By Michael Carruthers

The streaming rules can be an important tool in tax planning for trust clients.  However, the rules can be complex to apply in practice and many practitioners are unsure when they should actually be looking at the rules.  We’ve composed this list of frequently asked questions and answers to help identify when the rules apply and some of the practical issues that often emerge.

1. What if a trust deed is silent in relation to streaming?

   The legislation and accompanying explanatory memorandum do not deal specifically with the situation where the trust deed is silent in relation to streaming.

   The ATO’s previous view was that streaming could still be tax effective if the deed was silent on this issue as long as the records maintained by the trust were sufficient to identify the different classes of income that had been derived by the trust and distributed to the beneficiaries. At this stage, it is not entirely clear whether the ATO will take a similar approach when applying the new rules.  However, the ATO has made the following comment in a fact sheet dealing with the new streaming rules:

   “These amendments do not give trustees a power to stream if they do not already have this power, express or implied, under the trust deed. A streaming power may be implied if the deed confers on the trustee a power to distribute income or capital at the trustee's absolute discretion and there is nothing further in the deed or trust law in the relevant jurisdiction that fetters that power.”

   If you come across a trust deed that does not specifically allow streaming, then it would be worth considering whether the deed should be amended.  Legal advice should always be sought in relation to any proposed changes to trust deeds!

2. When would a trustee consider streaming franked dividends?

   Streaming of franked dividends would normally be considered in the following situations:

   • When there are both resident and non-resident beneficiaries and the trustee wants to ensure that the resident beneficiaries can obtain the full benefit of the franking credits;

   • Where the trustee is planning to distribute income to a company and that company is likely to be in a loss position (i.e., the excess franking credits would be converted into carried forward tax losses that would be trapped in the company); or

   • Where the trustee is planning to distribute income to a second trust and that trust is likely to be in a loss position (i.e., which could lead to the franking credits being trapped in the second trust).

3. When would a trustee consider streaming capital gains?

   Streaming of capital gains would normally be considered in the following situations:

   • Where the trust has made a discount capital gain and is planning to distribute income to a corporate beneficiary (in which case the benefit of the discount would be lost to the extent that the capital gain is attributed to the company);

   • Where the trust has made a discount capital gain and is planning to distribute income to a non-resident beneficiary or temporary resident (non-residents and temporary residents cannot generally access the CGT discount from 8 May 2012);

   • Where one or more beneficiaries have capital losses that could be offset against the capital gains attributed to them; or

   • Where the trust has made a capital gain from a foreign source and has a non-resident beneficiary (it would be necessary to consider the foreign tax implications of distributing to a non-resident beneficiary).

4. Can the trustee stream other types of income? For example, can the trustee stream foreign source income to non-resident beneficiaries?

   The ATO’s current view on this issue seems pretty clear.  See the comments below from an ATO fact sheet on the trust streaming rules:

   “The tax attributes of other types of income besides capital gains and franked distributions cannot be separately streamed to different beneficiaries in the way that capital gains and franked distributions may be streamed. Under the general trust-assessing provisions in the tax law, each beneficiary is taxed on a proportionate share of each component of net income and cannot be treated as having a share of net income that consists of one category of income.

   It is only under separate provisions, such as those dealing with capital gains and franked dividends, where a beneficiary may be taken to have derived income of a particular character. The tax effectiveness of streaming particular types of income to particular beneficiaries will depend on the effect of relevant tax law provisions.”

   For example, if we follow the ATO’s view this means that it would not be possible to stream foreign income specifically to a non-resident beneficiary for tax purposes. The foreign income would be split on a proportionate basis amongst all the income beneficiaries.
   Gold and Platinum Members read on for how the Courts view this in Federal Commissioner of Taxation v Greenhatch [2012] FCAFC 84

   
   

   

   Despite the ATO’s views on this issue, some practitioners and commentators suggest that this approach may not always be technically correct. For example, when it comes to distributions of unfranked dividends or interest to non-resident beneficiaries, the withholding tax provisions could potentially enable a form of streaming as they operate outside the general trust rules.

   Given the ongoing uncertainty around this issue the Commissioner intends to provide guidance in the form of public rulings on the issue of whether streaming of certain types of income to non-residents (e.g., foreign income, dividends, interest and royalties) can be tax effective. The Commissioner will also provide guidance on the streaming of foreign income on which foreign tax has been paid.

