Edited version of your private ruling

Authorisation Number: 1012568415449

Ruling

Subject: Trusts - Amount of trust income to which no beneficiary is presently entitled

Question 1

Do the beneficiaries named in the Will have a present entitlement to the income of the Estate for the relevant years?

Answer

Yes.

Question 2

If the answer to question 1 is "yes", is the amount to be included in the assessable income of the trust under either sections 99 or 99A of the Income Tax Assessment Act 1936 (1936) calculated using the proportionate approach?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The Taxpayer is the Trustee of the Estate of the Deceased.

The Executors of the Estate are all residents of Australia for tax purposes.

The Supreme Court granted probate.

The liabilities of the Estate were discharged or adequately provided for prior to the end of the first year of income year.

The Will of the Deceased provides that the Deceased's spouse is to receive an annual income amount (CPI adjusted) during their lifetime.

The Will of the Deceased also provides that the Deceased's child is to receive an annual income amount (CPI adjusted) for a certain number of years from the date of death.

Neither the spouse nor the child is under a legal disability. Both are residents of Australia for tax purposes.

The date X years from the date of death is known as the Date of Distribution.

Up to the Date of Distribution, the Executors have the ability to appoint income and capital of the Estate to the residuary beneficiaries of the Estate.

The spouse has put forward the proposition that they have no present entitlement to any of the income of the Estate, on the basis that the amount to which they are entitled pursuant to the Will must be paid regardless of whether the income of the Estate is sufficient to fund it.

A clause of the Will is in the following terms:

I DIRECT my Trustee to ensure that at all times they retain adequate and sufficient monies in my Trust Estate to ensure payment of the income amounts provided for in paragraphs X(a) and (b) hereof AND I DECLARE that the term 'income" in this clause shall include all profits or gains (including capital gains earned from the date of my death) taken into account in calculating the net income from my Residuary Estate, and exempt income, as defined in section 95(1) of the Income Tax Assessment Act 1936, or of the Income Tax Assessment Act 1997, notwithstanding that the whole or any part thereof may otherwise constitute capital of my Trust Estate.

For the year ended 30 June 20XX, the income of the Estate was an amount of $XX. An amount of $X (which would represent X.XX% of the income of the Estate) was paid to the spouse; an amount of $X (which would represent X.XX%) was paid to the child; and the remainder was retained in the Estate.

The net income (in terms of section 95(1) of the ITAA 1936) of the Estate for the ended 30 June 20XX was an amount of $XX.

The accounts of the Estate for the year ended 30 June 20XX have not been finalised yet. However, the spouse was paid an amount as stipulated by the will; and the child was also paid an amount.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 section 99,

Income Tax Assessment Act 1936 Section 99A and

Income Tax Assessment Act 1936 Subsection 99A(4).

Reasons for decision

Question 1

Summary

The beneficiaries named in the Will have a present entitlement to the income of the estate and the trustee will only be assessable on the proportion of the estate to which no beneficiary is presently entitled.

Detailed reasoning

Under paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936), a beneficiary of a trust will be assessed on a share of the assessable income of the trust only to the extent that they are presently entitled to that share. Under subsection 99A(4) of the ITAA 1936 the trustee of a trust will be assessed on the share of trust income to which no beneficiary is presently entitled. In the present matter it is therefore necessary to examine whether any beneficiaries are presently entitled to a share of the net income of the Trust.

Present entitlement has been discuss in case law including FC of T v. Whiting (1943) 68 CLR 199; 7 ATD 179 and Taylor Trust, Trustees of v. FC of T (1970) 119 CLR 444; 70 ATC 4026.

In order for a beneficiary to be presently entitled to trust income, the following conditions must be satisfied:

(i) The beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent. This 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 legal disability);

(ii) The income must be legally available for distribution to the beneficiary. In the case of a deceased estate, the beneficiaries will not be presently entitled to income until it is possible to ascertain the residue with certainty (after provision for debts, legacies, etc)

Taxation Ruling IT 2622 provides the Commissioner's view on present entitlement during the stages of administration of deceased estates. In general, beneficiaries cannot be presently entitled to income derived by a deceased estate until after the estate has been fully administered and the residue is determined.

However, as stated in paragraph 14 of IT 2622, where during administration of a deceased estate the point is reached where it is apparent to the executor that part of the net income of the estate will not be required to pay for debts etc, the executor may pay income to the beneficiaries. In this situation, although the estate is not wound up the beneficiaries will be presently entitled to the income.

In Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16 (Colonial), the Federal Court rejected the Commissioner's submission that the test of present entitlement prescribed in Harmer v Federal Commissioner of Taxation 91 ATC 500 must be satisfied at the time relevant income is received by the trustee. The Court instead held that the test will be satisfied if an entitlement arises by the end of an income year.

Following the decision in Colonial the Commissioner issued a Decision Impact Statement in which he stated that:

"the ATO accepts that the test of present entitlement in Division 6 is not one that must be satisfied at the time income is derived by a trustee. However, for all trusts, the test is one that must be satisfied by the end of the relevant income year."

In this situation, the beneficiaries named in the Will have been paid amounts during the relevant income years from the estate as per the will. These amounts have been paid from the net income of the estate in satisfaction of their annual payment. Therefore the beneficiaries named in the Will have a present entitlement to the income of the estate and the trustee will only be assessable on the proportion of the estate to which no beneficiary is presently entitled.

Question 2

Summary

The share of trust income to be included in the assessable income under sections 99 or 99A of the ITAA 1936 is determined using the proportionate approach.

Detailed reasoning

If a share of a trust's taxable income is not assessable to any beneficiary under paragraph 97(1)(a) of the ITAA 1936, then section 99A of the ITAA 1936 will apply. Subsection 99A(4) states:

(4) Where there is no part of the net income of a resident trust estate:

(a) that is included in the assessable income of a beneficiary of the trust estate in pursuance of section 97;

(b) in respect of which the trustee of the trust estate is assessed and liable to pay tax in pursuance of section 98; or

(c) that represents income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia;

the trustee shall be assessed and is liable to pay tax on the net income of the trust estate at the rate declared by the Parliament for the purposes of this section.

Under paragraph 97(1)(a) of the ITAA 1936, a beneficiary of a trust will be assessed on a share of the assessable income of the trust only to the extent that they are presently entitled to that share. Under subsection 99A(4) of the ITAA 1936 the trustee of a trust will be assessed on the share of trust income to which no beneficiary is presently entitled.

To determine the amount of net income that no beneficiary is presently entitled, the trustee would need to subtract from the net income of the estate that share to which beneficiaries are presently entitled.

The first step is to calculate the share of net income to which beneficiaries are presently entitled (Taxation Determination TD 2012/22). Consistent with the decision in Federal Commissioner of Taxation v Bamford [2010] HCA 10, this amount is established by:

(a) calculating how much of the income of the trust estate that beneficiaries are presently entitled, or taken to be presently entitled, as a percentage of the income (howsoever the entitlement is expressed for trust purposes); and

(b) apply that percentage to the net income of the trust estate.

After subtracting this calculated amount from the net income of the estate, the result will be the share of net income of a trust estate to which no beneficiary is presently entitled and will be assessable to the trustee of the estate under sections 99 or 99A of the ITAA 1936.