In the lead-up to the end of the financial year, the ATO has warned that it is looking closely at how trusts distribute income and to whom. This is a continued area of focus from the ATO.
In recent years, the way trusts distribute income has come under intense scrutiny. Trustees need to carefully consider trust distribution arrangements before appointing or distributing income to beneficiaries.
We have been reviewing this and assisting clients over the last few years, particularly as the ATO has ramped up their activity and focus in this area. You may remember some of our articles over the years in this regard:
The ATO are focusing on a number of areas, which include:
► The Beneficiaries – What does your trust deed say?
An area of concern is that trustees do not consider the trust deed before income is appointed. The answer to what the trust can do, who it can allocate income to and how, is typically in the trust deed. This should be your first point of call. Most discretionary trusts established in the last three (3) years already take into account many of the issues with distributing to beneficiaries. Older deeds require a review to check that the Deed allows for distributions to be most tax-effective.
Review your Trust deed
- Conduct a review of the trust deed and any amendments to ensure trustees are making decisions consistent with the terms of the deed;
- Check the trust vesting date. The trust deed will specify what happens when the trust vests. If the trust vests, the trustees might be directed to distribute the income and property of the trust to particular beneficiaries. The trustee may no longer have the discretion to decide who to appoint income or capital to;
- Check who the intended beneficiaries are, and also keep in mind that some beneficiaries might have different entitlements to income and capital under the trust deed;
- Timing and requirements for resolutions – Check the deed for any conditions and requirements for trustee resolutions, including the need to have the resolution in writing and the timing of when it’s required to be made. For example, the deed might require trustees to take specific actions before 30 June;
- If you are looking to stream capital gains or franked distributions to particular beneficiaries, check whether the trust deed prevents this and whether the streaming requirements have been met.
Family trust and interposed entity elections
A family trust election helps wrap the trust’s workings around a specific individual’s family group. These elections can help protect trust losses, company losses, and franking credits but can also cause significant tax problems if used incorrectly.
An interposed entity election makes an entity a member of the family group of an individual.
Where these elections are in place, it is essential that trustees understand the implications before making any decisions on distributions. Distributions of trust income outside the specified individual’s family group will trigger family trust distribution tax at penalty rates.
► Beneficiaries – Who receives the benefit?
The ATO is also on the lookout for arrangements where amounts are allocated or appointed to beneficiaries, but they don’t receive the real financial benefit of the distribution. If the arrangement has the effect of reducing the overall tax paid on the income of the trust, then this will generally increase the level of risk involved and attract the ATO’s attention.
► Data Matching – Increased reporting on tax returns
Changes have been made to capture more information on the tax return and how trusts distribute income. These include:
- Trust tax return: Four new capital gains tax labels have been added. Beneficiaries should be provided with this information to match what is reported in their returns.
- Beneficiaries: – All trust income beneficiaries will be required to lodge a new trust income schedule. This schedule should align with your distributions as set out in the trust’s distribution statement.
We have also been advising clients to be aware of the ATO focus, particularly on data matching. The ATO requires more data to be provided in tax returns and then uses this to track down any anomalies. This has driven the ATO to conduct audits and reviews of tax returns, which we have advised clients to be aware of. We remind clients to review this article in this regard:
Trusts offer many advantages, including the ability to customise income distribution. However, it’s important to note that this flexibility comes with the responsibility of maintaining strong controls and compliance.
The ATO is increasingly strident about how trusts distribute income and the tax impact of those distributions. Trustees need to get it right because if trust distributions are found to be invalid, the tax ramifications can be significant.
Please get in touch with us if you have any concerns, and we will assist you.
