I. Trusts
15.4. The scheme of the provisions of Division 6 of Part III of the Act, which has parallels in other common law countries,
involves the calculation of the ‘net income of a trust estate’ (in general, net income in the sense of those words in
Chapter 7) of a year of income and the allocation of that net income, for purposes of determining the incidence of tax on
it, between the beneficiaries and the trust estate. The allocations to beneficiaries are made in terms of their ‘present
entitlements’ to trust income. There is judicial opinion that at least those parts of Division 6 which depend on the
calculation of the net income of the trust estate have no application when income is derived from a foreign source. The
discussion in this section of the chapter assumes that no foreign
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element is involved: in other words, that
the income has an Australian source and the trustee and beneficiaries are Australian residents. International aspects are
separately considered later.
15.5. If a beneficiary becomes entitled to part of the income of a trust and later that part is distributed to him, the income will be taxed under Division 6 when the entitlement arises, and no further tax will be charged under Division 6 when the income is actually received by the beneficiary. However, if the beneficiary receives an amount, out of the income of the trust, before he becomes entitled to the amount under the terms of the trust, he is, it seems, subject to tax on what he receives by virtue of section 26(b). This section (a survival of provisions predating those now embodied in Division 6) includes in income for tax purposes ‘beneficial interests in income derived under any … trust’. Its effect is, presumably, to tax the amount received, and the manner of taxation intended by Division 6 is thereby defeated. In the Committee's view the legislation should provide that income of a trust to which a beneficiary is entitled or to which he becomes entitled is taxed only under the provisions of Division 6. A provision akin to that in section 101, discussed in paragraph 15.10, will be required to ensure that where an amount is received in advance of the beneficiary becoming entitled, it will enter the calculation of the ‘present entitlement’ of the beneficiary for purposes of allocating net income of the trust to him.
15.6. The allocation of net income to a beneficiary should involve the consequence that the character of any item of that net income is carried through to the beneficiary. The provisions of Division 6 explicitly recognise this as far as exempt income is concerned and it is understood that the Commissioner follows this principle in regard to other items of income. In the Committee's view, the Commissioner's practice should be followed, and supported by express provisions which will, for example, ensure that entitlement to tax credits in relation to dividends received, under the Committee's company tax proposals in Chapter 16, also carries through to the beneficiary.
15.7. The allocation of net income of the trust between beneficiaries and the trustee involves initially determining how much of the net income is to be taxed as income of the beneficiaries, the remainder, if any, then being taxed as income of the trust. A number of issues arise in applying the concepts used in this allocation. These relate to the meaning of ‘present entitlement’, and the interrelationship in this regard of tax accounting and trust accounting; the meaning of present entitlement where the beneficiary is under a disability; the consequences of differences between net income of the trust estate and trust income; the treatment of distributions from income that has been taxed as income of the trust; the rate of tax applicable to the income taxed as income of the trust; and the treatment of losses suffered by the trust.
Present Entitlement
15.8. The meaning of present entitlement has been the subject of a number of judicial decisions. In general, a
beneficiary is presently entitled to trust income when he can claim immediate payment from the trustee. Where there is
a right to income of a deceased estate, there cannot be a present entitlement until the administration of the estate
has proceeded to the point where the personal representative becomes a trustee. This occurs when the personal
representative has completed the performance of his executorial duties of getting in the assets, paying or providing
for the debts, funeral and testamentary expenses and legacies and then holds the remainder of the property in the
estate in trust for one or more of the beneficiaries. There are unresolved questions as to the manner of taxation when
the personal representative becomes a trustee in the course of a tax year of income. Assuming the trust accounting
year and
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the tax accounting year correspond, the question whether the net income of the trust estate prior
to the personal representative becoming a trustee is to be taxed as income of the trust or as income of the life
tenant may be thought to depend on the appropriateness of a trust account being taken on the change in status of the
personal representative. There is no guidance in the Act or the judicial authorities. The matter is further
complicated by the fact that the personal representative may complete his executorial duties in relation to one part
of the estate but have further duties to perform in relation to another part. A similar problem arises where a
contingent interest in a trust becomes a vested interest during a year of income. The Commissioner's present practice,
it is understood, is to assess the beneficiary on the income for the whole of the year of income during which the
executor's administration is completed or the interest vests unless the trustee can show, by taking accounts when he
completes his duties as executor or when the interest vests, that the income should be divided between the trust and
the beneficiary. In the Committee's view, the Act should be changed to follow this practice; however, the requirements
as to accounts should be sufficiently flexible to allow for the situation where the administration is completed in
relation to part of the estate but not in relation to the balance.
