Trustees of discretionary trusts are required to resolve (either through minutes of a meeting or by ordinary resolution) before 30 June each year which beneficiaries of the trust will receive income (and possibly capital) of the trust for that year ended 30 June.
This doesn’t necessarily mean that the resolutions need to be formally documented before 30 June, but if ever questioned by the ATO, some form of evidence that the resolutions were actually made before 30 June would need to be provided. This could be something as simple as a note on the back of an envelope signed by the trustees. The ATO will, however, want to see some form of evidence, even if the resolution was made orally. If the trustee is a company, the directors of the company should be aware that it is a requirement under the Corporations Act 2001 that any resolution (whether in a meeting or not) made by the company should be documented within 1 month (see section 251A(1)). It is therefore best practice to formally document the resolution of the trustee on or before 30 June of each income year.
Before documenting such a resolution there are a couple of fundamental things from the trust deed that each trustee should be aware of. These are:
“Income of the trust” (or however it is referred to in the trust deed) is not accounting income (according to accounting standards) nor is it taxable income (according to tax law). It is a separate and distinct concept that is determined from the common law principles and accounting procedures adopted by trustees over time.
Modern trust deeds have attempted to simplify this definition by defining trust income with reference to the taxable and/or accounting income of the trust. For example, a trust deed may define income as “income calculated under section 95 of the ITAA 1936” (which is in essence taxable income). This will mean that any resolution of the trustee creating a present entitlement to trust income must refer to trust income that equates to tax income. It does not mean that the resolution should appoint “taxable income” amongst the beneficiaries, it should still appoint “trust income” that just so happens to equate to taxable income. It would be wrong in these circumstances to resolve to distribute trust income that equates to the accounting income or to refer to the distribution of accounting income in the resolution.
Often the distributable income and the accounting or taxable income of the trust will not be equal. The courts have confirmed in Bamford that where this is so, the proportionate method of distributing income is to be applied. That is, the difference between trust income and accounting/tax income is allocated amongst the beneficiaries in accordance with their respective share of trust income. A possible problem with this situation is where a trustee has resolved to distribute trust income that is in excess of the actual income of the trust, then a beneficiary is presently entitled to (and can demand from the trustee) an amount of income that does not exist.
It is important for a trustee to determine and consider all available beneficiaries before making any determination as to which beneficiaries will receive a share of income of the trust. A trustee should always ensure that any person that they propose to distribute to, meets the definition of a beneficiary under the trust deed. Where income has been distributed to a person that is not a beneficiary, the trustee will be deemed to have income to which no beneficiary is presently entitled. Unless there are provisions in the trust deed that nominate “default beneficiaries” to receive this share of income before 30 June, the trustee will be taxed on this amount at top marginal tax rates. There are also possible ramifications for the trustee as they have breached their powers under the trust deed as income has been paid to persons who were not beneficiaries.
It has always been common practice for trustees to allocate certain classes of income (i.e. franked income) to certain beneficiaries. With the 2011 amendments to subdivisions 115-C and 207-B of the ITAA97, it is now clear that Capital Gains and Franked Income can be streamed and will be assessed to the beneficiary in receipt of them. It also follows that any franking credit or discounted portion of capital gain will flow to the beneficiary that received the franked income or capital gain. It is also a requirement to allocate certain expenses directly related to the streamed amount (i.e. interest expenses on borrowings for the franked income).
Whilst this is possible in accordance with tax law, the trust deed must first permit streaming of income. The trust deed should provide authority for the trustee to separately account for and allocate various components or classes of trust income. Therefore, it is important that before resolving to stream any income of the trust, each trustee checks this is permitted under the trust deed and if not, resolves to amend the trust deed (if permitted) before 30 June.
It is the obligation of the trustee to resolve to distribute income at the end of each year. Whilst many advisors will provide guidance and assistance in doing so, each person who accepts office as trustee, should be aware of this responsibility.
As only the trustee can resolve to do so, it is important that only the current trustee makes such a resolution as a resolution by any other person (i.e. a prior trustee) will not be valid.
For accountants assisting their clients in preparing minutes or resolutions to distribute trust income, standard distribution minutes that accounting software providers generate will generally not suffice. Trustees should identify the distributable, accounting and tax income of each trust and ensure that the resolutions distribute the correct income that has been calculated in accordance with the trust deed. If the trust deed requires the trustee to invoke its discretion as to determining how income of the trust is to be calculated, then this discretion should be made. It may also be appropriate in certain instances to resolve to adopt another method in calculating trust income, provided this is permitted under the trust deed.
Be sure to check that your trust deed permits streaming and utilise this where you have franked distributions and capital gains mixed with other income of the trust.
All trustees should clearly identify and check the beneficiaries of the trust to avoid any additional tax or potential breaches of their trustee powers.
 FC of T v Bamford & Ors; Bamford & Anor v FC of T 2010 ATC 20-170
This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this article, or what it means for you, your business or your clients' businesses, please feel free to contact us.