Issues with drafting a trust resolution
An overriding requirement to be mindful of in drafting a trust resolution is to ensure that all trust income is distributed to trust beneficiaries no later than 30 June in the relevant income year (or as required by the deed, if earlier). This is required to avoid a trustee assessment under S.99A (or the triggering of a default beneficiary clause). This can be achieved in a variety of ways, including:
- Percentage distribution – A trustee may choose to distribute trust income using percentages whereby each beneficiary is entitled to a fixed proportion of trust income and, thus, a fixed proportion of net (taxable) income. For example: trust income is distributed 20% to Ben, 30% to Eva and 50% to ZED Pty Ltd (note the percentages must add up to 100% to ensure no trust income remains undistributed). As 20% of trust income is distributed to Ben, he is prima facie assessed on 20% of the net (taxable) income (which may represent a different dollar amount).
- Fixed dollar distribution – An example of this approach is: the first $6,000 of trust income to Jack, the next $30,000 to Patrick, etc. This does not necessarily mean that a beneficiary is assessed on that fixed dollar amount; they may be, but it will depend on whether there is a difference between trust income and net (taxable) income (under the proportionate approach).
Be cautious with fixed dollar distributions as they can be problematic if the exact trust income has not been quantified by the time the resolution is prepared (which is often the case), or if trust income is later amended upwards. To overcome the risk that part of the trust income is not distributed, a ‘balance beneficiary’ can be used. For example: the first $6,000 of trust income to Jack, the next $30,000 to Patrick and the balance to ABC Pty Ltd. In this example, ABC Pty Ltd is referred to as a ‘balance beneficiary’.
- Combination – It is also possible for trustees to distribute trust income using a combination of fixed amount and percentage distributions. For example: the first $6,000 of trust income to Edmund, the next $10,000 to Violet, the balance to Mark and Aplus Pty Ltd in equal proportions.
Note that trustees will need to ensure that the trust resolution is drafted in a way that achieves the trustees’ objectives. For instance, the trust resolution may be drafted to deal with all trust income (including franked dividends and capital gains included in trust income) or it may be drafted in such a way as to stream franked dividend and/or capital gains to one or more trust beneficiaries and then deal collectively with the reminder of the trust income.
The benefit of having a default beneficiary clause
The facts in Dalby’s case indicate that the trust’s deed did not have a default beneficiary clause (i.e., this assumption is made because the ATO’s position paper noted that the lack of a trust resolution would give rise to a trustee assessment, without mention of default beneficiaries).
To avoid a trustee assessment, many discretionary trust deeds include a default beneficiary clause. The purpose of such a clause is to automatically distribute any income of the trust on (or before) 30 June each year to certain nominated beneficiaries (usually the adult primary beneficiaries, referred to as the ‘default beneficiaries’) to the extent the trustee has not exercised its discretion to distribute the trust’s income by a specified date and time.
The rationale for this is that it is better to have the income automatically distributed to beneficiaries who may be on a tax rate that is lower than the top marginal tax rate, than to have the income definitely taxed at the top tax rate in the hands of the trustee under S.99A.
In other words, the primary purpose of a default beneficiary clause is to provide a ‘safety net’ if no beneficiary has otherwise been made presently entitled to all or part of the trust income.
Note that, to be effective, a default beneficiary clause should ensure the default distribution occurs at or before the required time. For this reason, trust deeds will often ensure that a default income distribution clause is triggered if no distribution has been made by, for example, 11:30pm on 30 June (to ensure that the default beneficiaries have been made presently entitled just before the income year comes to an end). It is important to be careful in this regard, as some deeds take this caution even further, and may trigger the default clause on 29 June or even earlier.
TAX TIP – ATO challenging trustee resolutions
If the ATO is able to successfully argue that a trustee resolution to distribute trust income was not effectively made by 30 June, this prima facie means that there are no beneficiaries presently entitled to the trust income (and a trustee assessment under S.99A would normally arise). However, if the trust deed contains an effective default beneficiary clause, then the trustees will instead be able to rely on that clause to avoid the trustee assessment.
A disadvantage of having a default beneficiary clause is that a distribution may be made to a default beneficiary who the principal does not wish to benefit from the trust. For example, the triggering of a default beneficiary clause could lead to an automatic distribution of income being made to a person who is bankrupt or to a spouse who is separated from the principal.