New law clarifies the position with circular trust distributions
In 1999, the Federal Government introduced the ultimate beneficiary rules as an integrity measure aimed at preventing the use of complex chains of closely held trusts (i.e., broadly, private trusts) to avoid or indefinitely defer tax. These rules were subsequently replaced by the trustee beneficiary rules in 2007, which no longer required details of ultimate beneficiaries to be reported to the ATO. Instead, under these new rules, a trustee of a closely held trust was only required to report certain distributions made to another trust (i.e., a ‘trustee beneficiary’).
The trustee beneficiary rules, contained in Division 6D of Part III of the ITAA 1936, broadly:
- impose reporting obligations for a trustee of a closely held trust that has made certain distributions (whether of income or capital) to a trustee beneficiary; and
- contain an anti-avoidance provision, preventing a trustee of a closely held trust from entering into a ‘round robin’ arrangement of circular trust distributions with a trustee beneficiary.
A key element of these rules is that they only apply to a closely held trust. A ‘closely held trust’ is broadly defined in S.102UC(1) of the ITAA 1936 to include a discretionary trust, as well as a unit trust in which up to 20 individuals have direct or indirect fixed entitlements to 75% or more of income or capital in the trust. However, such trusts will not be a closely held trust where the trust is an ‘excluded trust’.
Importantly, a family trust (i.e., a trust that has made a family trust election) was not subject to the trustee beneficiary rules when the rules were first introduced, as family trusts were originally included in the definition of ‘excluded trust’ in S.102UC(4) of the ITAA 1936.
Accordingly, a trustee of a family trust was not required to report distributions made to a trustee beneficiary, and the anti-avoidance provision did not apply even when such distributions constituted circular trust distributions.
TAX TIP – ‘Closely held trust’ exclusion extends to certain other trusts
While the notes focus on how the ‘closely held trust’ exclusion applies to family trusts, similar exclusions apply to certain other trusts, including complying superannuation funds and some deceased estates. Refer to the definition of ‘excluded trust’ in S.102UC (4) of the ITAA 1936.
The Government recognised that the existing anti-avoidance provision was deficient, as it did not prevent family trusts from engaging in circular trust distributions. As a result, the Government made the following announcement as part of their 2018/19 Federal Budget:
“The Government will extend to family trusts a specific anti-avoidance rule that applies to other closely held trusts that engage in circular trust distributions”.
Recent changes to the law following the Federal Budget announcement are the subject topic of these notes. While the notes provide a broad overview of the trustee beneficiary rules, they do not include every detail of their operation. Reference should be made to Division 6D of Part III of the ITAA 1936, as well as to the ATO’s factsheet ‘Trustee beneficiary reporting rules’ (QC 21157) for a further discussion of these rules.
All legislative references are to the ITAA 1936, unless otherwise indicated.