15.9. There are unresolved issues when the trust accounting period, which may for example, end on each anniversary of the death of the testator or the making of the settlement, differs from the tax year of income. Where the trust estate carries on a business, clearly there can be no present entitlement of a person with a right to income until the time for taking the accounts of the business, and it is the person who then has the right to income who will be presently entitled. As the law is now framed, if there is no beneficiary presently entitled to trust income of any period to which net income of the trust estate relates, the relevant net income is taxed as income of the trust. In the Committee's view, there should be provisions requiring that the trust accounting period be treated as a substituted tax accounting period; it might be necessary also to require that the tax payable be adjusted to prevent a trust accounting period that differs from the normal tax accounting period being used as a method of deferring tax.
15.10. The point was made in paragraph 15.5 that an actual receipt of money or a benefit from the trust by a person with a right to income should be treated as a receipt of an amount to which the beneficiary is presently entitled. Another situation also calls for comment. A trustee may have a discretion to pay or apply income for the benefit of a beneficiary. Where he acts in exercise of such a discretion, section 101 provides that the beneficiary is deemed to be presently entitled to the amount so paid or applied. In the result the amount will go to determine the allocation of net income of the trust estate to be taxed to that beneficiary. The trustee's exercise of his discretion may be made at some time after the taking of the trust accounts for a year and will be treated by him as having been made from the trust income of that year. As the law stands, it is not clear whether the effect is to deem the beneficiary presently entitled to a share of the income of the year in question. Clearly in the interests of finality of assessment it is necessary to control the tax consequences that can flow from the trustee's exercise of his discretion. The Committee recommends that where the discretion is exercised within three months of the end of the trust accounting period and the trustee appropriates income of that period for the payment, the beneficiary should be deemed to be presently entitled to the amount of the income of the period thus paid or applied for his benefit. If the exercise and the appropriation are made more than three months from the end of the trust accounting period, the Commissioner should be given a discretion to treat the amount paid or applied in the same way.
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15.11. Where the trustee, in exercising a discretion of the kind just considered, appropriates income of a still earlier period, there are no tax consequences. The net income of the trust estate in that earlier period will already have been taxed either to the beneficiaries or to the trust.
15.12. The meaning of the phrase employed in section 101, ‘pay or apply … for the benefit of … beneficiaries’, is a matter of some doubt. Similar words used in a trust instrument or a statute giving a discretion to the trustee have been invested with a very wide meaning. The Committee recommends later in this chapter that where income is accumulated in a trust estate, any part of the corresponding net income of the estate that is not taxed to any beneficiary should bear tax at the maximum marginal rate. Section 101 will therefore, even more than now, offer a prospect of escaping tax at a high rate where an effective application for the benefit of a beneficiary on a lower rate is made. If the words of section 101 are given the wide meaning they have been given in other contexts, a resettlement of trust income on trusts under which the beneficiary has only a contingent entitlement to capital and income will serve to take the part of the net income of the trust estate that is resettled out of reach of the maximum marginal rate. In the Committee's view a resettlement of trust income should only be allowed to operate in this way if the terms of the resettlement give the beneficiary an absolute right to the corpus and to the income from it. If any wider meaning is to be attached to the words in section 101, the prospect arises that a beneficiary in the original trust may have a present liability for tax in respect of money to which he has no present entitlement and to which he has no vested right.
15.13. The notion of present entitlement to a share of the income of a trust estate does not depend on the source of moneys in fact used by the trustee in satisfying the rights of a beneficiary. In general, a person receiving an annuity from a trust is taxed on the amount he actually receives, whatever the source of the moneys used by the trustee. Where, however, the annuity is charged on income of the trust it should to this extent be taxed under the provisions of Division 6. Assume, for example, that the terms of a trust instrument provide for payment of an annuity of a set amount out of income, with a direction to the trustee to resort to corpus if the income is insufficient. If the income proves sufficient, the amount of the annuity should be treated as a share of the income of the trust and taxed under the provision of Division 6. If the annuity is only in part covered by the income, it should to the extent covered be treated as a share of the income of the trust and the balance not covered by income should be taxed as income under the general provisions of the Act.
