Edited version of private advice

Authorisation Number: 1052169985304

Date of advice: 20 September 2023

Ruling

Subject: Streaming of franked distributions

Question

Is the Executor of a deceased estate liable to be assessed and pay tax under sections 99 or 99A of the Income Tax Assessment Act 1936 (ITAA 1936) on that part of the section 95 of the ITAA 1936 net income in respect of a franked dividend they received and then distributed to beneficiaries of the Will?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.         Under the terms of the Will, Beneficiary A was left a sum of money that was subject to certain actions of Executor but was not a right to income of the Estate.

2.         Under the terms of the Will, Beneficiary B was left income of the estate subject to certain actions of Executor.

3.         During the income year the Executor received a franked dividend in respect of shares that form part of the Estate and paid part of the franked distribution to Beneficiary A and paid the rest to Beneficiary B.

4.         The records prepared by the Executor before 30 June 20XX show that the amount received was a franked dividend and lists the amount each beneficiary received.

5.         The Estate has not reached the point of full administration and is in the intermediate stage of administration.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 section 95AAA

Income Tax Assessment Act 1936 paragraph 97(1)(a)

Income Tax Assessment Act 1936 section 98

Income Tax Assessment Act 1936 section 98A

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1936 section 100

Income Tax Assessment Act 1997 Subdivision 207-B

Income Tax Assessment Act 1997 section 207-25

Income Tax Assessment Act 1997 section 207-50

Income Tax Assessment Act 1997 subsection 207-50(3)

Income Tax Assessment Act 1997 subsection 207-50(4)

Income Tax Assessment Act 1997 paragraph 207-50(4)(c)

Income Tax Assessment Act 1997 section 207-55

Income Tax Assessment Act 1997 subsection 207-55(1)

Income Tax Assessment Act 1997 subsection 207-55(2)

Income Tax Assessment Act 1997 subsection 207-55(3)

Income Tax Assessment Act 1997 subsection 207-55(4)

Income Tax Assessment Act 1997 subparagraph 207-55(4)(a)(i)

Income Tax Assessment Act 1997 paragraph 207-55(4)(b)

Income Tax Assessment Act 1997 subsection 207-58(1)

Income Tax Assessment Act 1997 paragraph 207-58(1)(a)

Income Tax Assessment Act 1997 section 207-55

Income Tax Assessment Act 1997 section 950-150

Income Tax Assessment Act 1997 subsection 950-150(2)

Income Tax Assessment Act 1997 section 974-160

Reasons for decision

Background - income of the trust

1.    The net income of a trust estate is defined in section 95 of the ITAA 1936:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 393 of the Income Tax Assessment Act 1997 (Farm management deposits) and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.

A trust may be required to work out its net income in a special way by Division 266 or 267 in Schedule 2F to this Act or Division 275 of the Income Tax Assessment Act 1997.

2.    Paragraphs 82 to 90 of Draft Taxation Ruling TR 2012/D1 Income tax: meaning of 'income of the trust estate', sets out the Commissioner's view on the income of a trust estate as follows:

82. The income considered for Division 6 purposes is that of a 'trust estate'.

83. The expression 'trust estate' is not defined for the purposes of Division 6, although it is generally taken to mean the estate which is vested in a trustee, that is, the trust property.

84. Comments of the majority of the High Court in FCT v. Everett support the view that 'trust estate' is synonymous with 'trust property'. In that case, the taxpayer assigned to his wife a share of his interest in a partnership which carried with it an entitlement to receive a share of the future income attributable to it. Consequently an immediate trust was established of a proprietary right which yielded or earned future income.

85. The Commissioner assessed the taxpayer in respect of the share of partnership profits paid to the taxpayer's wife in respect of the 1973 income year. The Commissioner had argued that the profits payable to the taxpayer's wife were not net income in relation to a trust estate for the purposes of section 95. The Court observed

The appellant's contention is that the income payable to the respondent's wife was not, as the majority in the Federal Court held, 'the net income of a trust estate'' within the meaning of sec. 95 of the Act. The argument is based very largely on the proposition, founded on the judgment of Kitto J. in Stewart Dawson Holdings Pty. Ltd. v. F.C. of T. (1965) 39 A.L.J.R. 300, at p. 301, that income derived by a trustee from his own property or by means of his personal exertion, 'income with respect to which a trust arises at the moment of derivation'', does not answer the statutory description. Kitto J. was making the point that when a person establishes a trust of his future income simpliciter, the income when it is derived is the subject matter or corpus of the trust, not the fruit of it. To use the terminology of sec. 95, it is because the income is the 'trust estate'' that it cannot be 'the net income of'' that trust estate. His Honour's remarks do not touch the case where an immediate trust is established of a proprietary right which yields or earns future income. Then the income is accurately described as income of a trust estate. For reasons which we have already given, this is the situation which obtains here.

