Discretionary Family Trust Q?

Discussion in 'Accounting & Tax' started by 65fbk, 2nd Mar, 2018.

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  1. 65fbk

    65fbk Member

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    Q
    I have two q's regarding how best to operate a trust.

    1)
    I understand the trust pays no tax if it distributes all earnings to beneficiaries each year.
    If it fails to do this, it pays 49% on retained profits.

    When June 30 is approaching, I don't know the exact earnings figure. This is unknown till after June 30 when I do the tax return. By this time it is too late to do the distribution.

    How do you manage this situation so ALL profits are distributed prior to the EOFY?


    2)
    Say a trust has been loaned money by the trustee/director.
    The trust now earns money and starts to repay this debt (interest free).
    The loan repayments are not an expense. If there was interest, that would be an expense.
    How do you get around the trust having to pay 49% tax on the earnings before it makes loan repayments?

    MANY THANKS!
     
  2. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Its the resolutions the trustee makes "All income to X" or "$20,000 to X and the remainder to Y"

    Otherwise the trustee will need to work out the income of the trust.

    2. The trustee would have a written loan agreement with the director. (A trustee cannot borrow from themselves). Repayment of principal is not taxable but if the trust is repaying the loan out of income it would be taxable.
     
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  3. Ross Forrester

    Ross Forrester Well-Known Member

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    You allocate a percentage of profits and make sure you have allocate 100% or you ensure one person receives the balance of all income.
     
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  4. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    1. By seeking advice and guidance and the above suggestions are some of the ways. What does the deed prescribe if it does ? The ATO increasingly seek this information.
    2. Repayments arent a loan expense even if it has interest. The interest that is charged is an expense. The repaymnet reduces the debt that will include the accrued interest. The financial records for the trust would reflect the changed liability
     
  5. D.T.

    D.T. Specialist Property Manager Business Member

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    Do percentages, then you don't need to know the specific amounts.

    What you should really be doing though is talking to your tax professional more often so that you know where you, your partner, and all of your entities are up to in order to plan for where things are going to be distributed.
     
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  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Keep in mind the consequences if the ATO denies a deduction and the assesable income of the trust suddenly jumps.

    What if the trust has $832 income and the trustee resolves distributes
    $416 to child A, and
    $416 to child B.

    Then suddenly there is an audit and $1000 in expenses claimed by the trust is disallowed?
    The income of the kids will increase by $500 each and they will be taxed at 66%.

    Better wording, in this case, may be
    $416 to child A, and
    $416 to child B, and
    the rest to X


    There was a recent case involving contingent distributions such as ‘should the Commissioner of Taxation disallow any amount as a deduction or include any amount in the assessable income of the trust …’. This sort of thing will result in the beneficiary not being presently entitlted tot he income.
     
  7. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I have seen many resolutions which could fail for all sorts of issues.

    eg Distribute $416 to Child A, $416 to Child B. The trust income includes franked income and a cash distribution of $416 is paid. However the Net Trust Income for the trust may be grossed up and be higher than the $416 yet the resolution says $416.

    I personally prefer use of a remainder beneficiary as Terry suggests. eg X for all the remaining net trust income. And be specific about the distribution as being Net Tax Income of The Trust rather than a distribution"...It gives clarity that the distribution resolution IS tax purposes and not cash amounts.

    The other complex area is streamed distributions. For example where the trustee is permitted and exercises a right to distribute specific income to a specific person or class of persons. eg CGT amounts, franked income etc.

    There can also be other dangers not apparent to a DIY taxpayer. For trusts these can include:
    - Failure to prepare financial records of the trust income, expenses, assets and liabilities. That is a fatal error and a sign of a serious concern.
    - Errors in streaming, resolutions etc
    - Personal Services Income issues
    - Division 7A
    - Physical v's book (accounting) distributions
    - Incorrect claims for related party interest in a manner that may provide a scheme benefit
    - Part IVA (anti-avoidance)
    - Legal issues eg borrowing errors + asset protection defects and more.

    One of the serious issues I see is resolutions to distribute unit trust income. Often by well meaning but inexperienced advisers. Where a beneficiary has a fixed entitlement should it even be necessary ? And what happens if a issue sees a change to trust income ? A resolution would be of no practical benefit.
     
  8. Hamish Blair

    Hamish Blair Well-Known Member

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    Can a discretionary trust distribute dividend income to one beneficiary and the attached franking credits to a different beneficiary?
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    no
     
  10. Mike A

    Mike A Well-Known Member

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    1. A trust must also have at least one dollar of income to be able to distribute the franking credits.

