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Authorisation Number: 1051199773260

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Date of advice: 9 March 2017

Ruling

Subject: Trust income and present entitlement

Question 1

Is the Trustee liable to be assessed under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) on the income derived by The Family Trust for the year ended 30 June 20YY?

Answer

No. As the Trust Deed contains a provision for a default beneficiary, that beneficiary is taken to be presently entitled to the income of the Trust for the year ended 30 June 20YY.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

Relevant facts and circumstances

You are a new trustee of A discretionary family trust. There are currently three co-trustees.

The family trust deed was drawn up originally in 19UU. Your parents were joint trustees until your parent's death in 20VV, after which your parent became the sole trustee until their death in 20YY.

The co-trustees are named as joint executors as well as equal beneficiaries in your late parent's Will.

In late 20YY, the solicitor overseeing the estate administration drew up a "Deed of Appointment and Retirement of Trustees." The trust deed lists you, your parents, your siblings, partners, and the grandchildren, spouses of grandchildren etc as beneficiaries.

Your parent (from 20VV onward), as trustee, always distributed the trust income, as of 30 June each year, 100% to themselves as beneficiary. This is documented uniformly every year without exception in their record of resolution with the trust tax return and their individual tax return. 

From early 20WW through to late 20YY you were the sole Enduring Power Of Attorney (EPOA) for your parent. From late 20YY your X siblings and you were joint EPOAs.

Your parent (the trustee and a beneficiary of the trust) did not record a resolution for the trust income distribution in the last year of their life, for 20XX-YY year of income. Nor was any kind of note or documenting made by them that could be considered bona fide evidence of their wishes or decision for trust income distribution.

The Family Trust Deed

Clause 10.1 of the Trust Deed (Disposition of Income and Losses) sets out how the income of the Trust is to be applied. It also sets how that income is to be applied in the event of the Trustee failing to make a resolution.

“10.1 Until the vesting day the Trustee shall stand possession of the income of the Trust Fund derived by it in any financial year including any income derived from any other Trust estate to which the Trust Fund created by this deed is presently entitled at the end of any financial year or such portion of such income as the Trustee may in its absolute discretion deem meet upon trust absolutely for the beneficiaries then living or any one or more of them and in such shares and proportions as the Trustee shall in its absolute discretion determine prior to the thirtieth day of June in such year and in the event of the Trustee failing to make such determination as aforesaid with respect to the income or any portion thereof and failing to make a determination to accumulate such income then such income or such portion (as the case may be) shall be held upon trust absolutely for such of the beneficiaries as shall from time to time be nominated as residuary income beneficiaries equally as between them.. The first residuary income beneficiary shall be X and Y. The Trustee may from time to time nominate by resolution any other person or person revocably or otherwise to be residuary income beneficiaries in addition to or in substitution for the first or any subsequent residuary income beneficiaries. It is hereby expressly declared that any beneficiary in whose favour any such determination as to income as aforesaid is made or any beneficiary who becomes entitled to income in default of any such determination shall be absolutely and presently entitled to such income for the purposes of this Deed the end of the financial year of the Trust Fund shall be deemed to take place on the Thirtieth day of June of each year. It is expressly declared that the Trustee may resolve to make one or more interim distributions of income during any financial year. In the event that during any period the Trust suffers losses (not being capital losses) the Trustee shall not be required to recoup such losses out of the corpus of the Trust Fund AND past losses (not being capital losses) shall so far as possible be recouped out of the income of the Trust Fund and not the capital of the Trust Fund.”

Relevant legislative provisions

Income Tax Assessment Act 1936

Division 6

Section 97

Section 98

Section 99

Section 99A

Reasons for decision

Question 1

There is no definition of the term presently entitled in Income Tax Assessment Act 1936 (ITAA 1936) or the Income Tax Assessment Act 1997 (ITAA 1997). It is therefore necessary to establish the meaning which has been given to the term by the courts.

The principal cases on the concept of present entitlement are the High Court decisions in Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199; (1943) 7 ATD 179; (1943) 2 AITR 421 (Whiting's Case) and Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444; 70 ATC 4026; (1970) 1 ATR 582 (Taylor's Case). The principles in Taylor's Case are also dealt with in Income Tax Ruling IT 319.

The main principles emerging from Whiting's and Taylor's Case are:

● The income must be legally available for distribution to the beneficiary. It does not matter whether the amount of income has not been exactly ascertained. Therefore, the fact that you are not in a position to know exactly what is available to distribute to a beneficiary does not alter the fact that in a legal sense, a beneficiary can still demand payment and be presently entitled;

● The beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent which means that the beneficiary must have the right to demand immediate payment (or would have had the right to demand payment had they not been under a legal disability). An interest is said to be defeasible where it can be brought to an end and indefeasible where it cannot.