5. Can the franking credits still be claimed if the trustee does not stream franked dividends to specific beneficiaries?

   Yes, assuming the trust has positive trust income and taxable income and the beneficiaries satisfy the holding period rules. The franked dividends and franking credits will be split amongst the income beneficiaries on a proportionate basis.

6. What happens to the franking credits if the trust is in a loss position?

   If there is no net taxable income in the trust for the year then the franking credits will remain in the trust and cannot be used by the beneficiaries regardless of whether the trust has a positive amount of income as determined under the trust deed. The franking credits cannot be carried forward to a future year and will effectively be lost. The trustee cannot claim a refund of the franking credits.

   If there is a positive amount of net taxable income in the trust, but the income of the trust (as determined in accordance with the trust deed) is negative or nil, then the franking credits would also remain trapped in the trust. The trustee should be able to claim an offset for the franking credits, but would not be able to claim a refund of any excess franking credits.

   Even if the trust has positive taxable income and positive trust deed income, there is still a risk that the franking credits will be trapped in the trust. This can occur when the following conditions are present:

   • The trust only has positive trust deed income because capital gains are included in the income of the trust (i.e., the trust would have no trust deed income if capital gains did not form part of trust income); and

   • The trustee makes one or more beneficiaries specifically entitled to all of the capital gains.

   One way to avoid this adverse impact on the franking credits is to ensure that no beneficiaries are made specifically entitled to all of the capital gains. However, the trustee would still generally want to ensure that beneficiaries are presently entitled to all trust income for the year, including the capital gains that form part of trust income.

7. Does the definition of income in the trust deed matter under the new rules?

   It will still be vital to ensure that the trust deed is reviewed in order to confirm whether the trust has income that is available for distribution. Also, the application of the modified version of the proportionate approach will depend on the definition of trust income in the trust deed.

   For example, assume that the ABC Trust generated a loss from a rental property of $200 and derived a gross capital gain of $600 (subject to the CGT discount). It's necessary to review the trust deed to determine whether the trust has any income for the year that can be distributed. Three of the possibilities are as follows:

   • If the deed is silent as to the meaning of trust income the capital gain will not form part of trust income. The trust will have a loss of $200 and would have no income available for distribution. If the trustee makes beneficiaries specifically entitled to the capital gains (i.e., by making a capital distribution) then the beneficiaries should be taxed on the capital gains and the discount may still be available. However, if the trustee does not make beneficiaries specifically entitled to the capital gains they will be taxed in the hands of the trustee and the CGT discount will not be available.

   • If the deed includes gross capital gains in the definition of trust income then the income will be $400 for the year. In order for streaming to be effective, the trustee would need to make beneficiaries specifically entitled to the capital gains. If the trustee simply makes the beneficiaries presently entitled to all of the trust income but does not make any beneficiaries specifically entitled to the capital gains then the capital gains will be taxed in the hands of the beneficiaries under the proportionate approach.

   • If the deed equates trust income with taxable income then trust income will be $100 for the year. The exempt portion of the capital gain will form part of trust capital. If the trustee wants to make the beneficiaries specifically entitled to all of the capital gains they would need to make an income distribution and a capital distribution.

8. If a trust makes a discount capital gain, can the trustee distribute the exempt portion to one beneficiary and the taxable portion to another beneficiary?

   This would not be effective for tax purposes. Each of the beneficiaries would be assessed on 50% of the taxable capital gain that was made by the trust as they have each received 50% of the net financial benefit referable to the capital gain.

9. If a trust makes a discount capital gain and a non-discount capital gain, can the trustee distribute the discount capital gain to an individual beneficiary and the non-discount capital gain to a corporate beneficiary?

   Yes, it is possible to identify and stream specific capital gains made by the trust to particular beneficiaries.

10. What happens if the trust has positive franked dividends and/or capital gains but there is a rental loss?

    The legislation operates in order to reduce the taxable portion of the franked dividends and/or capital gains on a pro rata basis. The rules require you to calculate a “rateable reduction percentage” which is then applied to the franked dividends and/or capital gains. The rateable reduction percentage is calculated as:

    Taxable income of the trust (excluding franking credits) / (Net capital gain + net franked dividends)

    This reduction would also be required if the trust’s only income is from franked dividends and capital gains and the trust has general management expenses.

Michael Carruthers is the Tax Director for Knowledge Shop.  His upcoming training day, Tax Planning & Trusts, is coming up in Perth on 16 September, Sydney on 20 September, Brisbane on 7 October and Adelaide on 9 December.

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

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