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Ruling

Subject: Withholding obligations on trust distributing net income to exempt entity

Question 1

Does the trustee have to withhold income tax when distributing net income to an income tax exempt entity?

Answer

No

Question 2

What are the ATO's requirements for documentation regarding such distributions?

Answer

The trustee must notify the exempt entity in writing of its entitlement to a distribution from the trust within two months of the end of the income year.

Failure to do so may result in the trustee being assessed on the distribution amount at the highest marginal rate under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936).

This ruling applies for the following periods:

Income Year ending 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The trust is a discretionary family trust with a corporate trustee.

The trustee has inquired if the trust can distribute to specific religious organisations.

A copy of the trust deed has been provided.

Relevant legislative provisions

Income Tax Assessment Act 1936, section 99A

Income Tax Assessment Act 1936, section 100AA

Income Tax Assessment Act 1936, section 100AB

Section 12-175 of Schedule 1 to the Taxation Administration Act 1953

Section 12-180 of Schedule 1 to the Taxation Administration Act 1953

Reasons for decision

Question 1

It has been assumed that the proposed beneficiaries are "exempt entities" as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The related issue is whether the proposed beneficiaries are charities for the purpose of trust and tax law. These questions can not be confirmed for this ruling. Subsection 11-5 of the ITAA 1997 includes as "exempt entities" religious institutions, as considered in Item 1.2 of the table in section 50-5 of the ITAA 1997. To be exempt a religious institution must meet the conditions in section 50-50 of the ITAA 1997.

It must be noted that the resolution to distribute must be made by the end of the income year. The Commissioner's previous practice of allowing a period of two months after the end of the income year for the resolution to be made has been negated by the decision in Colonial First State Investments v. Federal Commissioner of Taxation [2011] FCA 16; 2011 ATC 20-235. As a consequence of that decision Income Tax Ruling IT 329 Income tax: discretionary trusts: section 101 - resolution of trustee was withdrawn effective 1 September 2011.

Pay-as-you-go withholding

The Pay-as-you-go withholding (PAYGW) provisions are set out within Chapter 2 of Schedule 1 of the Taxation Administration Act 1953 (TAA). For a payment such as a distribution of trust income to a beneficiary the PAYGW system might apply.

For example, section 12-175 of Schedule 1 to the TAA applies where a trustee distributes income of a closely held trust to a beneficiary. The provision sets various conditions that would require withholding from the distribution made.

However, paragraph 12-175(1)(d)(ii) requires that the beneficiary is not an "exempt entity"; meaning that withholding will not apply if the beneficiary is an exempt entity as defined above.

Similarly, section 12-180 of Schedule 1 to the TAA, concerning withholding requirements on a trustee where a beneficiary becomes presently entitled to income of a closely held trust, will not apply if the beneficiary is an exempt entity.

There is no other provision in Schedule 1 of the TAA that concerns withholding in respect of distributions of net trust income to an exempt entity.

Consequently, withholding under Division 12 of Schedule 1 to the TAA would not be required in respect of a distribution of net trust income to an exempt entity such as a religious institution.

Question 2

The trustee must retain a copy of the trustee resolution detailing the distribution of net income to beneficiaries. The trustee must also lodge income tax returns and keep all necessary taxation records regarding income and expenses, and how trust net income under section 95 of the ITAA 1936 has been calculated.

Trustees must pay particular attention to the ramifications of the decision in Commissioner of Taxation v. P & D Bamford Enterprises Pty Ltd; Philip and Davina Bamford v. Commissioner of Taxation [2010] HCA 10 (Bamford case) regarding the correct calculation of net income of the trust.

The release of 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 provides the ATO's view on many of the issues raised by the Bamford case.

Regarding specific distributions to exempt entities (charities), the trustee must be aware of provisions introduced by the Tax Laws Amendment (2011 Measures No. 5) Act 2011, which implemented changes that enable the streaming of franked dividends and capital gains for tax purposes, as well as introduced targeted anti-avoidance rules. These changes apply for the 2010-11 and later income years.

The anti-avoidance rules are contained in sections 100AA and 100AB of the ITAA 1936.

Section 100AA essentially requires a trustee who distributes net trust income to an exempt entity to notify that entity in writing of the entitlement within two months of the end of the relevant income year (subsection 100AA(1) of the ITAA 1936).

For that purpose notice in writing includes paying the exempt entity the distribution amount. Written notice may take the form of a statement, providing it sets out an amount that is quantifiable, such as a percentage of the income of the trust to which there is present entitlement.

Failure to give the required notice may invoke subsection 100AA(3), which sets out the consequences of not doing so as follows:

For the purposes of this Act, treat the exempt entity as not being presently entitled, and having never been presently entitled, to the amount mentioned in paragraph (1)(a) of the income of the trust estate, to the extent that the trustee failed to notify the exempt entity of that amount as mentioned in paragraph (1)(c).

The result will be the assessment to the trustee under section 99A of the ITAA 1936 on the whole amount of the distribution.

Section 100AB of the ITAA 1936 applies where an exempt entity's adjusted share of the income of the trust estate exceeds a prescribed benchmark percentage. Where that occurs, the exempt entity is treated as not being presently entitled to the "excess".

The excess is assessed to the trustee under section 99A of the ITAA 1936.

It is noted that the trustee makes, in each income year, a determination of the net income of the trust fund. The relevant Clause allows the trustee to 'pay apply or set aside' all or part of the net income for any one or more of the General Beneficiaries.

"Setting aside" of a distribution to a beneficiary is often carried out by setting the income aside in a separate account in the books of the Trust, in the name of the beneficiary, and such monies may constitute a loan at call. Effectively this becomes a case of unpaid present entitlements.

The interaction between this Clause and section 100AA of the ITAA 1936 has not been considered in this ruling. The trustee will need to be aware of the new legislation to avoid any perception of net trust income being diverted to an entity for the purposes of tax avoidance, with the recipient entity being unaware of its entitlement.