Edited version of private advice

Authorisation Number: 1052174076749

Date of advice: 28 September 2023

Ruling

Subject: Trusts - deceased estates - beneficiary

Question

Is the Applicant required to include any amount of franked distributions and franking credits in their assessable income in respect of franked dividends received by the Executors of the deceased estate in the relevant years pursuant to subsection 207-35(4) in Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Years ended 30 June XX and 30 June YY

The scheme commenced on:

XXXX

Relevant facts and circumstances

1.         The legal ownership of certain shares passed to the Executors of the deceased's Estate.

2.         Under the terms of the deceased's Will, the Applicant was left a gift of a sum of money.

3.         The terms of the Will provided that the gift to be paid to the Applicant was to be satisfied from certain receipts of the Executors. Those receipts were comprised of franked dividends that the Executors had received in respect of the shares that had passed to the Estate.

4.         The Applicant had an equitable chose in action to compel the Executors to correctly administer the Estate. However, the Applicant did not have a legal or equitable interest (either vested in interest or possession) in the shares or in the income of the Estate derived from the shares.

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

Reasons for decision

Question 1

Is the Applicant required to include any amount of franked distributions and franking credits in their assessable income in respect of franked dividends received by the Executors in the relevant years pursuant to subsection 207-35(4) in Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

No, the Applicant is not required to include any amount of franked distributions and franking credits in their assessable income under subsection 207-35(4) in Subdivision 207-B of the ITAA 1997 in respect of franked dividends received by the Executors as they were not presently entitled to any income of the Estate.

Detailed reasoning

Key concepts from Division 6

1.         Paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that where a beneficiary of a trust estate (not under a legal disability) is presently entitled to a share of the income of a trust estate, the assessable income of the beneficiary will include the beneficiary's share of the trust's net income calculated under section 95 of the ITAA 1936.

2.         The term 'beneficiary' includes any person for whose benefit the trust estate is to be administered and who is entitled to enforce the trustee's obligation to administer the trust according to its terms; Kafataris v Deputy Commissioner of Taxation [2008] FCA 1454 (Kafataris) per Lindgren at [42]; followed by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16 at [20] with application to section 97 of the ITAA 1936.

3.         In Kafataris Lindgren J said at [43]:

The word "beneficiary" reaches beyond a person who has a beneficial interest in the trust property. It is possible for the legal estate in land to be vested in "trustees" without equitable ownership being vested in someone else. The trustees must, however, owe fiduciary obligations in respect of the trust property to persons who, although they may have no interest in the trust property and may never have an interest in the trust property, are called "beneficiaries". In CPT Custodian Pty Ltd v Commissioner of State Revenue of the State of Victoria 2005 ATC 4925; (2005) 224 CLR 98, the High Court rejected (at [25]):

"a "dogma" that, where ownership is vested in a trustee, equitable ownership must necessarily be vested in someone else because it is an essential attribute of a trust that it confers upon individuals a complex of beneficial legal relations which may be called ownership."

That is to say, there can be a trustee who owes fiduciary obligations in respect of trust property to "beneficiaries" without any of the latter having a beneficial interest in the property.

4.         Relevantly, the term 'trustee' is defined in subsection 6(1) of the ITAA 1936 and includes an executor or administrator.

5.         The expression 'trust estate' is not defined for the purposes of Division 6, although it is generally taken to mean the estate (property) which is vested in a trustee, that is, the trust property.[1]

6.         In FCT v Australian Building Systems Pty Ltd (In Liq) [2015] HCA 48, Gordon J explained at [160] - [161]:

First, while the definition of " trustee " in s 6(1) of the 1936 Act goes beyond trusts of a settlement or testamentary trusts [159], the definition is stated to apply " unless the contrary intention appears ". Not every person or entity which answers the statutory definition of " trustee " in s 6(1) will be a trustee for the purposes of Div 6 of Pt III [160].

