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.