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Trusts – Trust income where refund occurs etc

An issue that has taxed the minds of the ATO and solicitors alike is what happens to the taxable income of a trust when the amount of income is adjusted. The ATO has raised the issue at the NTLG Trusts Sub-Committee meeting of November 2010.

Trust income

As discussed in our companion article Calculating trust income, a trustee is usually obliged to calculate the income of the trust for each income year, as if the trust were a resident entity. Only the income of the trust so calculated will then be distributed to the beneficiaries.

It is common for trust income to be distributed in such a way that specified amounts are distributed to beneficiaries; but with the balance of the trust income to be distributed after the specified amounts in a different manner.

Adjustments

The problem that arises is what happens to the trust income where the income of the trust is adjusted after distribution. This can occur where the trust receives a tax refund after an audit, or when the trustee corrects a previous error. It is not clear whether any amount thus received counts as being part of the “balance” of the trust income.

ATO’s example

The ATO set out the following example (here simplified) to demonstrate the problem.

Let us say a trustee of a trust calculates the trust’s income in respect of 2010/11. The trust deed states that income of the trust shall be the net income of the trust for tax law purposes. The trustee calculates the trust income as being $100,000.

The trustee lodges a trust return with the ATO accordingly. The trustee then executes a trustee resolution to the effect that:

  • $1,000 shall be distributed to Beneficiary A;
  • $1,000 shall be distributed to Beneficiary B;
  • $23,000 shall be distributed to Beneficiary C; and
  • the balance shall be distributed to Beneficiary D.
The trustee thus distributes $75,000 to D, since it calculated the trust income as being $100,000.
However, the ATO audits the trust. The audit finds that the trust’s income for that year should actually have been $120,000. The question is, what happens to the extra $20,000?
One approach would be for the entire $20,000 to be distributed to D, since it could be said to be part of the “balance” of the trust income. This would end up with D getting $95,000.
Another approach is for the $20,000 to be assessed proportionately to A, B, C and D based on their actual shares in the $100,000.

ATO response

The ATO’s preferred approach, however, is the first one – that is, for the entire adjusted amount to go to D. The reason given is that the trust deed has equated the trust income with tax law income. Thus, the trustee is obliged to stick with the tax law definition of trust income, even if this changes due to adjustments.

Conclusion

If you have concerns about trust income, call LAC Lawyers and we can provide advice and assistance.

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