This was the headline for the main story in the Australian Financial Review on Monday 18 May 2009.

The article was triggered as a result of the issue by the ATO of a draft Practice Statement (DPS) in relation to the determination and taxation of trust income.

The approach suggested in the draft Practice Statement is not as draconian as suggested in the Financial Review article, but it does reflect a significant change in approach by the ATO.

While the DPS is still a draft document, it presumably represents the current thinking of the ATO and advisors need to consider the views in the document when advising clients on trust distribution issues.

There are several significant changes foreshadowed in the DPS.

Firstly, the ATO is suggesting that, in future they will strictly apply the "proportionate approach" in determining who is taxable on capital gains derived by a trustee. Currently the ATO practice is to allow beneficiaries who receive a capital gain to elect to be taxed on that gain (PS LA 2005/1(GA)).

The ATO position on this issue is a little confusing. They indicate that, for the moment, taxpayers can continue to self assess by applying the approach in PS LA 2005 but, in an audit situation, they will strictly apply the law even if this is contrary to the practice statement.

The ATO also suggests it may no longer apply the long standing approach under which particular categories of income derived by a trustee have been accepted as retaining that character when distributed to beneficiaries (conduit approach).

In the DPS the ATO suggest it is unlikely that it will apply the conduit theory in future where a capital gain is distributed separately to particular beneficiaries.

This could be particularly important for clients endeavouring to stream capital gains and franked dividends to particular beneficiaries.

The ATO also repeat their stated view that they do not accept it is possible for the trust deed to allow the trustee a discretion to determine how to calculate income for the trust and that the only concept of income which will be accepted is what it refers to as "distributable income".

The distributable income will the amount of income under ordinary concepts which remains after the trustee has deducted "expenses and outgoings properly associated with the production of the income".

There are a number of practical steps practitioners should take immediately to protect clients and themselves.

  • Firstly, all "standard" distribution minutes should be reviewed and, if necessary, amended. Relying on existing precedent distribution minutes could cause significant problems.
  • Trust deeds should be reviewed to ascertain if there is a definition of income. If the trust income is defined as being equivalent to section 95 net income, this should be amended to ensure that notional amounts (such as franking credits) are excluded (subject to resettlement issues).
    If this is not done, it may not be possible to ensure beneficiaries are presently entitled to 100% of trust income.
  • If the trust deed does allow the trustee a discretion as to how income will be determined in each year, then distribution minutes should reflect whether the trustee has actually made a determination. The failure to do this was fatal for the taxpayer in Bamford's case.
  • Where the trustee has derived a capital gain it would be prudent to frame the distribution minutes so that it is clear that the capital gain is being distributed to particular beneficiaries rather than simply as part of distributable income.
    The distribution minute should cater for the possibility that the distribution will in fact be a capital distribution.
  • If a capital gain is distributed to particular beneficiaries then, at least while PS LA 2005/1(GA) remains in force, the distribution minutes should incorporate an agreement by those beneficiaries receiving the capital gain that they will pay the tax on that amount in order to ensure that there is an agreement that complies with that Practice Statement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.