86. The many references in Division 6 to the 'income of the trust estate' show that the trust estate and its income are distinct concepts, the income being the product of the estate. The distinction was most recently commented upon by the Full Federal Court in Leighton v. Commissioner of Taxation. In that case, Mr Leighton was the trustee of a trust for the benefit of two companies, Salina and Kolton, and the Full Federal Court observed:

The share sale proceeds deposited... into the Westpac Bank account in Mr Leighton's name... did not represent the income of either Salina or Kolton but rather represented the realisation of the income... already derived by these companies. Upon being deposited, the proceeds were impressed with a trust in favour of Salina and Kolton, but they did not comprise the income of a trust estate. Rather, those deposited proceeds constituted or augmented a trust estate of which Mr Leighton was trustee. The income of that trust estate was such income, if any, as was later derived from the investment of that trust estate, e.g. any bank interest on the deposited proceeds.

87. As the trust estate and its income are distinct concepts, it follows that something which formed part of the trust estate at the start of an income year cannot itself be income for that year.

88. It would seem that in determining the product of (or income flowing from) the trust estate, the trust estate should be thought of in broad terms so as to include, for example, any rights the trustee has to be considered as a discretionary object in other trusts.

89. The income, being a product of, or a flow from, the trust estate, must represent, in total, an actual accretion to the trust estate for the relevant period. In other words, that which is 'income' cannot in total exceed (although it can be less than) the yield or accretion to the fund for the relevant period. And it must represent an accretion that, following its production, is capable of adhering to, or forming part of, the trust estate. However, in this context an accretion need not be a realised gain - it may in appropriate cases reflect an unrealised gain which represents an increase in value which has accrued to the trust.

90. Where the income of a trust is defined by reference to its net income, it may often be the case that an amount which purportedly forms part of the trust income does not represent anything flowing to or coming home to (or an accretion to) the trust estate. These amounts are described in this draft Ruling as notional amounts - see discussion in paragraph 6.

3.    A franked distribution, such as the franked distribution received by the Estate is income of the Estate in the 2021 income year. Although income of the trust, franked distributions are brought to tax under Subdivision 207-B, as summarised in paragraphs 3 to 5 of TR 2012/D1:

3. For the 2010-11 and later income years, capital gains and franked distributions included in the net income of a trust are brought to tax in accordance with Subdivisions 115-C and 207-B of the Income Tax Assessment Act 1997 (ITAA 1997) respectively.

4. The balance of the net income (that is the net income excluding capital gains and franked distribution) of the trust is still assessed under Division 6 in the manner described in paragraph 2, but modified by Division 6E of Part III (Division 6E).

5. Division 6E adjusts the rules in Division 6 to ensure that capital gains and franked distributions are not taxed twice (that is, as a result of Subdivisions 115-C or 207-B of the ITAA 1997 and Division 6). In broad terms the effect of Division 6E is to apply Division 6 on the assumption that net capital gains and franked distributions are excluded from the trust's net income, and any amount relating to these things is excluded from the income of the trust estate. [1]

Background how income of the trust is taxed

4.    There are various statutory provisions within the ITAA 1936 and the ITAA 1997 that deal with how the net income of a trust is taxed and the interaction between these provisions is outlined in section 95AAA of Division 6 of the ITAA 1936, which states:

The following is a simplified outline of the relationship between this Division, Division 6E and Subdivisions 115-C and 207-B of the Income Tax Assessment Act 1997.

5.    This section is a guide[2] to the operating provisions and paragraphs 57 to 60 of Taxation Determination TD 2012/22 Income tax: for the purposes of paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) is a beneficiary's share of the net income of a trust estate worked out by reference to the proportion of the income of the trust estate to which the beneficiary is presently entitled provides a general overview of how the net income of a trust is allocated for tax purposes.

