Trusting your trust at tax time

If you are an SME that operates their business through a trust structure then you need to ensure that you have managed the formality of your trust distributions for this financial year.

Don’t look at this as something that you manage when the trust tax return is lodged or something that you can leave to your accountant. It is not that simple and if you do, it could come back to bite you.

Most family trusts are discretionary trusts. This is a non fixed trust whereby the trustee decides each year who to appoint the income to. As a beneficiary of the trust you do not have a right to the income until it is appointed to you by the trustee.

Prior to that time you merely have an expectation of a possible entitlement from the trust. Now if you are the trustee or control the trustee company then you might rightly take the view that you can decide the outcome of any distribution, so why all the fuss?

The answer is that for tax law purposes there are strict rules that determine both the right to income from a trust and the taxing point.

Where income is appointed to you then you are liable for the tax on that income. It forms a part of your assessable income for the year.

It is also possible for the trustee to not appoint the income to any of the beneficiaries. In this case the income is deemed to be income to which no beneficiary is presently entitled and in this case it is taxable in the hands of the trustee.

The tax level on this income is at the maximum tax rate. So the issue of appointment of income is an important one. It determines not only who is entitled to the income but also the taxation of that income.

Where your trust distribution will create tax efficiency by income being received by beneficiaries who are on less than the maximum tax rate, then the cost of getting it wrong can be the difference between their marginal tax rate and the maximum rate.

Under trust law where the trustee does appoint income to the beneficiaries this should be done by June 30 of the relevant year. Administratively the Tax Office accepts that appointment of income by August 31 will be effective for tax purposes.

This is a concession by the Tax Office designed to allow trustees time to determine the final end year position and then decide on who the income is to be appointed to.

There is an obvious danger in not appointing the income of the trust by that time. The ATO could determine that there was no valid appointment of income and assess the trustee on the amount.

The appointment of income does not necessarily mean the payment of the trust distribution. It is the resolution of the trustee as to what income will be appointed to which beneficiaries. This resolution will normally be evidenced by way of a trustee minute.

Payment can be made at the same time or a later time, although where one of your beneficiaries is a company don’t allow that distributed amount to remain outstanding beyond the date of lodgement of the trust tax return.

Over the years many trusts have left it much later than August 31 to determine the appointment of income. This is an area that the ATO are increasingly looking at, and one that you don’t want to be caught out on.

It may seem like just paper work to you but you need to get the formality right on this one.

Talk to your accountant about your year end position and action your trustee’s resolution as early as possible – certainly well before the end of August.

Greg Hayes is a director of Hayes Knight and specialises in taxation and business planning advice.