Ensure trust resolution is not contingent
It is important to be aware that, in some cases, a trustee’s attempt to draft a trust resolution to deal with (or anticipate) a later potential increase to trust income and/or net (taxable) income can render the entire resolution ineffective. Specifically, the wording (and intent) of a trust resolution may create a contingent interest for a trust beneficiary, which is problematic. For example, a trustee may resolve to distribute trust income to Mr Z & Mrs Z equally and then further resolve:
“…should the Commissioner later include any amount in assessable income, any consequent increase in trust income is set aside, effective 30 June 2020, for the benefit of ZZ Pty Ltd.”
Here, the intended or desired effect of the trust resolution is that Mr and Mrs Z equally share the tax burden on the trust’s net (taxable) income, unless the net (taxable) income of the trust is later increased (e.g., following an ATO audit), in which case, the increase is to be borne (solely) by ZZ Pty Ltd, being the ‘balance beneficiary’ (and not Mr and Mrs Z).
Unfortunately, if net (taxable) income is later increased, this resolution does not create a present entitlement in favour of ZZ Pty Ltd as of 30 June 2020 for taxation purposes. In fact, based on the decision in Lewski’s case (which is discussed below), such a resolution would be considered entirely contingent and, as such, would not create a present entitlement to any of the trust income as at 30 June 2020, in respect of Mr Z, Mrs Z or ZZ Pty Ltd. As a result, no beneficiary is presently entitled and a trustee assessment under S.99A or a ‘default beneficiary’ assessment would arise.
However, it is important to be aware that, just because a trust resolution is ineffective to create a present entitlement for taxation purposes (e.g., because it is contingent), that does not mean the trust resolution is not effective for trust law purposes. Interestingly, the ATO is of the view that, if the trust resolution is effective for trust purposes (to create an entitlement for trust purposes that is vested and indefeasible as at year end), there is no scope for a default beneficiary clause to operate (i.e., meaning the clause cannot be relied upon to prevent a trustee assessment under S.99A arising). Refer to the Decision Impact Statement in relation to Lewski’s case.
Contingent trust resolutions and Lewski’s case
The facts in Lewski’s case, in so far as they relate to the contingent trust resolution issue, can be summarised (and simplified) as follows:
- The corporate trustee of ACE (discretionary) Trust (the ‘trust’) prepared a one-page document on 30 June 2006 containing a number of resolutions, including the following:
- The trustee resolved to make an adult beneficiary, Roslyn Lewski, presently entitled to 100% of the trust income. The trust income was estimated to be $10.3
- The document also contained the following ‘variation of trust income resolution’:
“It was resolved that, should the Commissioner of Taxation disallow any amount as a deduction or include any amount in the assessable income of the trust, and not distribute that amount so disallowed as a deduction, or so include in the assessable income in accordance with the above appropriation, such amount or amounts are to be deemed to be distributed on 30 June 2006 in the following manner: 100% to Australian Commercial Underwriting Pty Ltd [a corporate beneficiary].”
The Full Federal Court acknowledged the wording of the above resolution was clumsy but ultimately found it “tolerably clear” that this resolution was intended to create a present entitlement, in favour of Australian Commercial Underwriting Pty Ltd, in respect of any increased trust income that may arise from an ATO adjustment.
- The net (taxable) income of the trust for the year was believed, by the trustee, to be nil (on the basis the trust had significant tax losses available). However, the ATO later audited the taxpayer and denied these losses, which had the effect of increasing the trust’s net (taxable) income to $10.1 million.
- The ATO sought to assess Roslyn Lewski on 100% of the $10.1 million net (taxable) income of the trust on the basis that she was presently entitled to 100% of the trust income. The ATO was of the view that the resolution purporting to make the corporate beneficiary, Australian Commercial Underwriting Pty Ltd, presently entitled to the increased trust income, such that it would be assessed on a share of the net (taxable) income, was contingent and ineffective (i.e., it did not create the requisite present entitlement as at 30 June 2006).
- The matter proceeded to the Tribunal, which found in the ATO’s favour, concluding that Roslyn Lewski was assessable on the $10.1 million net (taxable) income of the trust. This case was referred to as TVKS v FCT [2016] AATA 1010.
- This Tribunal decision was then appealed to the Full Federal Court, as discussed below.