The Discretionary Trust Deed Trap with CGT

Most trust deeds are poorly written and drafted by lawyers who arent tax specialists. And many who are may not be client facing advisers who see defects or benefits for taxpayers

Another issue is evident that inevitably limits the ability for the trustee to distribute CGT amounts and its in probably 99% of trust deeds.

Issue : Most deeds (but not all) permit streaming of income / capital any allow the trustee to characterise certain forms of income etc. eg Interest, dividends, franked income, CGT amounts.
This is a good thing. It can allow a trustee to elect to distribute prior to 30 June for specific types of income to benefit certain beneficiaries....This process is called streaming. An example is CGT amounts relating to shares to be streamed to a non-resident. That income may be exempt from Australian tax (as it is not taxable Australian property) and reduce net trust income. (s855-10 ITAA97)

However most deeds contain a fatal flaw. And its generally attributed to the insistence of many legal practitioners to define what may not need to be defined. Or the wrong definition. They overly define terms in the deed with reference to generally accepted legal practice by reference to the tax laws and dont then modify that view.

eg Most deeds define "Net capital gains" with reference to "The Tax Act" or specifically to s995-I (definitions) in ITAA97. This invariably directs the reader to s102-5 of the Act. This is the formula for how to work out a net CGT amount. A net capital gain occurs by following the 5 steps. The final result is the net capital gain. This formula requires the current year losses be applied to current year gains. ALL of them. Gains v losses. None are excluded excepting perhaps small business exemptions. And requires that prior year CGT losses also be applied. There is no discretion to defer that choice. Or to select a specific gain (only) and pass that to a specific beneficiary

Problem :
What happens if the trust has gain/s and loss/es ? According to the formula in s102-5 the net gain is AFTER all gains, losses etc are considered. You cant specifically exclude one or other of the gains and distribute a specific sum to specific beneficiaries. Or choose to not claim prior year losses. And most deeds also fail to permit a trustee to resolve to distribute income more than once each year.

Fix :
Well the deed could be amended by a solicitor under instructions from the trustee but Part IVA would likely operate. This considers where a tax benefit is the predominant purpose then the amendment may be an element of scheme to obtain a tax benefit. The Commissioner could then disregard the variation and impose tax upon the trustee at the default rate and with penalties.

The solution may be to consider amending well prior to any CGT event so that the terms of the deed permit a trustee to elect to identify a specific CGT event or amount and distribute that rather than "net capital gains"

Which trusts are most affected ?
- Trusts with carried forward CGT or income losses
- Trusts with potential non-resident beneficiaries
- Trusts with investments that may produce property or non-property gains
- Trusts with BOTH property and non-property CGT outcomes