Present Entitlement of a Beneficiary under a Disability
15.14. The interpretation of present entitlement as meaning a right to claim immediate payment from the trustee would appear to prevent a person under a disability (for example, a minor), who cannot enforce payment because he cannot give a valid receipt, from ever being presently entitled except when a deeming provision like section 101 operates. But this consequence would conflict with the evident intention of section 98 which contemplates that a person under a disability may be presently entitled. The interpretation of ‘presently entitled’ as including a situation where a person is prevented only by his disability from claiming immediate payment, which has been adopted in one judicial decision, should, in the view of the Committee, be confirmed.
15.15. Where a person under a disability is presently entitled to income of a trust, tax on his allocation of the net
income of the trust estate must be paid by the trustee as the agent of the beneficiary (section 98). The allocation
must nonetheless be included
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in a return by the beneficiary if he has income from any other source. The
tax paid by the trustee is a credit against tax assessed on the beneficiary's income from all sources (section 100).
However, the tax credit apparently cannot give rise to a refund. A beneficiary may have deductible outgoings exceeding
his income from sources other than the trust and may fairly claim to be over-taxed. In the Committee's view, the tax
credit in these circumstances should be available as a refund. Alternatively, section 98 should be repealed. Basically
it appears to be designed to ensure the collection to tax on income assessable to a minor and, to a limited extent, to
other persons under legal disability. There are undoubtedly many cases where minors derive income directly and in
their own right from dividends, interest and rent, and the Committee is not aware of any difficulties in collecting
tax in these cases. If section 98 is retained there will need to be further provisions to make the refund available
and to give effect to the proposal elsewhere in this report for assessing the unearned income of a minor at a rate of
tax based on the income of the parent. The need for these provisions would be avoided and the law simplified if
section 98, and consequently section 100, were repealed. In cases of difficulty the special garnishee provisions in
section 218 would be available to the Commissioner.
Net Income of the Trust Estate and Trust Income
15.16. The amount of trust income to which a beneficiary is presently entitled determines the fraction of net income of the trust estate on which he is subject to tax. Trust income is a concept of trust law, its amount depending on principles of trust law and the terms of the trust instrument. Net income of the trust estate is a concept of tax law which owes much to the example of trust law, but its elements differ in significant ways.
15.17. Net income for tax purposes may exceed trust law income. Thus bonus shares may not in all cases be trust income; they may nevertheless be income for tax purposes. The value, for tax law purposes, of stock on a grazing property may be less than the value for trust law purposes and this may give rise to an amount of deemed income for tax purposes when the stock is sold. A premium received on the grant of a lease may be trust income, in which event it will be spread over the period of the lease; when such a premium is income for tax purposes, the whole amount is included in income in the year of receipt. Prudent management of a trust may demand more generous depreciation provisions than the tax law allows, and trust law may require a deduction against trust income of the costs of non-permanent improvements which are not deductible in determining net income for tax purposes.
15.18. When net income for tax purposes exceeds trust income, the scheme of Division 6 may be thought to operate unfairly. While generally it may be true that income for tax purposes is simply a figure for calculating tax on the trust law income, there are important respects in which this is not so. To the extent, for instance, that income for tax purposes includes bonus shares which, under the trust instrument, form part of corpus, it seems unfair for the whole of this income to be used to calculate the tax to be paid by the beneficiary entitled to income and who, if he has no interest in corpus, has no claim to those shares. The Committee recommends that where the trust income to which the income beneficiary is presently entitled is less than the net income of the trust estate, he should as a general rule be taxed on an amount equal to his entitlement to trust income and the excess income for tax purposes should be taxed to the trust.