As Rich and Dixon JJ stated in Howey v Federal Commissioner of Taxation [161], the references to " income of the trust estate " in s 31 of the 1922 Act (the predecessor to Div 6 of Pt III) suggested that the person who answers the description " trustee " in that context " must stand in some relation to the proprietary right [by] which the income arises, even although [that person] need not be a trustee in the proper sense".

7.         Although an executor of the estate of a deceased person in that capacity is not a trustee under general law, as a person in whom legal ownership of the assets of the estate is vested and having duties to perform with respect to those assets for the benefit of those interested under the terms of the will of the deceased, an executor is a trustee for the purposes of Division 6.

Meaning of the term 'income of the trust estate':

8.         As section 97 of the ITAA 1936 requires the beneficiary to be presently entitled to income of a trust estate, it is necessary to establish the meaning of the terms 'presently entitled' and 'income of the trust estate'.

9.         The term 'income of the trust estate', as provided in subsection 97(1) of the ITAA 1936, is not defined in the ITAA 1936. However, it has been judicially considered by the High Court in Commissioner of Taxation v Phillip Bamford & Ors; Phillip Bamford & Anor v Commissioner of Taxation [2010] HCA 10;240 CLR 481 (Bamford). Consistent with the decision in Zeta Force Pty Ltd v Commissioner of Taxation, the Court held in Bamford that:

The words 'income of a trust estate' in the opening part of subsection 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument ... The beneficiary's 'share' is his share of the distributable income.

10.      The Bamford decision highlights that the income of a trust estate for trust law and tax law purposes are distinct and do not necessarily equate and as such, the term 'income of a trust estate' pursuant to section 97 of the ITAA 1936 takes on a meaning from trust law principles rather than tax law principles.

'Income of the trust estate' and interaction with Subdivision 207-B:

11.      Draft Taxation Ruling TR 2012/D1 Income tax: meaning of 'income of the trust estate' (TR 2012/D1) summarises the way in which income of a trust estate is taxed when it includes franked dividends or capital gains:

... Division 6 [of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)] contains rules for assessing the net income of a trust calculated under section 95 (referred to in this ruling as the trust's 'net income').

2. Prior to the 2010-11 income year, a resident beneficiary of a trust estate who was presently entitled to a share of the income of the trust estate and not under a legal disability was assessed under section 97 on that same proportionate share of the entire net income of the trust estate. Section 98 operated in a similar manner to assess the trustee on behalf of certain beneficiaries who were presently entitled to income of the trust estate but were under a legal disability or were non-residents at the end of the income year; and certain beneficiaries who were deemed by subsection 95A(2) to be presently entitled to income of the trust estate. If there was some net income not assessed to or in respect of any beneficiary, then the trustee was generally assessed on that net income under section 99 or section 99A.

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. [footnotes omitted]

12.      TR 2012/D1 explains at paragraph 86, that 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.

Meaning of the term 'presently entitled':

13.      Whether a beneficiary is 'presently entitled' to income of a trust estate is a central concept in determining where the liability to tax falls under Division 6.

14.      The principles for determining whether a beneficiary is 'presently entitled' to income of a trust estate are outlined by the High Court in Harmer v. Federal Commissioner of Taxation [1991] HCA 51 (Harmer) at [8], namely 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.

15.      Whether a beneficiary is 'presently entitled' to income of a trust estate for the purposes of subsection 97(1) is to be determined by reference to the general law of trusts, including the terms of the particular trust in question: Commissioner of Taxation v Bamford [2010] HCA 10 (Bamford) at [36]-[39]; Colonial First State at [26]-[27], [37]-[38]; FC of T v Moignard [2015] FCA 143 at [39].

16.      Taxation Ruling IT 2622 Income tax: present entitlement during the stages of administration of deceased estates at paragraph 7, states the Commissioner's view that:

In a deceased estate, whether a beneficiary is presently entitled to a share of the income of a trust estate for the purposes of Division 6 of Part III of the Act depends on:

(a) The stage reached in the administration of the deceased estate.

