If you haven’t looked at your family trust deeds in a while, it is about time to. The decision of the High Court in Commissioner of Taxation v Philip Bamford & Ors [2010] HCA 10, is now a couple of years old, and yet we still see trust beneficiaries paying tax on more trust income than they need to, or being hit with high tax rates. By updating your family trust documents, you can ensure that you have as much control over tax outcomes as possible.

Section 97(1) of the Income Tax Assessment Act 1936 (ITAA36) provides that where a beneficiary of a trust estate who is not under a legal disability is presently entitled to a share of the income of the trust estate, their assessable income will include so much of that share of the net income of the trust estate.

In 2010, the meaning of these terms was considered by the High Court.  Mr and Mrs Bamford were beneficiaries of a discretionary trust the distributions from which were made not in fixed proportions of the income of the trust estate, but rather in fixed amounts to some beneficiaries, with a residual amount to another beneficiary.   However, in determining the net income of the trust estate for the purposes of s97(1), the trustee mistakenly treated certain expenses as allowable deductions.  The result of this was that the net income of the trust estate was somewhat higher than the trustee had considered it to be when initially making the distributions.  

The Bamfords argued that where there was a disparity between the net income of the trust estate and the distributable income, each beneficiary’s share of the net income ought to have been calculated in accordance with the terms of the distribution made under the deed, which in this case would have meant that the bulk of the increase would have gone to the beneficiary entitled to the residual amount.  The Commissioner, on the other hand, calculated the ratio which the actual distributions bore to the distributable income, and then applied that ratio to the excess of net income over the distributable income, which resulted in the Bamfords being assessable on a large portion of the increase.      

The High Court preferred the Commissioner’s approach (which is referred to as the “proportionate approach”).  Unfortunately for the Bamfords, this meant not only that they were taxed on income which they didn’t actually receive, but that the trust income flowed in ways not expected by the trustee.  

The Bamford decision is also authority for the proposition that a trust deed could allow a trustee to include amounts in the ‘income of the trust estate’ which were not “income according to ordinary concepts”, but rather “statutory income”, in this case a net capital gain.

In light of this decision, it is imperative that accountants, tax agents and trustees ensure that their family trust deeds are up to date. A well drafted trust deed that allows a trustee to define the income of the trust will give a trustee more control in determining the tax outcomes of the beneficiaries.  Without such provisions in a trust deed, trustees might find their power to manage the flow of distributions from the trust severely constrained.

Also, a trust deed which does not confer a power to treat a net capital gain as “income of a trust estate” on a trustee may result in the trustee being taxed at the highest marginal rate under s99A ITAA36. To safeguard your family trust conduct an update using Law Central’s Family Trust- Streaming and Bamford Update, available through our document building process online.

Gold and Platinum members read on to find out how you should tweak the provisions of your trust to maintain as much control of taxable income as possible.

If you are yet to do so, it is advisable to update your trust deeds as soon as possible. If you fail to do so, beneficiaries may become liable to be taxed on income they don’t actually receive. Trustees may also be subject to being taxed at high marginal rates. The Australian Tax Office has instructed its officers to delicately examine trust deeds and amendments to resolve issues arising from assessing the net income of a trust. Therefore it is in your best interests to get your family trust in order.

• Family Trust
• Trust Distribution Minutes 11/12
• Family Trust Update Bamford
• Family Trust Update Trustee