15.19. This rule is clearly appropriate whenever the tax that would thus be paid by the trust is, on trust accounting
principles, charged against corpus and the beneficiary has no interest in corpus. Where the tax is charged against
corpus but the income
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beneficiary has an interest in corpus, the appropriateness of the rule will depend
on the extent of his interest. If he has the entire vested interest in corpus, there is good reason to tax him by
reference to the whole of his share in the net income of the trust and, indeed, if there is another income beneficiary
to tax him by reference to the excess in relation to that beneficiary as well. If he has a less interest in corpus,
the reason is not so compelling. The Committee, however, sees administrative difficulties in a qualification of the
general rule which would make the taxing of the income beneficiary on the amount of the excess depend on the extent of
the beneficiary's interest in corpus and a prediction of how the trustee would charge the tax if the excess were taxed
to the estate and not to the beneficiary.
15.20. The appropriateness of the general rule when the tax that would be paid is charged against income also varies with the circumstances. Consider, for example, a lease premium the whole of which is income for tax purposes in the year it is received by the trust but only an apportioned amount of it is, in that year, trust income to which the income beneficiary is presently entitled. In this case, tax on the excess in the year of receipt is clearly not a charge on corpus but a charge on trust income spread over the period of the lease. The appropriateness of the general rule will depend on the way in which trust accounting deals with tax paid on the excess. If it is spread only over the years after the first year, the income beneficiary of the first year will be taxed on an amount undiminished by tax on the excess. In subsequent years the income beneficiary will receive an amount diminished by a part of the tax on the excess but will not be subject to tax on what he receives, his receipt being a distribution from income already taxed. This, on balance, would appear to produce a satisfactory result. If any part of the tax on the excess is charged against income in the first year, there are mathematical complications in determining the amount of the excess, and the income beneficiary in the first year, who will receive no more than the income beneficiaries of later years, is the only one to be subject to tax on what he receives.
15.21. The general rule may be thought less appropriate where the excess results from depreciation being applied in determining the trust income from letting a building and depreciation being denied in determining the income for tax purposes. In the first year the amount to which the income beneficiary is presently entitled will be undiminished by tax to be paid by the trust on the excess. In the following year, however, there will be a smaller amount to which the income beneficiary is presently entitled, since his entitlement will have been diminished by the tax paid by the trust on the excess. The excess will thus increase each year at a diminishing rate and eventually stabilise. The point of stabilisation will depend on the tax rate applied to the excess. In this illustration the function of spreading the tax liability more fairly between income beneficiaries of different years is not apparent.
15.22. Though the general rule is thus more appropriate in some cases than others, the Committee prefers the certainty
of a single rule to a rule which, in the interests of a more refined expression of fairness, is subject to exceptions.
There may, however, be justification for allowing the income beneficiary (or in the case of a minor beneficiary, the
trustee) an election to be taxed on the excess as part of his income. The election would offer an avenue of escape
from what in a particular case might be an unfair rate of tax otherwise applying to the excess. There is of course a
possibility of the election being used as a method of avoiding tax, for example where the person ultimately entitled
to corpus has a substantial income and the income beneficiary only a modest one or where the income beneficiary has an
interest in several trusts. The possibility
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could be controlled by restrictions on the election: for
instance, election might be expressly denied if the income beneficiary has no interest in corpus or an interest in
corpus significantly less than his interest in income, and there might be a requirement that the election can be made
only in respect of one trust.
15.23. A special situation arises when a deceased estate is taxed on income derived during the course of administration and the assessment is paid by the trustee after the administration is complete and a beneficiary is now presently entitled to income. The Committee proposes that, in general, income derived during the course of administration should be taxed at rates determined on the assumption that the income is that of an individual as under the present section 99. If the trustee has provided for payment of the tax out of the income, no problems arise. If, however, he charges the tax against income of the later year in which the tax is paid, there will be an excess in that year to which the general rule would be applicable. The Committee sees no reason why the tax consequences may not be left to depend in this way on the trust accounting followed by the trustee.
15.24. The difference between trust income and net income of a trust estate due to the trustee having met an assessment to income tax imposed on the trust estate may be thought to have some parallel in the situation arising when the trustee meets an assessment, under section 98, as agent for the beneficiary under a disability. It should be made clear, however, that the general rule proposed in paragraph 15.18 has no application in this situation. Tax is paid by the trustee as agent and is recoverable by him from the entitlement of the beneficiary; but this should not affect the amount of the entitlement of the beneficiary for purposes of the operation of the scheme of Division 6.