(b) The terms of the deceased's will or codicil, trust law and principles enunciated and orders made by the Courts.

(c) Whether any discretionary payments have been made to the beneficiary by the executor or trustee.

17.      A leading case on present entitlement is the decision of the High Court in FC of T v Whiting (1943) 68 CLR 199 (Whiting's Case). The High Court held that a residuary beneficiary of a deceased estate cannot be presently entitled to the income of the trust estate until the estate has been fully administered. The High Court explained how 'presently entitled' in Division 6 should be construed in the context of a deceased estate:

With great respect, it appears to us that these provisions must be construed in the light of the general principles of law applicable to the administration of estates by executors and trustees at law and in equity. The crucial question is at what moment of time, having regard to these general principles and to the provisions of the trust instrument, can it be said that a beneficiary has become presently entitled to a share in the income of a trust estate. A beneficiary under a will may become entitled to a share of such income as an annuitant, legatee, or a residuary beneficiary. His right to share in such income would be determined by the trusts in the will, these trusts being administered in accordance with such rules of equitable administration (where applicable) as those laid down in such cases as Allhusen v Whittell (above), and Howe v Lord Dartmouth, (1802) 7 Ves. 137, 32 ER 56. (emphasis added)

Application of the key concepts of Division 6

18.      In applying the principles discussed above, the Executors of the Estate are trustees of a trust estate for the purposes of Division 6. They have legal ownership of assets of the Estate and duties to perform with respect to those assets for the benefit of those interested under the terms of the Will. In carrying out those functions they are required to comply with the terms of the Will.

19.      The Applicant had an equitable chose in action to compel the Executors to correctly administer the Estate. As an entity interested in the Estate and entitled to enforce the Executors to administer the Estate in accordance with the terms of the Will, the Applicant can be described as a beneficiary of the Estate for the purposes of Division 6.

20.      As per Whiting, whether a beneficiary under a will is presently entitled to income of the estate must be determined be examining the rights under the trusts in the will to determine if the beneficiary has a vested and indefeasible right to income and a present legal right to demand and receive payment of that income.

21.      The Applicant was entitled to a gift of a lump sum under the Will. The Applicant did not acquire any legal or equitable interest under the terms of the Will in the shares or in the income derived from the shares.

22.      Accordingly, as the Applicant did not have a vested interest in the receipts, she was not presently entitled to any income of the Executors comprising the receipts for the purposes of Division 6.

Taxation of franked dividends

23.      As explained above, Division 6E modifies the operation of Division 6 by excluding amounts relevant to capital gains, franked distributions and franking credits from the calculations of assessable amounts under sections 97, 98, 99, 99A and 100.

24.      Subdivision 207-B of the ITAA 1997 provides for the taxation treatment for franked distributions and franking credits.

25.      Subdivision 207-B of the ITAA 1997 has the effect that an amount corresponding to franked distributions is taxed in the hands of the beneficiaries of the trust and, if necessary, the trustee. It also has the effect that the entity in whose hands those distributions are taxed can take advantage of the relevant amount of related franking credits.

26.      Paragraphs 74 to 76 of Taxation Determination TD 2012/22 Income tax: for the purposes of paragraph 97(1)(a) of the Income Tax Assessment Act 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? summarises how a franked distribution is allocated under Subdivision 207-B:

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.

Subdivision 207-B franked distributions

27.      Section 207-25 of the ITAA 1997, 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.

28.      Subsection 207-35(1) provides that where a franked distribution is made to a partnership or a trustee of a trust (but not a corporate tax entity or a complying superannuation entity) in an income year, the assessable income of the partnership or trust for that income year includes the franking credit on the franked distribution. The amount is in addition to any other amount included in their assessable income in relation to the distribution under any other provision of this Act: subsection 207-35(2).

29.      When a franked distribution flows indirectly to a beneficiary of a trust, the beneficiary's share of the franked distribution and the franking credit is included in the beneficiary's assessable income by virtue of subsections 207-35(3) and (4).

