Edited version of your written advice

Authorisation Number: 1013125137003

Date of advice: 1 December 2016

Ruling

Subject: Income tax - trusts - trust income - present entitlement and taxed at special rates - section 99A

Question 1

Were the charitable institutions presently entitled to all of the income (including the capital gains) of the trust for the income year ended 30 June 20YY?

Answer

Yes.

Question 2

Will the trustees of the Trust be assessed to tax under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of any of the income (including capital gains) of the Trust for the income year ended 30 June 20YY?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20YY.

The scheme commences on:

1 July 20XX.

Relevant facts and circumstances

The Settlement Trust was established by Trust Deed.

A Memorandum was made by Trustee 1 providing for the winding up of the Trust after their death and for the distribution of capital and income in equal shares to various charitable institutions.

Trustee 2 and Trustee 3 (the Trustees) are the Trustees of the Trust. Prior to their death, Trustee 1 was also a trustee of the Trust with the Trustees.

In letters to each of the charitable institutions they were notified by the Trustees that they were to be beneficiaries of the Settlement Trust as per the Memorandum made by Trustee 1 prior to their death.

The Settlement Trust entered into a contract of sale for the disposal of a property and received cash proceeds. The disposal of the property resulted in a net capital gain for the Settlement Trust after applying the 50% CGT discount.

During the year ended 30 June 20YY, the Settlement Trust also disposed of a share portfolio (all shares were sold prior to March 20YY) and realised cash proceeds. The disposal of the share portfolio resulted in a further net capital gain for the Settlement Trust after utilising carry forward capital losses and applying the 50% CGT discount.

Accordingly, the sale of the property and share portfolio realised net capital gains for the Settlement Trust for the income year ended 30 June 20YY.

The trustees of the Settlement Trust executed a Notice of Appointment in March 20YY to:

1. Vest the Settlement Trust;

2. Determine that the capital of the Settlement Trust be vested in the charitable institutions in equal proportions; and

3. Determine that the net income of the Settlement Trust for the income year from 1 July 20XX to the vesting day be distributed to the charitable institutions in equal proportions.

The various charitable institutions were sent a further letter regarding the progress of the winding up of the Settlement Trust.

Net income of the Settlement Trust as referred to in the Trust Deed is not defined anywhere in the Trust Deed.

For the income year ended 30 June 20YY, the Settlement Trust had taxable income.

The tax return of the Settlement Trust for the year ended 30 June 20YY was lodged on the basis that the charitable institutions were presently entitled to the income of the Settlement Trust in equal proportions in accordance with the Notice of Appointment.

The Settlement Trust paid some of the monies to the charitable institutions in equal proportions. No further payments have been made since this payment.

Relevant legislative provisions

Income Tax Assessment Act 1936

Division 6

Division 6E

Subsection 95(1)

Section 97

Subsection 97(1)

Subsection 95A(2)

Section 99A

Section 100AA

and

Income Tax Assessment Act 1997

Section 50-1

Section 50-5

Subdivision 115-C

Subdivision 207-B.

Reasons for decision

Question 1

Summary

The charitable institutions were presently entitled to all of the income (including the capital gains) of the Settlement Trust for the income year ended 30 June 20YY.

Detailed reasoning

Under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936), a beneficiary who is presently entitled to a share of the 'income of the trust estate' is assessed on 'that share' of the trust's notional taxable income worked out under section 95 of the ITAA 1936. That notional taxable income is referred to as the 'net income' of the trust estate.

In considering the meanings to be given to 'income of the trust estate' and 'share', the High Court clarified in Commissioner of Taxation v Bamford and Ors; Bamford and Anor v Commissioner of Taxation [2010] HCA 10; 240 CLR 481 (Bamford) that:

● 'income of the trust estate' in section 97 of the ITAA 1936 refers to the distributable income of the trust as determined according to trust law and in accordance with the deed; and

● 'share' means 'proportion' such that once the share of the distributable income of the trust to which the beneficiary is presently entitled is determined, the beneficiary is assessed on that same percentage share of the trust's net income as defined in section 95 of the ITAA 1936.

The High Court also found that a trustee resolution, made under a power in the trust instrument, to treat a capital receipt as income was effective to treat the capital receipt as income of the trust estate for the purposes of section 97 of the ITAA 1936.