Accumulating Income
15.25. The scheme of Division 6 involves taxing the trust on that part of the income of the estate for tax purposes which is not taxed in the hands of a beneficiary or in the hands of the trustee as agent for a beneficiary. The phrases ‘accumulating income’ and ‘accumulated income’ are used in this chapter to refer to such income. They are not intended to extend to income to which a beneficiary is presently entitled that is retained by the trustee.
15.26. There are two questions to be considered in this regard. The first is the appropriate treatment of distributions made from accumulated income already taxed to the trust; the second is the rate of tax to be applied in taxing the trust.
15.27. Although not the subject of an express exemption, it is a clear inference from Division 6 that a distribution from accumulated income which has been taxed to the trust is not subject to tax in the hands of the beneficiary receiving the distribution. The argument in any case would be that income which has been accumulated, more especially when it has been taxed, has ceased to have the quality of income when it is distributed; it is, in effect, received by the beneficiary as capital.
15.28. It would therefore be a radical departure from the scheme of Division 6 to follow the scheme in relation to companies and tax the beneficiary on distribution, with appropriate credit for tax paid by the trust. The Committee does not favour any such change. The giving of credit, which ought in principle to be a full credit, would involve major administrative difficulties.
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15.29. If there were a strong case on equity grounds for this radical departure, these administrative difficulties might not be thought too high a price to pay. The basic approach of Division 6 to the taxing of trust income is the allocation of that income to the beneficiaries who alone are taxed on it. The equity question therefore arises only in relation to income that cannot be allocated because there is no beneficiary with a vested claim to it. In the case of company income, there will almost invariably be shareholders with vested interests in the income at the time it is derived by the company; and where they are low-income shareholders, taxing the company on undistributed profits and not taxing the shareholders on later distribution is inequitable. The Committee does not, however, see a similar case in equity for attempting to relate the tax on accumulated income of a trust to the tax situation of persons who, at the time income was derived, had no more than contingent interests in that income.
15.30. What is a proper rate of tax to apply to the accumulating income? Until 1964 such income was taxed in all cases as if it were the income of an individual. In that year an alternative was introduced whereby the income is in some circumstances subject to tax at a flat rate (currently 50 per cent) unless the Commissioner is of the opinion that it would be unreasonable to tax it in this way. The alternative was introduced to overcome tax avoidance practices to which the Ligertwood Committee drew attention in 1961. Bizarre possibilities in minimising tax are introduced when multiple incomes, each separately taxed, can be created by setting up a multiplicity of trusts, all in the interests of one person.
15.31. As a measure to defeat tax avoidance, the alternative provision has serious shortcomings. For one thing, the rate of 50 per cent which Parliament has set leaves a tax advantage where the marginal rate of the person who it is intended will ultimately receive the income is higher than 50 per cent. For another, the provision has no application to a trust created by a will or resulting from an intestacy. In general the Committee sees no reason for distinguishing between the inter vivos trust and the testamentary trust. A multiplicity of testamentary trusts in the interests of the one person is not unlikely. In any event, the inter vivos vesting of assets in a testamentary trust, which has been held not to give rise to a new trust, defeats whatever purpose might be served by the distinction.
15.32. The Committee recommends that the rate of levy on income taxed to a trust should, in general, be the maximum marginal rate applying to an individual taxpayer. The rate will discourage the setting up of accumulation trusts having tax avoidance as their object; moreover, where there is no beneficiary with a vested interest there is, except in some circumstances which might be the subject of special provisions, no obvious reason for preferring any other rate. Possible special provisions applying another rate are considered in the following paragraphs.
15.33. Where the estate of a deceased person is in course of administration and income is taxed to the estate, it is not unreasonable to regard the estate as a projection of the personality of the deceased. This would involve retaining the present law by which the income in question is taxed as the income of an individual. Similar treatment should continue to be given, too, to moneys received by the estate that would have been income of the deceased person had he received them in his lifetime: these are treated as income of the estate under section 101A.