30.      Subsection 207-35(3) provides:

Subsection (4) applies if:

(a) a *franked distribution is made, or *flows indirectly, to a partnership or the trustee of a trust in an income year; and

(b) the assessable income of the partnership or trust for that year includes an amount (the franking credit amount ) that is all or a part of the additional amount of assessable income included under subsection (1) in relation to the distribution; and

(c) the distribution flows indirectly to an entity that is a partner in the partnership, or a beneficiary or the trustee of the trust; and

(d) disregarding Division 6E of Part III of the Income Tax Assessment Act 1936, the entity has an amount of assessable income for that year that is attributable to all or a part of the distribution.

31.      Pursuant to paragraph 207-35(3)(d), for subsection (4) to apply the entity must have an amount included in assessable income, disregarding Division 6E. That is, a beneficiary, must have been required to include an amount in their assessable income under Division 6, disregarding the operation of Division 6E.

32.      Subsection 207-35(4) relevantly provides:

Despite any provisions in Divisions 5 and 6 of Part III of the Income Tax Assessment Act 1936, the entity's assessable income for that year also includes:

...

(b) in the case of an entity that is a beneficiary of a trust:

(i) so much of the franking credit amount as is equal to the entity's share of the franking credit on the distribution; and

(ii) the amount mentioned in section 207-37.

Example:

A franked distribution of $70 is made to the trustee of a trust in an income year. The trust also has $100 of assessable income from other sources. Under subsection (1), the trust's assessable income includes an additional amount of $30 (which is the franking credit on the distribution). The trust has a net income of $200 for that income year.

There are 2 beneficiaries of the trust, P and Q, who are presently entitled to the trust's income. Under the trust deed, P is entitled to all of the franked distribution and Q is entitled to all other income.

The distribution flows indirectly to P (as P has a share of the trust's net income that is covered by paragraph 97(1)(a) and has a share of the distribution under section 207-55 equal to 100% of the distribution).

Under this subsection, P's assessable income includes $70 (the amount mentioned in section 207-37 (attributable franked distribution)) and also includes the full amount of the franking credit (as P's share of the franking credit on the distribution is $30 under section 207-57). Q's assessable income does not include any of the amount of the franked distribution or the franking credit.

33.      When a franked distribution flows indirectly to a trustee of a trust, the trustee's share of the franked distribution and the franking credit is included in the trustee's assessable amount and the trustee is liable to pay tax by virtue of subsections 207-35(5) and (6).

34.      The Explanatory Memorandum to the Tax Laws Amendment (2011 Measure No. 5) Bill 2011 (the EM) explains the effects of the introduced subsections 207-35(3) to (6):

2.142...The effect of these amendments when read together with Division 6E is that:

•         subsections 207-35(3) and (4) deal with the treatment of franking credits and franked distributions for the beneficiary of a trust; and

•         subsections 207-35(5) and (6) deal separately with the treatment of franking credits and franked distributions for the trustee of a trust that, disregarding Division 6E, would be assessed and liable to tax under section 98, 99 or 99A.

2.143 In order to ensure the effective operation of section 207-35, the requirements in paragraphs 207-35(3)(d) and (5)(c) apply disregarding the operation of Division 6E. This is necessary to ensure that relevant entities have an amount of assessable income for the purposes of section 207-35. [Schedule 2, item 18, paragraphs 207-35(3)(d) and 207-35(5)(c)]

35.      Section 207-37(1) provides for the attributable franked distribution in the case where the net income of the trust estate (disregarding franking credits) is a positive amount after removing net capital gains and franked distributions. It provides as follows:

The amount is the product of:

(a) the amount of the *franked distribution (to the extent that an amount of the franked distribution remained after reducing it by deductions that were directly relevant to it); and

(b) the beneficiary's or the trustee's (as the case requires) *share of the franked distribution (see section 207-55), divided by the amount of the franked distribution.