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 the trust estate worked out by reference to the proportion of the income of the trust estate to which the beneficiary is presently entitled? (TD 2012/22) provides the ATO's view on the application of the 'proportionate approach' to the assessment of trust net income.

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.

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 of Part III of the ITAA 1936 (Division 6), but modified by Division 6E of Part III of the ITAA 1936 (Division 6E).

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.

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 (TR 2012/D1) provides the ATO's view on many of the issues raised by the Bamford case.

Paragraphs 12 and 13 of TR 2012/D1 provide the following in relation to the amount beneficiary can be made presently entitled to:

12. In the context of Division 6, the 'income of the trust estate', is not a reference to the gross income of a trust estate, but rather a reference to the net amount of income to which a beneficiary could be made presently entitled or accumulated. That is, it is a reference to the income available for distribution to beneficiaries or accumulation by the trustee, commonly referred to as 'distributable income'.

13. Notwithstanding how a particular trust deed may define income, the 'income of the trust estate' for Division 6 purposes must therefore be represented by a net accretion to the trust estate for the relevant period. In effect, the statutory context places a cap on what the income the trust estate may be for Division 6 purposes. Specifically, for these purposes, the income of a trust estate for an income year cannot be more than the sum of:

● the accretions to the trust estate (whether accretions of property, including cash, or value) for that year;

● less any accretions to the trust estate for that year which have not been allocated, pursuant to the general law of trusts (as that may be affected by the particular trust instrument), to income [and therefore cannot be distributed as income]; and

● less any depletions to the trust estate (whether depletions of property, including cash, or value) for that year which, pursuant to the general law of trusts (as that may be affected by the particular trust instrument), have been allocated as being chargeable against income.

Regarding specific distributions to exempt entities (charities), trustees 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 of the ITAA 1936 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) of the ITAA 1936, 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.

Prior to their death, Trustee 1 executed a Memorandum directing that the Settlement Trust be wound up as soon as practicable after their death and that the beneficiaries of the Trust should be the same charitable institutions as provided for in their will.

The charitable institutions were first notified about their beneficiary status by letter.

Pursuant to the Trust Deed, the Trustees of the Settlement Trust executed a Notice of Appointment March 20YY to determine that the net income of the Settlement Trust be distributed to the charitable institutions in equal proportions for that income year.

Net income of the trust estate is not defined in the trust deed and so its distributable income should be calculated having regard to the rules and presumptions in general tax law.

In the same Notice of Appointment it was also determined by the Trustees that the capital of the trust be vested in the same charitable institutions in equal proportions.

Further correspondence was sent to each of the charitable institutions advising them that there would be a distribution made in the year ended 30 June 20YY.

After the end of the financial year but not within two months, another letter was sent to each of the charities along with a cheque for their share of the distribution.

Whilst the actual payment of the distribution didn't occur within two months of the end of the financial year as required by section 100AA of the ITAA 1936, notification of the pending proportional distribution had been made to each of the charitable institutions before the end of the financial year thus satisfying section 100AA of the ITAA 1936.

Therefore the charitable institutions were presently entitled to all of the income (including the capital gains) of the trust for the income year ended 30 June 20YY.

Question 2

Summary

The Trustees of the Trust will not be assessed to tax under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of any of the income (including capital gains) of the Trust for the income year ended 30 June 20YY.

Detailed reasoning

Under section 99A of the ITAA 1936, the trustee of a trust is assessed on that part of the net income of the trust estate that is not included in the assessable income of a beneficiary in pursuance of section 97 of the ITAA 1937.

Section 97 of the ITAA 1936 provides that a resident beneficiary shall include in their assessable income all the income of a trust estate to which they are presently entitled.

If an exempt entity is covered by section 50-5 of the Income Tax Assessment Act 1997 (ITAA 1997), section 50-1 of the ITAA 1997 applies to exempt the ordinary and statutory income (that is, assessable income) of that entity from income tax.

As all of the trust income is first included in assessable income of the beneficiaries under section 97 of the ITAA 1936, before becoming exempt income by virtue of section 50-1 of the ITAA 1997, there is no part of the income of the trust estate to which section 99A of the ITAA 1936 will apply.