57.Where a beneficiary is presently entitled to a share of the income of a trust estate, paragraph 97(1)(a) of the ITAA 1936 requires the beneficiary to include in their assessable income that share of the trust's net income. In Commissioner of Taxation v. Bamford, the High Court endorsed the proposition that beneficiaries can only be presently entitled to whatever is generally regarded as the distributable income of the trust (that is, the amount which can be distributed to beneficiaries or accumulated by the trustee). Further, the Court held that the reference to 'that share' meant the income to which the beneficiary was presently entitled as a proportion of the total trust income.

58. Under the proportionate approach, the amount to be included in a beneficiary's assessable income under paragraph 97(1)(a) of the ITAA 1936 is the product of a two step mathematical calculation.

59. The first step of that calculation involves determining the amount of income to which a beneficiary is presently entitled and converting that amount into a percentage share of the total trust income available for distribution. The second step involves applying that percentage to the net income of the trust.

60. The terms of a trust deed and the trustee's actions pursuant to it, including the way in which resolutions to distribute income are worded, are critical in determining the outcomes under the proportionate approach: see examples 1, 2, 3 and 4.

6.    How a franked distribution is allocated under Subdivision 207-B is summarised in paragraphs 66 to 68 and 74 to 76 of TD 2012/22:

66. For the 2010-11 and later income years, capital gains and franked distributions from the trust's net income, and any amount relating to these things is excluded from the income of the trust estate. Example 11 illustrates.

67. As a result of modifications under Division 6E of Part III of the ITAA 1936 (Division 6E), the balance of the net income (that is the net income excluding amounts attributable to capital gains and franked distributions) of the trust is still assessed under Division 6 effectively in the manner described in paragraphs 57 to 59

68. Division 6E adjusts the rules in Division 6 to ensure that capital gains and franked distributions are not taxed twice (that is, once as a result of the operation of Subdivisions 115-C or 207-B of the ITAA 1997 and again by reason of Division 6). In broad terms the effect of Division 6E is to carve out net capital gains and franked distributions from the operation of Division 6 by excluding net capital gains and franked distributions from the trust's net income, and any amount relating to these things is excluded from the income of the trust estate. Example 11 illustrates this.

Subdivision 207-B of the ITAA 1997

74. Franked distributions of a trust are allocated to beneficiaries and the trustee in accordance with the rules in Subdivision 207-B of the ITAA 1997. These rules differentiate between entities with a specific entitlement to all or part of a franked distribution and other entities. Trustees cannot be specifically entitled to a franked distribution.

75. If there is some part of a franked distribution to which no beneficiary is specifically entitled, a beneficiary or the trustee will be taken to have a share of the franked distribution equal to that franked distribution multiplied by their 'adjusted Division 6 percentage' of the income of the trust estate in the relevant income year.

76. Similarly to capital gains, this means that where no entity is specifically entitled to any capital gain or franked distribution of the trust, each beneficiary will generally be assessable on their proportionate share of the net franked distributions of the trust and attached franking credits, and the trustee will generally be similarly assessed where there is no income of the trust estate or income of the trust estate to which no beneficiary is presently entitled.

7.    In respect of present entitlements to a deceased estate, paragraphs 8 to 14 of

8.    IT 2622 Income tax: present entitlement during the stages of administration of deceased estates states:

8. Division 6 requires the ascertainment of the "net income" of the trust estate as defined in subsection 95(1) of the Act. The net income of the trust is then assessed to the beneficiary or to the trustee depending on whether the beneficiary is presently entitled to income of the trust estate or is under a legal disability.

9. Beneficiaries cannot enjoy present entitlement to income derived by a deceased estate during the administration of the estate. Income of a deceased estate in income years before the administration of the estate is complete, is the income of the executors or administrators and is not income of the beneficiaries. During the initial stage of the administration (as described in paragraph 6 above) no beneficiary is presently entitled to the income derived.

10. The leading Australian case on present entitlement under a trust arising during the course of administration of an estate is the decision of the High Court of Australia in F.C. of T. v. Whiting (1943) 68 CLR 199; 7 ATD 179. The Court held that a beneficiary of a deceased estate cannot be presently entitled to the income of the estate until the estate has been fully administered.

11. In their joint judgment, Latham C J and Williams J stated (CLR at 216; ATD at 184), that numerous authorities had established that:

".... until an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debts, annuities and legacies and the amount of the residue thereby ascertained, the income of the residuary estate is the income of the executors and not of the residuary beneficiaries."

