Trust deed of the Simms Discretionary Trust

The trust deed of the Simms Discretionary Trust (the ‘trust’) determines trust income under ‘ordinary concepts’. For the 2020 income year, trust income and net (taxable) income is both $100,000 and are comprised solely of business income.

On 30 June 2020, the trustee resolves to distribute trust income as follows:

• Pete (resident adult individual): the first $40,000;
• Connor (resident adult individual): the next $40,000; and
• Jane (resident adult individual): the balance.

Applying the proportionate approach in Division 6, the $100,000 net (taxable) income of the trust is assessed to the beneficiaries as follows:

Unfortunately, as a result of a subsequent ATO review, it is found that an incorrect tax deduction of $10,000 was claimed for entertainment expenses. An adjustment is made which increases net (taxable) income to $110,000. Note, however, that the upward amendment to net (taxable) income does not alter trust income, as this is determined under ‘ordinary concepts’, where the entertainment expenses were properly charged against the income of the trust (when calculating the income of the trust under ‘ordinary concepts’, the trustee has no regard for the tax treatment of any particular item of income or expenditure).

Who is assessed on the additional $10,000 of net (taxable) income in this case?

Under the proportionate approach, each beneficiary applies their respective share of the trust income, being 40%, 40% and 20%, to the additional net (taxable) income of $10,000 which results in each of them being assessed on the additional amount, as follows:

Would the outcome differ if the trust deed contained an ‘income equalisation’ clause?

Yes. In that case, the trust income would also increase to $110,000 (i.e., under such a clause, trust income is defined to be equal to net (taxable) income determined under S.95, which is intended to remove any difference between trust income (to which beneficiaries are made presently entitled) and net (taxable) income (upon which beneficiaries are assessed).

Therefore, because Pete and Connor were distributed fixed amounts (being $40,000 and

$40,000 respectively), Jane, as the ‘balance beneficiary’, would be presently entitled to the additional $10,000 trust income. Accordingly, each beneficiary would be assessed as follows:

Jane (being the ‘balance beneficiary’) would pick up the additional trust income and, therefore, applying the proportionate approach, she would be assessed on the additional $10,000 (calculated as $30,000 less the $20,000 she had already been assessed on).

If the ATO imposes an upward amendment in respect of a fully streamed franked dividend and/or capital gain, then the tax consequences will generally only affect the beneficiary (or beneficiaries) to whom the franked dividend and/or capital gain was streamed.

However, be cautious as, if the amendment also affects trust income, it may be prudent to review how the specific entitlement was initially drafted to ensure the franked dividend and/or capital gain was in fact fully streamed. This will depend on the wording of the entitlement (e.g., was the initial entitlement created in ‘fixed dollar amounts’ and, if so, was a ‘balance beneficiary’ used?).