This presentation provides an overview of the legal basics of trusts and the practical implications of recent court decisions in related to taxation trusts including Bamford v Commissioner of Taxation, Harris, Clark, Colonial First State and Hopkins.

1. Matthew Burgess
Partner
May 2013
What you must know post Bamford
Working with trusts

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Overview
■ Trusts
■ Bamford
■ Practical issues
■ Case studies

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Forms of trust
■ Fixed
■ Unit
■ Discretionary (family)
■ Hybrid
■ Resulting, constructive etc
■ Bare
■ Lineal descendant
■ Section 102 trusts

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Legal basics
■ A legal relationship where
□ Legal owner of property – trustee
□ Holds property – trust property
□ For the benefit of others – beneficiaries (beneficial
ownership)
□ On certain terms/rules – trust deed

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
Settlor
Settlement Sum
Beneficiaries
Example
Trust
Trustee Pty Ltd

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Bamford background
■ Income Tax Assessment Act 1936 differentiates between
□ ‘income of the trust estate’
– (trust law income, section 97 income)
□ ‘net income of the trust estate’
– (tax law income, section 95 income)
■ Beneficiaries who are presently entitled to a share of the income of
the trust estate assessed on that share of the net income of the
trust estate

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Bamford v Commissioner of Taxation
Bamford Trust
P & D Bamford Enterprises Pty Ltd
Mr B
Church of Scientology
Child 1 Child 1
Mrs B

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Bamford v Commissioner of Taxation
Facts
■ No definition of ‘income’ or ‘net income’
■ But - trustee could:
□ exercise a power of appointment in favour of beneficiaries in relation to the
‘income’ (distribute income)
□ determine whether any receipt or payment was on income or capital account

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Bamford v Commissioner of Taxation
2000 income year
Technical question
■ What does the phrase ‘that share of the net income’ in section 97 mean?
■ Commissioner: that proportion
■ Taxpayer: if expressed as a dollar amount, that amount; if expressed as a
balance, the balance

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Bamford v Commissioner of Taxation
2000 income year
Answer
■ Following Zeta Force, the proportionate approach must apply
■ Calculate the proportion the beneficiary’s entitlement to the trust income
bears to the total trust income
■ The beneficiary is assessed on that proportion of the net income

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Bamford v Commissioner of Taxation
2002 income year
Technical question
■ Are Mr and Mrs B presently entitled to a share of the income of the trust
estate?
□ Does the capital gain form part of the income of the trust estate?
■ Commissioner: No – only ordinary income
■ Taxpayers: Yes – because trustee resolved to deal with capital gain as
income

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Bamford v Commissioner of Taxation
2002 income year
Answer
■ The ‘income of the trust estate’ can be determined in accordance with the
trust deed
■ Where the trust deed gives the trustee the power to include capital gains in
distributable income and the trustee exercises this power, the capital gain
will form part of the income of the trust estate for section 97 purposes

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Action required on deeds
■ Review deeds for correct and effective power
■ Deeds might not do what they purport to
□ how is ‘income’ defined under the deed
□ how does the re-characterisation work – for income and expenses
□ is there a power of attribution of income
■ Ensure trustee actually exercises power of
re-characterisation if required
■ Use appropriate minutes/resolutions

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Comments
■ Best practice discretionary trusts require
□ income or capital to be identified
□ the trustee can make a determination that
– a capital gain forms part of the income component
– all deductible expenses are to be offset against such part of the income
component not comprised of capital gains
■ Still need to consider other differences
□ franking credits
□ losses

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Recommended approach
■ Review deeds
□ some will need amendment
□ all will need to have relevant powers clearly identified
■ Trust resolutions to
□ firstly
– expressly exercise relevant powers defining ‘income of the trust
estate’/trust income
□ secondly
– distribute trust income
■ Tax estimates and trust accounting consistent with ‘real’ trust
income and distributions

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Taxation of trust income – where are we now
■ Interim legislation received assent on 29 June 2011 for streaming
capital gain and dividends/franking credits
■ TR2012/D1
■ Full review underway
□ Policy Design Paper due in May 2012
□ draft legislation in July and Oct 2012
□ July 2013 commencement (?)