36.      Subsection 207-50 sets out the only circumstances in which a franked distribution flows indirectly to an entity or through an entity.

37.      Relevantly, subsection 207-50(3) provides for when a franked distribution flows indirectly to a beneficiary of a trust:

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).

38.      Therefore, a franked distribution received by a trustee of a trust estate will only flow indirectly to a beneficiary that is presently entitled to income of the trust estate resulting in the beneficiary having a share of the trust's net income under paragraph 97(1)(a) of the ITAA 1936 or section 98A (applicable to non-resident beneficiaries that are presently entitled to income) and section 100 (applicable to presently entitled beneficiaries that have a legal disability or otherwise have a vested and indefeasible interest). That is, a beneficiary can only be liable for tax on franked distributions, if the beneficiary is presently entitled to income of the trust estate.[2]

39.      A beneficiary's or trustee's share of a distribution is worked out under subsections 207-55(1) and (2), which states:

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.

40.      The amount that is to be allocated 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.

41.      In respect of a trust that received the franked distribution, the relevant item in the table in subsection 207-55(3) is item 3:

Table 1: Relevant item in the table in subsection 207-55(3) is item 3

42.      Item 3 and subsection 207-55(4) together have the effect that where a trust receives a franked distribution and the distribution flows indirectly through the trust to a beneficiary, the beneficiary's share of the franked distribution is calculated under subsection 207-55(4) as the sum of:

•       the amount of the franked distribution to which the beneficiary is specifically entitled (as set out in section 207-58); and

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

43.      If a franked distribution does not flow indirectly to a beneficiary so that they have a share amount under subsection 207-50(3), item 3 of the table in subsection 207-55(3) will not apply to that beneficiary. Therefore, the beneficiary is not required to work out a share of the franked distribution and there is no requirement to consider specific entitlement for that beneficiary under subsection 207-55(4).

Application to your circumstances

44.      The Applicant had an entitlement to a gift of a lump sum but did not have an entitlement to the income of the Estate and in particular the receipts.

45.      The gift was not a distribution of income from a trust estate. The character of the gift in the hands of the Applicant is of a capital lump sum.

46.      That the Applicant's gift was to be paid from a fund that comprised receipts of franked dividends does not make the Applicant presently entitled to the income comprising those receipts.

47.      As the Applicant did not have a vested and indefeasible interest in any income of the Estate, including the receipts which comprised of franked distributions, they were not presently entitled to income of the Estate and would not be required to include an amount in their assessable income under paragraph 97(1)(a) of the ITAA 1936.

48.      Therefore, the Applicant did not satisfy paragraph 207-50(3)(b) and a franked distribution did not flow indirectly to the Applicant as a beneficiary of the Estate.

49.      As a franked distribution did not flow indirectly to the Applicant, and they did not have a share amount under subsection 207-50(3), item 3 of the table in subsection 207-55(3) does not apply to the Applicant. Therefore, they were not required to work out a share of the franked distribution and there is no requirement to consider specific entitlement under subsection 207-55(4).

50.      As a franked distribution did not flow indirectly to the Applicant as a beneficiary of the Estate, the Applicant did not satisfy paragraph 207-35(3)(c).

51.      Further, the Applicant did not have an amount of assessable income that is attributable to all or a part of the distribution, disregarding the operation of Division 6E, as they were not presently entitled to any income of the Estate. Therefore, the Applicant did not satisfy paragraph 207-35(3)(d).

52.      Therefore, subsection 207-35(4) does not apply to the Applicant and their assessable income does not include any attributable franked distribution or any franking credits in respect of franked dividends received by the Executors.

[1] Paragraphs 83 of Draft Taxation Ruling TR 2012/D1 Income tax: meaning of 'income of the trust estate',

[2] The note to subsection 102UX(1) in Division 6E of the ITAA 1936 states that the disregarding of franked distributions is only made for the purpose of working out the amounts included in the assessable income of a beneficiary under section 97. They 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).