    2. If the franking credits are greater than 5k the trust needs to have made a family trust election for the beneficiary to receive the benefits of the franking credits.

    3. Trust needs to comply with the 45 day holding rule.

    4. If you distribute the profits to a company and the trust lends funds to a beneficiary consider the application of division 7a
     
  11. 65fbk

    65fbk Member

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    Thanks to all who replied.



    Terry, there must be a basic fundamental I am not understanding.
    I assume the trust must determine, and pay it's distributions before 30 June?
    So on or before that day, I must know who much the trust has made during the year as I can only transfer actual dollars to a beneficiaries account, not a 'percentage', or a 'remainder'.
    Typically you wouldn't prep the tax return until some time after June 30, so how do you know how much money there is to distribute?
    I'm sure this is actually quite simple, and I am making an assumption or misunderstanding something.

    Regarding the loan repayments, they are repaid by the trust with undistributed funds, so I suspect those funds are in effect distributed to the trust prior to the trust using these funds to repay the loan, and hence attract 49% tax as undistributed funds do?
     
  12. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    No, that is correct. Therefore with trusts the trustee must determine the income before 30 June. If it doesn't then there could be adverse consequences.

    Many get confused with trusts and loan repayments. I might write something separate on this.
     
  13. Mike A

    Mike A Well-Known Member

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    Who is advising you cant distribute percentages ? No competent professional im aware of.
     
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  14. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Percentages are often a great idea when incorporated together with a remainder to XXX to avoid a proportionate adjustment if taxable income later changes. Many people get it horridly wrong I will caution - Usually because they dont know what the net trust income actually is.

    For example a trust which has no carried fwd income loss. It may have income that comprises:

    - Interest $200
    - Franked Div $2400
    - Unfranked Div $600
    - Net foreign source income $1000 with credits of $101 available
    - CGT (Eligible for discount) $2000
    The trust has a CGT loss of $400 carried forward

    What is the trust income that must be distributed? If you dont know how the amount of $6,828 was determined then you may need professional advice before making a resolution. If a beneficiary has carried forward CGT losses you also may need to consider a resolution that addresses income streaming.

    A trust which has managed fund income may be unable to determine its trust income at 30 June as the managed fund may make its trust distribution as late as August.

    Another problem I see which I must caution is a resolution to distribute a small amount $$$ to parents who have received or may in the future receive Centrelink benefits. A very dangerous choice.

    Paying a distribution is one matter. That is normally made by way of a resolution which then follows with an accounting entry. Later the physical distribution is made....Sometimes partially paid before 30 June even !! There are important tax rules to consider if the distribution is deferred.....In some cases it may need to be paid prior to the tax lodgement.
     
  15. Mike A

    Mike A Well-Known Member

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    what amount goes into Label 53 - Income of the Trust Estate ? even with a streaming clause that complies with Bamford the amount of a franking credit may be included in the calculation of the trust’s net income under subsection 207-35(1) of the ITAA 1997, but does not form part of the distributable income of the trust estate.

    http://law.ato.gov.au/atolaw/view.htm?DocID=DTR/TR2012D1/NAT/ATO/00001


    When a trust deed defines trust income as net income under an income equalisation clause, trustees must be very careful when making an analysis of the income of the trust. This is because net income can often include notional amounts that, according to TR 2012/D1 cannot form part of the income of the trust.

    A common example of a notional amount is a franking credit which is included in assessable income (when a franked distribution is received). The ATO’s view in this regard is that a franking credit is a feature of the tax law that cannot be considered to be an accretion to the trust and as such will not be taken into account when working out trust income.

    A trust with an income equalisation clause that does not exclude franking credits from its calculation of trust income will in almost all cases inflate its calculation of trust income. This can lead to the following problems:

    · an unexpected allocations of taxable income between beneficiaries

    · cause a wastage of franking credits

    · give rise to a section 99A trustee assessment.

    These notional amounts would otherwise increase or decrease the calculation of trust income
     
    Last edited: 5th Mar, 2018
  16. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    That very issue is why so many ask questions. What figure do I put at 53 ?....And even then our software insists on various distribution labels all adding up and agreeing in total etc. I wouldnt attempt to fill in a T form by hand.

    Then throw in non-resident beneficiaries etc.........

    Taxing trusts like companies could simplify the whole issue.