Tax Tip 201: Can a Trust Distribute Franking Credits to Someone Other than the Dividend Recipient?

Can a Trust Distribute Franking Credits to Someone Other than the Dividend Recipient?

No.

Franking credits are not income as defined in the tax act nor are they assets of a trust. They therefore cannot be allocated to someone, but they must flow out as directed by Division 207 of the ITAA36.


It was previously thought that the franking credits could be distributed separately but this ‘bifurcation assumption’ was recently held be to be legally ineffective by the High Court in the case of Federal Commissioner of Taxation v Thomas [2018] HCA 31

 

Can a trust distribute an amount of franking credit that is not "a share" of the relevant franking credit ? No. Trust tax laws require that a beneficiary receive a share of trust income. Efforts to manipulate the amount of franking credit taint the tax credit and it is not then available. This was the chief issue in the Thomas decision.

If the trust breaches the 45 days trading rule how does that affect the distribution to a beneficiary ? The trustee will be unable to recognise the franking credits if the 45 days rule is not met and no concession allowed by the Commissioner is satisfied. Hence the trustee will not report the dividend as franked and no beneficiary will receive a share of any franking credit as a consequence.

Trusts making a distribution of franked dividends may be required to make a family trust election. This may impose limits and tax issues on "non-family" members of that family group by reference to a test individual. Tax advice is recommended.

 

When you get a dividend, it has 3 ‘components’ as I see it:

1) The actual cash amount;
2) The imputed income; and
3) The franking credit.

So, if I am reading this correctly, when 1) is received by the trust and distributed to (say) beneficiary A, 2) and 3) must all also go to beneficiary A and not be ‘distributed’ elsewhere. Ie. 2) and 3) must follow 1).

 

yep

 

This post raises the following question :

How do you distribute dividend income from a trust if your aim is to reduce overall tax.

Under the current dividend imputation arrangements, I think the answer is straightforward - distribute to beneficiaries with the lowest MTR. In my example, component 1 and 2 are minimised. If total tax payable is otherwise zero, then 3 (imputation credits) are still of value, as the Government reimburses these to all taxpayers if they otherwise have a zero tax obligation.

So, distribute to the beneficiary with the lowest MTR is the right approach.

But, this will change slightly if the ALP wins power as their policy is to stop franking credit reimbursements. So, assuming ALP wins, what is the optimal approach?

Clearly, you want to minimise tax on 1 and 2, so that points you to distributions to beneficiaries on the lowest MTR.

BUT

If you distribute to someone with a 0% MTR, they will not get 3) reimbursed. Any excess franking credits are lost.

So, the right approach is more complex. Clearly, you should still look to beneficiaries with low MTRs, but not so low such they don’t have other income, and hence a tax obligation against which to offset the franking credit (under the ALP policy, if you cannot offset it, you lose it).

Will need to jump on a spreadsheet when I have a moment to figure this out.

 

Yes, we won't know how it will pan out with the labour's law by pressrelease until we hear some details.

Perhaps wait unit next monday before starting your spreadsheet??

 

The cash (1) doesnt need to be paid. Merely making the beneficiary entitled is sufficient for 2 + 3 to be a element of the beneficiary share of net trust income

 

I suspect that the ALP will manage the proposed policy in two ways.

1. Tax trusts like companies. This will mean PAYG instalments etc will impact cashflow as much as the tax needing to likely be prepaid.

2. Likely introduce a CGT concession permitting restructure for Disc Trust to Company. Alternatively I read a paper recently on another option similar to this which was to permit a disc trust to make a election to become a fixed trust for a limited range of family beneficiaries limited to the family trust election system. The duty issue could be a concern for some trusts however.

I have to agree with Terry that until we see what the draft laws are and what may be finally approved its speculation. In a nutshell its a big tax grab and has potential to add a massive tax cost to small businesses. For unfranked income from a trust there are some concerns. eg What happens when a trust distributes a capital gain as an element ? Is that also now subject to a base tax rate of 30%. ? The press release didnt say it wouldnt. If a beneficiary had a tax c/fwd CGT loss that could impose a further 30% tax on something presently taxed at 0%.

ALP call it avoidance. Its not avoidance when a family use a trust to invest and asset protect and share the income. Blatant bucket company abuse is about to become the big exploitation scheme and only in future years will they realise it