12. And later their Honours added (CLR at 216; ATD at 184):

"The only part of an estate which can be made available to satisfy the claims of the beneficiaries is that part which remains after the funeral and testamentary expenses, death duties and debts have been paid or provided for, if necessary out of the whole estate, including any income earned by the estate during the period of realization."

13. Until the estate of a testator has been fully administered and the net residue ascertained, a residuary beneficiary has no proprietary interest in any specific investment forming part of the estate or in the income from any such investment. Both corpus and income are the property of the executors or administrators: Lord Sudeley v. Attorney-General [1897] A.C. 11; Dr Barnardo's Homes National Incorporated Association v. Commissioners for Special Purposes [1921] 2 A.C. 1. See also Pajels v. MacDonald (1936) 54 CLR 519 at 526; Corbett v. I.R.C. (1937) 4 All E.R. 700 at 707 and C.S.D. (Qld) v. Livingston (1964) 112 CLR 12.

14. During the intermediate stage of administration of a deceased estate (as described in paragraph 6 above), the point may be reached where it is apparent to the executor that part of the net income of the estate will not be required to either pay or provide for debts, etc. The executor in this situation might in exercise of the executor's discretion, in fact, pay some of the income to, or on behalf of, the beneficiaries. The beneficiaries in this situation will be presently entitled to the income to the extent of the amounts actually paid to them or actually paid on their behalf. The fact that the estate has not been fully administered does not prevent the beneficiaries in this situation from being presently entitled to the income actually paid to, or on behalf of, the beneficiaries.

9.    The Estate is in the intermediate stage of administration and in applying paragraph 14 of IT 2622 the beneficiaries of the Estate will only be presently entitled to income of the Estate where the Executors:

•                     exercise their discretion and pay some of the income to, or on behalf of, the beneficiaries, and

•                     actually paid income to the beneficiaries or actually paid the income to someone on the beneficiaries behalf.

Subdivision 207-B franked distributions

10.  Subsections 207-55(1) and (2) state:

207-55(1) The object of this section is to ensure that:

(a) the amount of a franked distribution made to a partnership or the trustee of a trust is allocated notionally amongst entities who derive benefits from that distribution; and

(b) that allocation corresponds with the way in which those benefits were derived.

Note: An entity can derive a benefit from the distribution (and therefore has a share of the distribution) without actually receiving any of the distribution: see subsection (2) of this section and the example at the end of section 207-50.

207-55(2) An entity's share of a franked distribution is an amount notionally allocated to the entity as its share of the distribution, whether or not the entity actually receives any of that distribution.

11.  As per the object[3] and the note to subsection 207-55(1) and subsection 207-55(2), section 207-55 can apply to an entity regardless of whether that entity received any of the franked distribution.[4]

12.  The amounts that is to be allocated to an entity[5] is determined under subsection 207-55(3), which states:

That amount is equal to the entity's share of the distribution as the focal entity in column 3 of an item of the table.

13.  In respect of a franked distribution that is made to the trustee of a trust, item 3 in the table in subsection 207-55(3) states:

14.  Column 1 of item 3 requires an examination of subsection 207-50(3) when the focal entity is a beneficiary, or subsection 207-50(4) when the focal entity is the trustee.

15.  The Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 2) Bill 2004 explains how section 207-50 is to be applied:

10.15 The definition of 'flow indirectly' in section 207-35 will be replaced so that a franked distribution can flow indirectly to an entity where the distribution, or part of the distribution, is exempt income or non-assessable non-exempt income in the hands of the recipient. Under the new definition, a franked distribution will be taken to flow indirectly to a partner in a partnership or to a beneficiary or the trustee of a trust if:

•                    the distribution is made to a partnership or trustee of a trust or flows indirectly to the partnership or to the trustee or beneficiary of the trust as a partner or beneficiary [Schedule 10, item 7, paragraphs 207-50(2)(a), (3)(a) and (4)(a)]; and

•                    one of the following is satisfied:

-             the partner has an individual interest in the partnership's net income or is allowed a deduction for a partnership loss under subsections 92(1) and (2) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(2)(b)]; or

-             the beneficiary has a share of the trust's net income under paragraph 97(1)(a) of the ITAA 1936 or an individual interest in the trust's net income under paragraph 98A(1)(a) or (b) or 100(1)(a) or (b) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(3)(b)]; or

-             the trustee is liable to be assessed on a share of the trust's net income in respect of a beneficiary under section 98 of the ITAA 1936 or assessed on all or part of the trust's net income for that year under section 99 or 99A of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(4)(b)]; and

•                    the entity's share of the franked distribution as calculated in new section 207-55 is a positive amount. That is, the entity must have an entitlement to part or all of the franked distribution [Schedule 10, item 7, paragraphs 207-50(2)(c), (3)(c) and (4)(c)].