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Dealing with the 2012 year
1 Division 6E –
streaming rules
2 Bamford decision
and DIS
3 Colonial decision
and DIS
4 ATO position in
TR 2012/D1
In light of the
Deed

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Streaming with Division 6E
Limited to dividends
& capital gains
Can stream where
trust deed
allows it
beneficiaries become
specifically entitled
‘recorded’ by 30 June
(dividends) and 31
August (capital gains)

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Streaming with Division 6E
■ Process
□ determine trust income and capital gains
(per trust deed)
□ create specific entitlements to the
‘economic’ amount capital gains and
franked dividends
□ issues with ‘section 95’ clauses to be
managed

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A sign of things to come
‘From the 2011–12 income year, trustees who make
beneficiaries entitled to trust income by way of
resolution must do so by the end of an income
year (June 30) for that to be effective for determining
who is to be assessed on the trust's income’
Rulings IT 328 and IT 329 have been withdrawn
with effect from September 2011
If a trustee makes a resolution after the end of an
income year there is a risk that the trustee may
be assessed on the trust income at the highest
marginal tax rate’
‘This campaign will be followed up with some
limited compliance activities to determine whether
your clients who are trustees have resolved to
distribute trust income by 30 June’
NTLG trust sub-committee
meeting on 21 February
2012 and Tax Agent Bulletin

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Australian Tax Office Release – 4 May 2012
Resolution
must be
made by 30
June
No
standard
format
Resolution
need not be in
writing -
franked
dividends and
capital gains

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Timing
What can be done?
analysis of
categories of
client
standard letters
with schedules
pre 30 June
informal
resolutions – later
document
‘formally’ on
behalf of trustee
resolutions –
reflect formula or
% determination
Australian Tax Office’s expectation is clear

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Distributions and resolutions
■ More important than ever to read the deed before 30 June to determine
parameters on
□ What
□ When
□ How
■ No ‘magic’ pro forma resolution
■ But standard structure is possible

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ATO Release – 4 May 2012
■ If a resolution is made before 30 June and formalised after, will the
formal resolution be accepted as evidence?
 An individual trustee documents by way of a note, dated 29 June, that they have
resolved to distribute the trust income in a certain way This note is later typed as
an official minute, which refers to the resolution of 29 June
 The trustees of a larger trust group may map out where distributions are to be
made to with appropriate percentages This ‘map’ is signed by the relevant trustees
before 30 June to evidence the resolutions that have been made
 The official minutes will refer to the date when the distributions were mapped out,
but may be drawn up after the end of the year

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Standard structure
■ What is ‘income’ under deed
■ Does the trustee have any powers re determining income
■ What are the types of income – is specific streaming of classes
desirable/required/possible
■ Intended beneficiaries – are they valid
■ Determine a formula

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Reality check
■ Not possible to get it exactly right
■ Cannot expect (for example) to get exactly $80,000 taxable income)
■ Need to allocate resources – clients with substantial tax issues
■ Giving ‘Mum & Dad’ all the income may actually make sense – ‘$360k test’

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Related issues
■ Impact of distributions not made by 30 June
■ default beneficiary clause
■ sometimes trustee taxed – depends on deed
■ Section 264 interview ‘stories’

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Trust tax estimates and accounting
■ Amended assessments will cause changes
□ warn clients about limits of estimates
■ Make trust accounting ‘real’
□ eg can’t have trust income to make up deemed assessable amounts or
non-deductible expenses, unless there is ‘excess’ capital to deem as
that income
□ if not ‘real’, ATO may challenge? – refer DIS comments

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Other Impacts?
■ Also, small business CGT concessions
□ small business participation percentage
□ CGT concession stakeholder
□ ‘Income’ rather than ‘income of the trust estate’
– (eg in section 152-70(1) table, item 3(a))
□ not covered by Bamford decision
■ Attribution
□ also warn clients
□ current pending decision
□ maybe still a role for PS LA 2005/1(GA) agreements

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Colonial First State
■ Colonial was the trustee of a retail fund – the retail fund invested in a
wholesale fund
■ It was proposed that the Constitution of the wholesale fund be amended
■ Colonial applied for a private ruling regarding the amendment
■ The proposed amendments to the constitution sought to give the
trustee discretion to:
□ stream different types of income to certain redeeming unitholders and
□ stream short term capital gains to a unitholder who redeemed their units
within 12 months and stream long term capital gains to redeeming
unitholders who had held for longer than 12 months
Facts