The principles concerning the meaning of present entitlement from Whiting and Taylor were applied by the Full High Court in FC of T v. Totledge Pty Ltd (1982) 82 ATC 4168; (1982) 12 ATR 830, when it said:

... the preferable construction of sec. 97(1) is to treat the requirement of present entitlement to a share of the income of the trust estate as not being concerned with distinctions between gross income as derived and 'surplus income' after payment of costs, expenses and outgoings but as referring to a present vested right to demand and receive payment of the whole or part of what has been received by the trustee as income and, retaining that character in his hands, is legally available to be distributed to those entitled to it as beneficiaries under the trusts to the relevant trust estate. Such a right to demand and receive payment represents a present entitlement to receive a share of what retains its character as income of the trust estate regardless of whether upon closer analysis, it can be seen to reflect a beneficial interest in gross income as derived or whether it represents no more than, for example, the right of an annuitant to be paid a particular amount from surplus or net income. Examination of the decided cases in which reference has been made to sec. 97(1) supports this approach.

Harmer and Ors v. FC of T 91 ATC 5000; (1991) 22 ATR 726 (Harmer) concerned disputed monies which were the subject of the competing claims were paid into Court and then deposited under the names of the claimant solicitors in a building society account to be held on trust pending the Court's determination of the claims. In two particular years prior to the determination of the claims, interest was earned and assessed under section 99A of the ITAA 1936. Both the High Court and Full High Court considered that, as the individual claimants' interests were at best contingent, the claimants were not presently entitled with the ordinary meaning of the term or within subsection 95A(2) of the ITAA 1936. Their interest was merely that they could have the funds properly administered and applied.

At the heart of the concept of present entitlement lies the immediate present right of a beneficiary to demand and receive payment of the income of the trust estate or a share of it. The leading High Court authority, Harmer, expressed the tests as follows:

The parties are agreed that the cases establish that a beneficiary is "presently entitled'' to a share of the income of a trust estate if, but only if:

(a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and

(b) 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 year of income and whether or not the trustee has the funds available for immediate payment.'

The judgment went on to say that the question of whether any one or more of the claimants were presently entitled must be answered as at the time when the interest was derived, that is to say, during the tax years.

When does present entitlement arise?

Although the tax legislation is silent on when present entitlement must be created, case law indicates that to create a present entitlement to income it is necessary to create that entitlement prior to the end of an income year. In Trustees of the Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525, Hill J stated at 4539:

“Present entitlement to the income must arise, if at all, at the latest by the end of the year of income.”

Therefore the ATO takes the view that a beneficiary's entitlement must be vested by 30 June. An entitlement that will only arise on the happening of an event in the future is not vested. For example, a resolution would not be effective if it stated that an entitlement of a beneficiary would arise in the event of a future adjustment to the trust's net (taxable) income by the ATO - see Pearson v FCT [2006] FCAFC 111 where Edmonds J stated:

“First, "present entitlement" in terms of Division 6 of Part III of the ITAA has to be determined by the end of the year of income to which the income relates, in the sense of its year of derivation.”

Furthermore, as a result of the High Court decision in Federal Commissioner of Taxation v. Bamford the ATO has withdrawn Income Tax Rulings IT 328 and IT 329. These rulings provided for an administrative practice that permitted trustees to have a two month period of grace after the end of the financial year to put in place valid trustee resolutions for the distribution of income for the preceding year. This administrative practice ceased to apply as from 1 September 2011.

Accordingly, if a trustee resolution is not made before the end of the financial year no beneficiary will be presently entitled to the income of the trust. In these instances it is necessary to examine the trust deed to establish if there are provisions for default beneficiaries and how those provisions operate.

Default beneficiaries

The Trust Deed for The Family Trust identifies (at clause 2.1) a number of beneficiaries and gives the Trustee the power to determine how much, if any, of the Trust income to distribute to each beneficiary each year. As the Trustee can exercise this power “in its absolute discretion” the Trust is a discretionary trust.

In this case none of the discretionary beneficiaries are presently entitled to any of the income of the Trust until the Trustee makes a determination that a distribution of an amount or proportion of trust income will be distributed to them. As soon as the Trustee makes a determination that a distribution of an amount or proportion of trust income will be distributed to a particular beneficiary, that beneficiary becomes presently entitled to that amount or proportion of the trust income.

In this instance the Trustee did not make a determination or resolution before 30 June 20YY. As a result no beneficiary was presently entitled to the income of the Trust for the year ended 30 June 20YY.

Therefore it is necessary to look to the 'default clause(s)' in the Trust Deed to determine how the income of the Trust is to be applied in the absence of a trustee resolution.

A trust deed may contain a provision that specifies that if the trustee has not, by the end of the income year, determined to distribute or accumulate some or all of the income of the trust, then that income is to be distributed to a default beneficiary. In this situation the default beneficiary automatically becomes presently entitled to the relevant amount or proportion of the trust income.

Clause 10.1 of The Family Trust Deed addresses the situation where Trustee fails to make a resolution as to how the income of the Trust should be applied:

“…and in the event of the Trustee failing to make such determination as aforesaid with respect to the income or any portion thereof and failing to make a determination to accumulate such income then such income or such portion (as the case may be) shall be held upon trust absolutely for such of the beneficiaries as shall from time to time be nominated as residuary income beneficiaries equally as between them.. The first residuary income beneficiary shall be X and X.”

The clause states that in the absence of a trustee resolution the residuary income beneficiary is entitled to the income or a proportion of the income of the Trust. As X passed away in 20VV and as there is no evidence of a resolution to appoint any other residuary beneficiary, Y is the sole residuary beneficiary presently entitled to the income of the Trust for the year ended 30 June 20YY.

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