Subsection 207-50(3) the beneficiaries of the Estate as focal entities.

16.  Subsection 207-50(3) states:

A franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

(a) during that income year, the distribution is made to the trustee of the trust, or flows indirectly to the trustee as a partner or beneficiary because of a previous application of subsection (2) or this subsection; and

(b) the beneficiary has this amount for that income year (the share amount ):

(i) a share of the trust's net income for that income year that is covered by paragraph 97(1)(a) of the Income Tax Assessment Act 1936; or

(ii) an individual interest in the trust' s net income for that income year that is covered by section 98A or 100 of that Act;

(whether or not the share amount becomes assessable income in the hands of the beneficiary); and

(c) the beneficiary ' s share of the distribution under section 207-55 is a positive amount (whether or not the beneficiary actually receives any of that share).

17.  Under subsection 207-50(3), a franked distribution can only flow indirectly to a beneficiary of a trust, if the beneficiary as a focal entity has:

•                     a share of the trust's net income for that income year that is covered by paragraph 97(1)(a) of the ITAA 1936, or

•                     an individual interest in the trust's net income for that income year that is covered by section 98A or 100 of the ITAA 1936.

18.  If a beneficiary does not have a share of the trust's net income or an individual interest in the trust's net income for the income year being examined, there cannot be an amount that flows through to that beneficiary.

19.  If an amount doesn't flow through to that beneficiary, column 3 will not apply to that beneficiary. Where column 3 doesn't apply, then there is no requirement to determine a specific entitlement for that beneficiary using the amount worked out under subsection 207-55(3).

20.  Beneficiary A did not right to income of the Estate and as such does not have:

•                    a share of the Estate's net income for that income year that is covered by paragraph 97(1)(a) of the ITAA 1936; or

•                    an individual interest in the Estate's net income for that income year that is covered by section 98A or 100 of the ITAA 1936.

21.  As a result, column 3 of item 3 of the table in subsection 207-55(3) does not need to be examined in respect of Beneficiary A's entitlement. As column 3 of item 3 of the table in subsection 207-55(3) does not need to be examined there is no requirement to determine if Beneficiary A has a specific entitlement under subsection 207-55(4).

22.  In respect of Beneficiary B this person does have an entitlement to income of the Estate can receive a.

•                    a share of the Estate's net income for that income year that is covered by paragraph 97(1)(a) of the ITAA 1936; or

•                    an individual interest in the Estate's net income for that income year that is covered by section 98A or 100 of the ITAA 1936.

23.  As Beneficiary B can receive a share of the Estate's net income, column 3 of item 3 of the table in subsection 207-55(3) will apply to that person as a focal entity.

Subsection 207-50(4) the Executors of the Estate as focal entities.

24.  Subsection 207-50(4) states:

A franked distribution flows indirectly to the trustee of a trust in an income year if, and only if:

(a) during that income year, the distribution is made to the trustee, or flows indirectly to the trustee as a partner or beneficiary because of a previous application of subsection (2) or (3); and

(b) the trustee is liable or, but for another provision in this Act, would be liable, to be assessed in respect of an amount (the share amount) that is:

(i) a share of the trust's net income for that income year under section 98 of the Income Tax Assessment Act 1936; or

(ii) all or a part of the trust's net income for that income year under section 99 or 99A of that Act;

(whether or not the share amount becomes assessable income in the hands of the trustee); and

(c) the trustee' s share of the distribution under section 207-55 is a positive amount (whether or not the trustee actually receives any of that share).

Note: A trustee to whom a franked distribution flows indirectly under this subsection is entitled to a tax offset under section 207-45 and the distribution does not flow indirectly through the trustee to another entity.

25.  Under subsection 207-50(4), a franked distribution can only flow indirectly to a trustee of a trust, if the trustee as a focal entity is liable or would have been liable to be assessed in respect of an amount (the share amount) that is:

•                    a share of the trust's net income for that income year under section 98 of the ITAA 1936, or

•                    all or a part of the trust's net income for that income year under section 99 or 99A of the ITAA 1936, and

•                    their share of the distribution under section 207-55 is a positive amount.