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Colonial First State
■ Doubt has been cast on the ability of certain trusts to allocate particular
components of income (eg capital or other taxable gains) to particular
unitholders
■ Concerns regarding the status of certain Australian unit trusts as ‘fixed trusts’
for Australian tax purposes
■ Proposed new management investment trust regime (effective from 1 July
2011) will address the issues in Colonial
Key points

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Government review of tax legislation
■ It was announced in December 2010 that the government will undertake
a full review of the way in which trusts are taxed
■ While there is a long way to go, it is reassuring that the rumoured
revisiting of the entity taxation regime has been expressly ruled out
■ July 2012 discussion paper on fixed trusts

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Response to Colonial
■ Vested test
■ Clearly defined rights
■ MIT focus?
■ What’s next

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Practical issues
■ Partly paid units
■ SMSFs
■ Synthetic equity
■ E4
■ Market value
■ Cloning (Div 126G)
■ Variation power

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Clark
■ Commercial Nominees confirmed
■ Significant variations available at law
■ Always read the deed
■ Stamp duty (other states & trustee duty)
■ Private rulings
■ Splitting & cloning

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Amending trust deeds
■ Resettlement issues
□ income and capital entitlements
□ default beneficiaries
□ vesting date
■ Creation of a new trust
■ Statement of principles
■ Stamp duty and CGT

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TD2012/D4
■ ‘Resettlement’
■ Commercial Nominees
■ Statement of principles
■ Examples
■ Stamp duty

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Hopkins
■ Amended assessments
■ Present entitlements
■ ATO v deed v minute
■ Distributions to ‘non beneficiaries’
■ Accountant’s evidence
■ Taxpayers 46, not 2

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Harris
■ Family law issues
■ Corporate beneficiary
■ Read the deed
■ 360’ feedback

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Summary
■ UPE refresher
■ ATO view – TR 2010/3 and PS LA 2010/4
■ Solutions - the sub trust approach
■ The impact of not adopting the sub trust approach

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Sub trust options
■ Apply above or adopt specific options from PS LA 2010/4
■ option 1 – a 7 year ‘interest’ only ‘loan’
■ option 2 – a 10 year ‘interest’ only ‘loan’
■ option 3 – an investment by the main trust in an income producing asset
■ option 4 - ?

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Options 1 and 2 - risks
■ how is ‘legally binding’ possible?
■ documentation issues ‘investment agreement’
■ if merely allocation of main trust income (as draft allowed) – not
legally binding
■ if actual loan - parties are main trust and sub-trust?
■ can this loan in itself cause Div 7A issues? – interposed entity rules

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Options 1 and 2 – risks (cont)
■ potentially best solution for 2011 year
■ implement ‘investment agreement’
■ ‘investment agreement’ needs to be drafted correctly to preserve the
position and satisfy the ATO requirements
□ arguably still a UPE if documented correctly
□ cash flow ‘interest’ due by lodgment date for 2012 ITR
□ although ‘interest’ must accrue from 1 July 2011

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Options 1 and 2 - outcome
■ ‘interest’ is ultimately assessable to company beneficiary of the
subtrust
■ if applied to income producing assets then ATO position that
‘interest’ is deductible to main trust that retains use of the funds
■ given that the ‘interest’ is potentially funded out of the trust
income it can give rise to a neutral outcome
■ no separate tax return

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Option 3
■ Specific investment by trust in income producing (or capital appreciating)
asset
■ Separate accounts and ITR (not required for options 1 and 2)
■ Arm’s length return
■ Payments must be made to company each year by ITR due date

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Option 4
■ Not specifically recognised in final practice statement
■ UPE in favour of company, placed on sub-trust
■ Sub-trust invests funds back into main trust
■ Main trust pays ‘rate of return to sub-trust’
□ Contemplated in draft PS LA 3362
□ Contemplated in TR 2010/3 at example 8 (an ‘investment on terms’ as
opposed to legally binding loan)

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Option 4 - outcomes
■ Possible to argue not a ‘loan’ but an ‘investment agreement’
■ Repayments linked to performance of trust business/investment
■ Lower or nil if losses in trust

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Rinehart

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Contact
Presenter: Matthew Burgess
Position: Partner
Direct line: 0403 209 977
Email: mburgess@mccullough.com.au
Website: www.matthewburgess.com.au