What does it mean to have power to determine if money is treated as capital or net income?

Hi All, new here, so first want to say hello. I also want to send my appreciation to some who have posted some great posts on information related to trusts on here. I have already learned some things in last couple of days.

I have my own trust and want to understand some things which I have found in the trust deed.

As the title suggests, there is a clause which says as the title says. So my first question is what on earth does it mean when the trust deed says the trustee has power to determine whether any money for the purposes of this Deed shall be considered as capital or net income...? (In another part of the trust deed is defines net income as within the meaning of Sec 95 of ITA Act 1936 or if the Trustee so determines any other generally accepted accounting method. )

Following up on that, why would a trustee decide to treat any money as capital instead of income? Can someone offer me some actual examples which would answer both questions?

Cheers

 

Example :

Trust has $200K of cash as its sole asset. It is invested and earns $2000 a year. The trustee resolves to make a distribution of $8,000.

Options
1. Silence. in a poor resolution Foolish. Does the $8K include the $2K of income or is the income undistributed as subject to trustee tax aat the highest marginal rate ?
2. Resolution to distribute $2k income to Beneficicary A and to loan $6k of trust capital to B. A will be assessable on "income" and B will not as the trustee has distributed / lent $6K of trust capital to B. B has no tax implications. It would be recorded as a trust receivable as B owes the trustee. Terms may be interest free.

There can be legal issues if the above occurs. A may sue the trustee if the loan to B is not repaid as a breach of trust. Has the trustee breached trust by not allowing trust capital to be prudently invested for benefit of beneficiaries ?

The deed should NOT define income according to ITAA36 alone. It may need updating and review by a solicitor. The issuing lawyer may be a option. The trustee cant determine something that cant be factual either. eg It cant have net taxable income of $11K as per tax return and also define net incoem for its own resolution at $8K. The resolution would be defective and trigger tax at the highest marginal rate - potentially double taxation even. Defective resolutions can be worse than no resolutions

 

Capital gains are not income under ordinary concepts. They are only income because of the tax act definition - statutory income. So this can create problems if the trust deed definition of income doesn't match the tax act definition. Then you have the 50% discount to consider too.

These sorts of clauses are designed to create flexibility and help the trustee deal with capital gains.

 

Thanks guys, I was really curious but based on your answers I don't think it will have any impact on me at this stage. I own a truck and run it through a company/trust but want to use any excess profits (above what I need to pay myself for bills etc) to invest.

So for example, if I net profit with the truck $55K, but only need $45K for my own bills, then the trust has $10K left over. At first I thought I could buy stocks with the excess $10K and this wouldn't incur any tax, but I have since been told that this is incorrect and I would have to either distribute the whole $55K, or otherwise have the trust pay the top marginal tax rate on that $10K (so effectively I could really only buy $5,500 worth of stocks). I just wondered if that clause in the trust deed meant this could be a workaround.

FYI, the trust deed does define net income as "within the meaning of Sec 95 of ITA Act 1936 ***or*** if the Trustee so determines any other generally accepted accounting method."

 

Do you really want to invest in the same entity as your operating business anyway?

 

Hi, I don't understand what you mean?

 

Say you run the business in a company. That allows you to retain earnings. But do you want the company that operates the business to also hold passive investments? If something goes wrong with the business, the investments are vulnerable.

 

Oh sorry, when I said company/trust I meant the trust has a company trustee.

But I think I get the jist of what you are saying, even with how I have it set up. If something happens whilst I am driving the truck (accident etc), even though I am insured, any other assets in the trust are at risk. Is this what you are driving at (pardon the pun)?

 

Yes. So the fact that retaining profit in the trust to invest is expensive doesnt matter, because you shouldnt be investing within the trust.

 

So let's assume I wanted to invest. Do I set up a new trust solely for this purpose, and then transfer any profits from my 1st trust to the second trust? I'm assuming the 2nd trust still has to pay tax on this?

 

Bucket company with another discretionary trust as a shareholder. Probably don't need a corporate trustee for the 2nd trust but your lawyer is the best person to ask.

 

Yes ive read about this beforr..if my memory serves me correctly this is so that you only pay company tax rate (30%??)on that money rather than 45% if it stays in the original trust

 

And also franking credits be passed on so it could effectively result in tax refund if passed on to a beneficiary with low income in later years.

 

Provided you arent drunk etc then the insurer will defend and meet a claim