26.  Applying paragraph 14 of IT 2622, in the intermediate stage of administration, beneficiaries are only presently entitled to income if they receive income of the Estate.

27.  As Beneficiary B Trusts is the only beneficiary who was left income of Estate, they are the only beneficiaries that could be paid income of the Estate.

28.  As such where income is not paid to (or on behalf of) the Beneficiary B then there is no beneficiary presently entitled to the amount not paid to Beneficiary B.

29.  As a result, the Executor is liable or would have been liable to be assessed in respect of an amount (the share amount) that is:

•                     a share of the trust's net income for that income year under section 98 of the Income Tax Assessment Act 1936; or

•                     all or a part of the trust's net income for that income year under section 99 or 99A of that Act.

30.  The final step, when looking at each distribution an amount will flow through to the Executor's share of the distribution under section 207-55 is a positive amount.

Column 3 Beneficiary B and the Executor (as focal entities) share of the franked distribution

31.  Column 3 of item 3 of the table in subsection 207-55(3) states that the focal entity's share of a franked distribution is determined under subsection 207-55(4), which states:

For the purposes of column 3 of item 3 of the table in subsection (3), the amount is the sum of:

(a) so much of the amount worked out under column 2 of item 3 of the table in subsection (3) to which:

(i) unless subparagraph (ii) applies - the focal entity is specifically entitled; or

(ii) if the focal entity is the trustee and has the share amount because of the operation of section 98 of the Income Tax Assessment Act 1936 in respect of a beneficiary (see subparagraph 207-50(4)(b)(i)) - the beneficiary is specifically entitled; and

(b) if there is an amount of the franked distribution to which no beneficiary is specifically entitled - that amount multiplied by:

(i) unless subparagraph (ii) applies - the focal entity's adjusted Division 6 percentage of the income of the trust for the relevant income year; or

(ii) if the focal entity is the trustee and has the share amount because of the operation of section 98 of the Income Tax Assessment Act 1936 in respect of a beneficiary (see subparagraph 207-50(4)(b)(i) ) - the beneficiary's adjusted Division 6 percentage of the income of the trust for the relevant income year.

32.  How subsection 207-55(4) should be interpreted is summarised in paragraphs 2.125 to 2.127 of the Explanatory Memorandum to the Tax Laws Amendment (2011 Measure No. 5) Bill 2011 (the EM):

2.125 Where a trust receives a franked distribution and the distribution flows through the trust to a beneficiary, the amendments to item 3 mean that the beneficiary's share of the franked distribution is now calculated under subsection 207-55(4) as the sum of:

•                    the amount of the franked distribution to which the beneficiary is specifically entitled (see paragraph 2.133); and

•                    the beneficiary's proportionate entitlement to any part of the franked distribution to which no beneficiary is specifically entitled.

[Schedule 2, item 23, subsection 207-55(4)]

2.126 Where a trustee is liable to be assessed and pay tax in respect of a beneficiary under section 98 of the ITAA 1936 (or would be so liable but for another provision in the Act such as Division 6E), subparagraph 207-55(4)(a)(ii) operates to treat the trustee as being specifically entitled to the amount of the franked distribution to which the relevant beneficiary is specifically entitled. [Schedule 2, item 23, paragraph 207-55(4)(a)]

2.127 A beneficiary's proportionate share of that part of a franked distribution to which no beneficiary is specifically entitled, is calculated in accordance with paragraph 207-55(4)(b). This amount is the amount of the franked distribution multiplied by the beneficiary's adjusted Division 6 percentage. Again allowance is made for circumstances where a trustee is assessed in respect of a beneficiary under section 98 of the ITAA 1936. [Schedule 2, item 23, subparagraphs 207-55(4)(b)(i) and (ii)]

33.  For subparagraph 207-55(4)(a)(i) to apply, Beneficiary B must be specifically entitled to an amount. When a beneficiary of a trust estate is 'specifically entitled to an amount' is set out in subsection 207-58(1) as follows:

A beneficiary of a trust estate is specifically entitled to an amount of a franked distribution made to the trust estate in an income year equal to the amount calculated under the following formula:

where:

net financial benefit means an amount equal to the financial benefit that is referable to the franked distribution (after any application by the trustee of expenses that are directly relevant to the franked distribution).

share of net financial benefit means an amount equal to the financial benefit that, in accordance with the terms of the trust:

(a) the beneficiary has received, or can be reasonably expected to receive; and

(b) is referable to the franked distribution (after application by the trustee of any expenses that are directly relevant to the franked distribution); and

(c) is recorded, in its character as referable to the franked distribution, in the accounts or records of the trust no later than the end of the income year.