15.34. It follows from paragraphs 15.16–15.24 that, except where an election is exercised, the excess of income for tax
purposes over income for trust purposes will be taxed as income of the trust. One might be tempted to argue that in
situations of this kind there is unlikely to be any need to discourage tax avoidance by the prospect of
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having to pay the maximum marginal rate. But if a lesser rate of tax is applied to the excess, there would still be
scope for tax avoidance, for example through the adoption by the trust instrument of trust accounting rules designed
to limit the amount of trust income. There will nevertheless be cases where, as in the illustration in paragraph 15.21
involving the lease premium, the application of the maximum marginal rate to the excess appears unfair. A compromise,
in the Committee's view, is for the amount by which the income of the trust calculated in accordance with income tax
principles exceeds the income calculated in accordance with trust law principles to be taxed as the income of an
individual who is not entitled to any concessional deductions but who is subject to a minimum rate of tax. The minimum
rate should be a specified percentage which is less than the rate of 50 per cent at present applied under section 99A.
The exception should not be available if the Commissioner reaches the view that the discrepancy between the two
amounts of income has been deliberately brought about by a provision in the trust instrument inserted for the purpose
of reducing the incidence of income tax.
15.35. The common form of will provides for the accumulation of income and the payment of that income to a child of the testator on the child reaching a certain age or, perhaps, marrying before that age. It seems inappropriate for the income arising from a trust of this sort to be taxed at the maximum marginal rate. The Committee considers that this income should be also taxed as the income of an individual who is not entitled to any concessional deductions but who is subject to a minimum rate of tax. Again, the minimum rate should be a specified percentage which is less than the rate of 50 per cent at present applied under section 99A. This exception should be limited to income arising under a trust created by will to which a child of the testator has a contingent entitlement, being income accumulated during the minority of the child.
Losses of Previous Years
15.36. While the scheme of Division 6 goes some distance towards treating income moving through a trust to a beneficiary in the same manner as income derived directly by a beneficiary, there are respects in which this is not so. The treatment of accumulated income is one instance. Another is the treatment of losses.
15.37. The present law, while taxing an income beneficiary on a share of the income subject to tax by reference to his present entitlement to income of the trust, does not allow him a deduction of an equivalent share of a loss for tax purposes suffered by the trust. Such a loss suffered by the trust is normally carried forward as a deduction against income otherwise subject to tax in a later year in accordance with the general principles for the application of losses established by the Act. Where there has been a loss for tax purposes in a particular year, there will normally have been a trust law loss in that same year. In this case, if the trust law loss is carried forward and charged against the trust law income in the later year in determining the amount of the entitlement of an income beneficiary, the tax law loss will be carried forward in determining the net income of the trust estate in that later year. If, however, the trust law loss is not charged against the trust income in the later year in determining the amount of the entitlement of an income beneficiary, the deduction of the tax loss is denied in determining the net income of the trust estate for purposes of the tax liability of that beneficiary in the later year. There is an exception to the rule denying the carry forward of the tax loss: the rule is not applied where the income beneficiary has an interest, presumably any interest, in the corpus of the trust estate. Where the income is accumulating income, the carry forward of the tax loss is allowed.
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15.38. It has been put to the Committee that the law should allow the income beneficiary a current deduction against his other income of a loss suffered by the trust. Where, under trust law, a loss is carried forward against future income, the denial to the income beneficiary of a deduction for the amount of a tax loss incurred by the trust in the current year seems to the Committee generally appropriate. If there is a prospect of a different income beneficiary replacing the present one in a later year, allowing the deduction to the present income beneficiary would not only produce complications but operate unfairly. In the later year the amount of trust income, but not the income of the trust for tax purposes, would be diminished by the trust loss.
15.39. Where, under trust law, a loss is charged against corpus, the denial to the income beneficiary of a current deduction also seems generally appropriate. In this case, too, there is the prospect that the income beneficiary will not be the person who in fact bears the loss.
15.40. It follows from the preceding paragraphs that a tax loss will not be deductible, whether the trust law directs that the loss be charged against corpus or directs that it be made good from future income of the trust, if the trust is terminated before the tax loss is fully absorbed. In the latter instance, the loss, in substance, will be borne by corpus so that in both instances the capital of the trust will have been diminished. Where there is a tax loss, which is thus not deductible, there is a case for treating it as deductible against the part included in income of any capital gains arising on the termination of the trust. This proposal is again raised in Chapter 23.