 97 or 98 on the one hand and deemed present entitlement arising under sec. 101 on the other. It was said that sec. 101 covered the field of all cases involving discretionary trusts. I doubt that conclusion.

A discretionary trust deed may provide a discretion in the trustee to determine, in respect of the income of a particular year, who among a class of beneficiaries is to be entitled. If that determination were made prior to 30 June in a year of income and was irrevocable the consequence would be under sec. 98 that there would be as at the end of the year of income (that being the relevant time to determine the issue) present entitlement under sec. 97. There would be no need to have any deemed present entitlement in such a class of case assuming, for present purposes, that there had been no payment of any amount to the beneficiary. In the class of case where there had been a payment, then sec. 95A(1) would deem the beneficiary to continue to be presently entitled to the income and thus keep sec. 97 of the Act applicable: cf. per Barwick C.J. in Union Fidelity Trustee Co. of Australia Ltd. v. F.C. of T. 69 ATC 4084; (1969) 119 C.L.R. 177 at ATC p. 4087; C.L.R. p. 182.

Where on the other hand a discretionary trust deed provides that the trustee has a discretion to pay or apply income of the trust estate to or for the benefit of beneficiaries at his discretion and where there has been a payment there would not (at least in the absence of sec. 95A(1) which was introduced in 1979) be present entitlement at the end of the year of income, nor in the event that income had been applied in favour of a beneficiary would there have been such present entitlement because, looking at the matter as at the end of the year of income, there would have been no right in the beneficiary to sue the trustee for his share of income, that right having been satisfied by the payment or application already made under sec. 101. Thus it is doubtful that sec. 101 was intended to cover the entire field. For almost all purposes (and perhaps indeed for all purposes) it will be irrelevant whether a beneficiary is presently entitled under sec. 97 or 98 or merely deemed to be presently entitled by force of sec. 101. ….

Thus, section 101 of the ITAA 1936 serves to deem amounts that have been paid or applied by a discretionary trust during an income year so that they remain present entitlements at the end of the year. If an amount has been paid or applied by the Trustee for the benefit of the beneficiary the beneficiary would no longer have a legal right to require payment or require the trustee to apply the income, as such without the deeming provision in section 101 of the ITAA 1936 there would be no present entitlement.

Ultimately whether a beneficiary is made presently entitled within the ordinary meaning of that expression or deemed presently entitled by virtue of section 101 of the ITAA 1936 will be of little practical consequence. What will matter is whether a present entitlement exists or not. If the discretion of a trustee to distribute is not exercised effectively in making a beneficiary presently entitled to income of the trust it could result, depending of the terms of the trust, that the trustee would be assessed under section 99A of the ITAA 1936 or default beneficiaries would be presently entitled to the income and taxed at their marginal rates under either section 97 or 98 of the ITAA 1936.

The Discretionary Trust deed provides the trustee with the power to apply income to beneficiaries in its absolute discretion. Distributions by The Discretionary Trust to The Corporate Beneficiary usually remain unpaid with the funds remaining in The Discretionary Trust. In other words the distributions from The Discretionary Trust to The Corporate Beneficiary are usually unpaid present entitlements.

The Corporate Beneficiary will either be presently entitled under the ordinary meaning of that term or deemed to be presently entitled under section 101 of the ITAA 1936. As explained, it will be of little practical consequence as to how. What is of importance is that The Corporate Beneficiary is made presently entitled. An ineffective exercise of the power of the trustee to distribute income would mean that the default beneficiaries would become presently entitled and taxed at their marginal rate.

As such, section 101 of the ITAA 1936 could, depending on whether a distribution has been paid or applied by the end of a period, operate to deem Then Corporate Beneficiary presently entitled to distributions of income made by The Trust.

Question 2

Summary

When The Corporate Beneficiary becomes presently entitled to the income of The Discretionary Trust it must include its share of the net income of The Trust in its assessable income in the year it is made presently entitled. It will not matter that the funds associated with the present entitlement remain unpaid, it is the present entitlement, not the form of the distribution as paid or applied, which determines the inclusion of the net income from The Discretionary Trust as assessable income of The Corporate Beneficiary.

Detailed reasoning

Relevantly subsection 97 of the ITAA 1936 states that:

Subject to Division 6D, where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:

(a) the assessable income of the beneficiary shall include:

(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; ….

Draft Taxation Ruling TR 2012/D1 Income tax: meaning of 'income of the trust estate' in Division 6 of Part III of the Income Tax Assessment Act 1936 and related provisions defines net income in paragraph 6 to mean:

…. the net income of a trust estate calculated pursuant to subsection 95(1) as the total assessable income of the trust estate calculated as if the trustee were a resident taxpayer less all allowable deductions (except for certain deductions identified in the provision).

Income of the trust estate is not a defined term and takes its meaning from trust law, paragraph 64 of TR 2012/D1 states that:

It is clear then that the determination of the income of a trust is grounded in trust law and generally involves a focus on the receipts and outgoings for an income year. The reference to trust law in this context encompasses various factors, including the general law, statutory law, trust accounting principles, the trust deed, the actions taken by the trustee in accordance with the deed (including a resolution to appoint income or capital to particular beneficiaries) and the settlor's intention.

The Discretionary Trust deed provides the trustee discretion to make beneficiaries presently entitled to the income of The Discretionary Trust. The beneficiaries include The Corporate Beneficiary. Where the trustee makes the Corporate Beneficiary presently entitled to income of The Discretionary Trust, section 97 of the ITAA 1936 will operate to include the share of net income relating to the income of The Discretionary Trust in the assessable income of The Corporate Beneficiary for that period. Provided The Corporate Beneficiary is presently entitled to the income of The Discretionary Trust, whether or not the distribution has been paid or applied, will not have any impact on the operation of section 97 of the ITAA 1936 including the associated net income in the assessable income of The Corporate Beneficiary.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).