34.  Moreover, paragraphs 2.37 to 2.40 of the EM states:

2.37 For streaming of capital gains and franked distributions to be effective for tax purposes, beneficiaries must be specifically entitled to them. That is:

•                    the beneficiary must receive, or reasonably be expected to receive, an amount equal to the 'net financial benefit' referable to the capital gain or franked distribution in the trust; and

•                    the entitlement must be recorded in its character as such in the accounts or records of the trust (see paragraph 2.62).

[Schedule 2, item 11, section 115 228, item 24, section 207-58 and item 27, subsection 995-1(1)]

2.38 Broadly, a beneficiary will be specifically entitled to the fraction of the (gross) tax amount that equals their fraction of the net trust amount referable to the capital gain or franked distribution. For example, a beneficiary that receives an amount specified to be half of the trust's profit from the sale of an asset will generally be specifically entitled to half of the (tax) capital gain realised on the asset. [Schedule 2, item 11, subsection 115-228(1) and item 24, subsection 207-58(1)]

2.39 When a beneficiary has a specific entitlement to a capital gain or franked distribution, the associated tax consequences in respect of that distribution will apply to that beneficiary. Furthermore, the beneficiary will not be assessed on any share of the trust's taxable income over and above the amounts assessed because of Subdivisions 115-C and 207-B.

2.40 Capital gains and franked distributions to which no beneficiary is specifically entitled will flow proportionally to beneficiaries and/or the trustee based on their share of income of the trust excluding amounts to which any beneficiary is specifically entitled. This 'adjusted Division 6 percentage' is explained further in paragraphs 2.71 to 2.75.

35.  The franked distributions referred to and being tested in the formula in subsection 207-58(1), is the franked distributions received that was trust income for the year and referable as franked distributions.

36.  The 'net financial benefit' is explained in paragraph 2.53 of the EM:

The net financial benefit referable to a franked distribution will normally equal the amount of the franked distribution after being reduced by directly relevant expenses. Directly relevant expenses could include any annual borrowing expenses (such as interest) incurred in respect of the underlying shares (allocated rateably against any franked and unfranked dividends from those shares) or management fees incurred in respect of managing an investment portfolio of shares for the purpose of deriving dividend income (allocated against dividend income as relevant).

37.  The net financial benefit is the relevant franked distribution less expenses that were directly relevant the franked distribution.

38.  The Executor has concluded that there are no expenses that are directly relevant to either franked distribution, so the net financial benefit is the amount of the franked distribution received.

39.  A beneficiary's specific entitlement is determined by their 'share of net financial benefit' which according to subsection 207-58(1) means:

an amount equal to the financial benefit that, in accordance with the terms of the trust:

(a) the beneficiary has received, or can be reasonably expected to receive; and

(b) is referable to the franked distribution (after application by the trustee of any expenses that are directly relevant to the franked distribution); and

(c) is recorded, in its character as referable to the franked distribution, in the accounts or records of the trust no later than the end of the income year

40.  'Financial benefit' is defined in section 974-160 as:

974-160(1) In this Act:

financial benefit:

(a) means anything of economic value; and

(b) includes property and services; and

(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;

even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.

974-160(2) In applying subsection (1), benefits and obligations are to be looked at separately and not set off against each other.

974-160(3) The regulations may provide that a thing specified in the regulations is a financial benefit for the purposes of this Act.

41.  Paragraph 2.44 of the EM sets out when a beneficiary has received an amount:

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

42.  As the Executor allocated and paid an amount to Beneficiary B a beneficiary of the trust estate has received a 'share of net financial benefit' under paragraph 207-58(1)(a).

43.  The next step is to determine if these amounts were referable and recorded in their character as referable to a franked distribution in the Estate's records. What these records could consist of are included in paragraphs 2.62 and 2.64 of the EM:

2.62 The amount (or fraction) of the net economic benefit that the beneficiary has received or can reasonably be expected to receive must also be recorded in its character as referable to the capital gain or franked distribution in the accounts or records of the trust. [Schedule 2, item 11, paragraph 115 228(1)(c) and item 24, paragraph 207 58(1)(c)]

2.63 The accounts or records of the trust would include the trust deed itself, statements of resolution or distribution statements, including schedules or notes attached to, or intended to be read with them. However, a record merely for tax purposes is not sufficient.

