Tax Tip 407: Making a Charity Presently Entitled to Trust income but Not Paying it

In the ‘good old days’ a trustee of a discretionary trust could make a charity presently entitled to the income of the trust. Trusts generally don’t pay tax, it is the beneficiary that pays the tax and they are taxed on the income of the trust if they are presently entitled to the income even if the trustee has not yet given them the income.


So an old trick was to make a charity entitled to the income but not telling them about it and not giving that income over to them. The income would remain in the trust and be reinvested and ultimately used by the controller of the trust for their own pleasures.

After a while this came to notice and the tax laws were amended by the insertion of s100AA into the ITAA36. INCOME TAX ASSESSMENT ACT 1936 - SECT 100AA Failure to pay or notify present entitlement of exempt entity

Now the trustee must pay or notify the beneficiary of their entitlement within 2 months of 30 June each year (which would be 31 August) otherwise they will be taken as not having made the beneficiary presently entitled.


Example

Homer controls the Simpson Family Discretionary Trust. It has $100,000 income for the year. At the pub Homer develops a cunning plan with his mate Barney. They will cause the trust to make a charity, the Royal Society for the Prevention of Drunkeness, a deductible gift recipient, entitled to the whole $100,000. But they don’t tell the charity.

The $100,000 is kept in the trust and Homer borrows it and uses it to fund his beer habit and to bribe an official to get him higher up on the kidney transplant list.

He does this year after year, and then in year 5 the ATO do an audit. The charity didn’t know about these income distributions because they were never received. Homer now has a problem. He didn’t give the charity notification in writing about the income. The ATO treat the charity as not having been presently entitled to the income and the trust is assessed on the $100,000 income each year at the top marginal tax rate (or it could be the default beneficiaries).

Under trust law the charity could still potentially chase the trustee for the money if it was made presently entitled to the income – the ATO only has the power to change who is taxed.t