Trust Deeds – do they need updating?

Firstly, the High Court decision of Commissioner of Taxation v Bamford (2010) HCA confirmed the ability of the Trustees of a discretionary trust to treat capital gains derived by the Trust as forming part of the net income of the Trust, provided that the relevant Trust Deed gave the Trustees such a power.  The issues litigated in this case included, amongst others, whether the distribution of a capital gain could be made to a specific beneficiary – the ATO had argued that a capital gain was not “income” for trust law purposes, and therefore could not be distributed to that beneficiary.

However, the High Court concluded, provided that the relevant Trust Deed had an appropriate clause within the Deed which allows the Trustees to specify that the receipt of capital proceeds from the disposal of an asset could be treated as being on income account, then the Trustees would be able to distribute the resultant capital gain solely to a specified beneficiary.

The High Court also noted that the Trustees resolution to distribute the income was an important consideration in being able to effectively distribute different classes of income to different beneficiaries.

In addition, the High Court confirmed that the “proportionate” approach to allocating any difference between accounting and taxation income was the correct method to use – basically, this means that if there is a difference between accounting and taxation income (for example, imputation credits or non-deductible expenditure) then this difference is apportioned across all beneficiaries, rather than being able to be allocated to one beneficiary only.

Secondly, as a result of the decision in Bamford, the government introduced new legislation which was enacted at the very end of June 2011, to introduce new provisions into the income tax legislation which specifically empowered the streaming of franked distributions (ie franked dividends or trust distributions containing franking credits) and capital gains, again in appropriate circumstances where the Trust Deed contained appropriate definitions, and the resolution streaming the income, were effective for such purposes.

Most trusts established over the last twenty years or so generally have clauses allowing the Trustee to determine whether a particular receipt is on income or capital account, thereby allowing the Trustee to distribute a capital gain – however, this is not always the case.

In light of the two significant developments referred to above, the review of Trust Deeds and operations should be undertaken to determine the necessity of updating the deed.  The view of “best practice” is that all Trust Deeds should be reviewed and updated to reflect current interpretation of taxation and trust laws.

If a Trust Deed already has appropriate clauses and, the “streaming” of income is not undertaken by the Trustees, then an update of the deed may not be required.

It is important to note that this review and updating should be undertaken by a suitably qualified legal practitioner specialising in this area to ensure that a “resettlement” does not occur of the Trust – a “resettlement” would have negative stamp duty and capital gains tax consequences.

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Source: Written by Chris Wybenga, Managing Director of Wybenga & Partners Pty Limited, Chartered Accountants, Sydney