2.64 The following resolutions or trust entitlements would satisfy the requirement of being 'recorded in its character as referable':

•                    Under the trust deed, a beneficiary is entitled to all of the capital gains of the trust.

•                    The trustee resolves to distribute all of the dividends of the trust to a beneficiary.

•                    Under a trust deed that includes capital gains as income (either by default or because the trustee exercises a power to re-characterise the amount as income), a beneficiary is entitled to all of the profits made on or derived from an asset.

•                    Under a trust deed that does not include capital gains as income, the trustee resolves to advance capital representing profits from the sale of a property equally to the beneficiaries.

44.  The entitlement that Beneficiary B could receive or expect to receive 'in accordance with the terms of the trust' are a share of the net income of the Estate or an amount that was referable to a franked distribution.

45.  When examining the definition of 'share of net financial benefit' in subsection 207-58(1), the amount paid to Beneficiary B was recorded in Estate's records as a franked distribution which was a beneficiary who had rights under the terms of the Will to receive a share of a franked distribution.

46.  Therefore, the share of the franked distribution Beneficiary B received from the Estate that the amount listed in the record of payment.

47.  Paragraph 207-55(4)(b) states:

if there is an amount of the franked distribution to which no beneficiary is specifically entitled - that amount multiplied by:

(i) unless subparagraph (ii) applies - the focal entity's adjusted Division 6 percentage of the income of the trust for the relevant income year; or

(ii) if the focal entity is the trustee and has the share amount because of the operation of section 98 of the Income Tax Assessment Act 1936 in respect of a beneficiary (see subparagraph 207-50(4)(b)(i)) - the beneficiary s adjusted Division 6 percentage of the income of the trust for the relevant income year.

48.  In respect of the amount listed in the record of payment for the franked distribution the Estate the amount showing as having been paid to Beneficiary A is the amount no beneficiary was specifically entitled to.

49.  This amount will form the basis of the amount calculated under paragraph 207-55(4)(b) as the Executor's share of the franked distribution for the purposes of column 3 of item 3 in the table in subsection 207-55(3).

50.  Section 207-25, which is the guide to Subdivision 207-B, states:

This Subdivision deals with an entity that receives a benefit of a franked distribution where:

(a) the distribution is made to a partnership or the trustee of a trust; and

(b) the benefit is received either directly or through other interposed partnerships or trusts.

The distribution is regarded as flowing indirectly to the entity under this Subdivision.

On the basis of a notional amount of the entity's share of the distribution, the entity may be entitled to have an amount included in its assessable income and/or a tax offset under this Subdivision.

51.  As there is an amount under section 207-50 that flows through to the Estate in respect of the franked distribution it received, there is an amount in respect of the distribution that the Executor would need to include in the Estate's assessable income under either section 99 or 99A of the ITAA 1936.

[1] The note to subsection 102UX(1) in Division 6E of the ITAA 1936 about the assumptions that disregards franked distributions, states that the assumptions are only for the purpose of working out the amounts included in the assessable income mentioned in paragraphs (a),(b) and (c) of that subsection. The assumptions are not made for 'any other purposes (for example, determining the income of a trust estate, the net income of a trust estate, or the amount of a present entitlement of a beneficiary of a trust estate to the income of the trust estate)'.

[2] A guide is defined in section 950-150 and forms part of the ITAA 1997 but is kept separate from the operating provisions and is only considered in the following circumstance:

(a) in determining the purpose or object underlying the provision; or

(b) to confirm that the provision's meaning is the ordinary meaning conveyed by its text, taking into account its context in the Act and the purpose or object underlying the provision; or

(c) in determining the provision's meaning if the provision is ambiguous or obscure; or

(d) in determining the provision's meaning if the ordinary meaning conveyed by its text, taking into account its context in the Act and the purpose or object underlying the provision, leads to a result that is manifestly absurd or is unreasonable.

[3] An object is a guide to a provision under subsection 950-150(2)

[4] In this instance the Executors paid the franked distribution it received to beneficiaries using the percentages set down each record of payment .

[5] The positive amount referred to in paragraph 207-50(4)(c)

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