Following the much anticipated High Court decision in Bamford, the Australian Taxation Office (
ATO) has now issued a draft
Decision Impact Statement and Practice Statement
PS LA 2010/1 setting out its view of the consequences of the decision and what action it will take. It would be an understatement to suggest that the ATO has attacked issues beyond those dealt with by the Court in Bamford.
The Court has confirmed what we believed was the correct position: if the trustee has the power, it can determine what is "income", which can include a capital gain; and the proportionate approach applies.
That clarity has still left us with a mess: we just know more clearly what is the real mess. The good thing is that the ATO agrees that the existing 'rules' should apply for 2010 and there is no need to rush into changing deeds or the way distributions are made. The Decision Impact Statement states that any change in administration and application of the law will only apply from 1 July 2010.
For many clients, the combination of the Bamford implications, the Division 7A/UPE ruling and Practice Statement and the legislative changes to Division 7A regarding private use assets means that it is time to step back and undertake a substantial review of the family and business structure. As an advisor you should be telling your clients that, as part of your 2010-11 tax engagement, a review of their overall structure and tax management strategies is mandatory. The main reason for this is that there is one major impact in the ATO's view: streaming of classes of income is dead.
In any event, leaving aside streaming, there are many structures which fail the basics of asset protection: separating assets and risk. How many trading trusts are funded by substantial, unsecured, unpaid trust distributions?
What should you do?
Action before 30 June 2010: where the trust makes a capital gain in the 2010 income year and has an unsatisfactory definition of 'income', you could amend the deed (subject to comments below about possible resettlement of the trust). However, the existing PSLA 2005/1 should enable the 'right' outcome to be achieved.
Action after 30 June 2010:
- Trust deeds need to be reviewed to ensure the income definition and trustee's discretion gives the trustee discretion to determine what is income but, in default, adopts a section 95 definition;
- just because there is a power to amend the deed doesn't mean there is an automatic entitlement to do so;
- making such amendments could potentially lead to a resettlement if the effect is to alter the "substratum" of the trust: the settlor's purpose in establishing the trust and the potential or actual beneficiaries' entitlements.
- Some issues that remain somewhat uncertain, including:
- the ability for trustees to stream different classes of income to different beneficiaries, eg capital gains to individuals and franked dividends to companies or individuals on lower rates of tax;
- can expenses be allocated against different classes of income and how are adjustments to net income to be apportioned between different streamed classes of income?;
- how can trustees account for notional tax amounts (other than tax credits) such as deemed capital gains and franking credits?;
- how to deal with capital gains forming part of the trust's net income in cases where the capital gains would be assessable to beneficiaries who are distributed the trust's income but do not have an interest in the trust's capital gains. To date the Commissioner has administered the law, in accordance with PS LA 2005/1 (GA), so as to permit the parties to choose whether the beneficiaries or the trustee are assessed on the capital gains;
- how to deal with capital gains that have been distributed or allocated to "capital" beneficiaries in cases where the trust has no income or where the income (but not the capital gain) has been distributed to "income" beneficiaries. Again, the Commissioner has administered the law in accordance with PS LA 2005/1 (GA) to permit the parties to choose whether the income beneficiaries, the trustee or the capital beneficiaries are assessed on the capital gain; and
- whether amendments to trust deeds changing or including income definitions amount to a resettlement for income tax and duty. The Commissioner's Statement of Principles indicates that such a change or inclusion is unlikely to be a resettlement for income tax purposes in the case of an ordinary discretionary trust, but what may be the implications for a trust with different income and capital beneficiaries?
The sleeper
The ATO has taken the view that a "share" means a numerical percentage of all of the trust's net income. This means a slice approach applies and the benefits of distributing different characters or classes of income to different beneficiaries is ineffective. As such, the Commissioner will withdraw the ruling on streaming, TR 92/13. We think this approach is wrong, and wasn't open to the Commissioner following the decision in Bamford. Even if it is accepted that "share" means proportionate rather than "portion" or "part", in our view, calculation of proportions can be achieved in a number of ways, not just as a "straight" percentage.
If streaming is dead, this has major ramifications for trustees and practitioners.
We may end up with more trusts - a capital trust, an income trust and a trading trust - and maybe more trading companies. Entity tax may yet have a life!
Submissions on the draft Decision Impact Statement are due on 28 July 2010, so it will be some time before we have further "clarity" on the way ahead.
Click here for a summary table of action items required.