Who pays tax on an increase in net (taxable) income?
As illustrated in Dalby’s case, in drafting a trust resolution, it is crucial that trustees consider the implications that will arise if the net (taxable) income of the trust increases post year-end and/or there is an adjustment to trust income. In Dalby’s case, the ATO denied the trust a deduction of $900,000, causing a substantial increase in the trust’s net (taxable) income, as discussed above.
By way of background, the question of who will be taxed on an increase to the net (taxable) income of a trust depends on a number of factors including the following:
- How trust income was defined (e.g., if an income equalisation clause applies then an increase in net (taxable) income will generally cause an increase in trust income – refer to the example below to see how this may work in practice);
- If and how the trust income was distributed (e.g., is there a trust resolution or, if not, does the trust deed contain a default beneficiary clause?); and
- How the distribution trust resolution was drafted (e.g., was a ‘balance beneficiary’ used?).
Typically, the determination of who will pay tax on any additional net (taxable) income arising as a result of a post year-end amendment, will depend on whether:
- the increase in net (taxable) income results in an increase in trust income; or
- the increase in net (taxable) income does not result in an increase in trust income.
A useful way to understand how an increase in net (taxable) income will be taxed is to work through an example of how each of these scenarios plays out in practice. Refer below and to TD 2012/22.
TAX TIP – Distributing trust income under the proportionate approach
By way of background, for trust law purposes, income of the trust is calculated with reference to the trust deed and the general law of trusts. It is trust income that trust beneficiaries are made presently entitled to (or specifically entitled to, in the case of ‘streamed’ capital gains or franked dividends) and this entitlement then forms the basis upon which the net (taxable) income of the trust is taxed. Under the proportionate approach, the beneficiaries of a trust are broadly taxed on their ‘share of the net (taxable) income’ of a trust based on their proportionate share of any ‘trust income’ to which they have been made ‘presently entitled’ (or ‘specifically entitled’ in the case of ‘streamed’ capital gains or franked dividends).