'Colonial' decision released

Earlier in the month the long awaited 'Colonial' decision was released by the Federal Court.

Although, unlike other tax cases last year (such as Bamford and Thomas), the taxpayer was largely unsuccessful, the Colonial decision again reinforces that the provisions of the trust deed are critical.

For those interested the full title of the case is 'Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16' (Federal Court of Australia, Stone J, 18 January 2011).

In brief terms, the key aspects of the decision were as follows:

1. The main interest in the decision will be for the Australian funds management industry as it focussed on the tax effect of provisions in a unit trust that sought to allocate part of the taxable income to a unitholder redeeming units.

2. The tests that must be satisfied to meet the definition of a 'fixed trust' for tax purposes will be difficult for many unit trusts. Here the unit trust was held not to constitute a fixed trust, primarily due to the wide amendment power that allowed changes to be made to unitholders' entitlements. The ability to satisfy the Tax Act definition of fixed trust is important in a number of areas including -

(a) to carry forward tax losses;
(b) passing through franking credits to unit holders; and
(c) where superannuation funds are unitholders, avoiding application of the ‘non-arm’s length income’ rules (note that prior to 1 July 2007, these rules were called ‘special income’).

3. The attempt by way of variation to provide the trustee the discretion to allocate discounted and non-discounted capital gains to unitholders on redemption was ineffective.

As set out in the post on 17 December 2010, it has been confirmed that there will be a full review of the way in which trusts are taxed.

The Colonial decision further highlights the need for a comprehensive review of the existing rules and Stone J mentions the need for legislative change in this regard.

A number of commentators also believe the proposed managed investment trust attribution regime (due to take effect on 1 July 2011) may address many of the concerns raised in Colonial.
Until next week.

Bamford driven review of Tax Act

While I had flagged there would be no further post this year, the Government has made a mid December announcement yesterday worth noting.

As you will read elsewhere, it has been confirmed that there will be a full review of the way in which trusts are taxed.

Relevant extracts of Bill Shorten's announcement are set out below.

While there is obviously a long way to go, it is reassuring that the rumoured revisiting of the entity taxation regime has been expressly ruled out.
1. There are major uncertainties after Bamford, especially about the extent to which amounts derived by trustees retain their character (for example, as capital gains or franked dividends) when they flow through to beneficiaries.
2. A public consultation process (has been announced) as the first step towards updating the trust income tax provisions in Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) and rewriting them into the 1997 Act.
3. "In developing an initial consultation paper for release in the first part of 2011, Treasury will draw heavily on the expertise of the private sector, particularly through the established Tax Design Panel process and the Board of Taxation," said the Assistant Treasurer
4. "The options to be canvassed in public consultation will be developed within the broad policy framework currently applying to the taxation of trust income".
5. Any options will seek to ensure that net taxable income of a trust is assessed primarily to beneficiaries. Trustees will continue to be assessed only to the extent that amounts of net taxable income are not otherwise assessable to beneficiaries. The options will not include the taxation of trusts as companies, which would be a major departure from the current law.
6. “Based on advice I have sought from the Board of Taxation, I will also consider further whether there are any issues that must be addressed in this current tax year".
7. "Trust tax law has been an ongoing issue for some time and it is important to simplify the system, rewrite the rules and give more certainty to the many thousands of small businesses and farmers who use trusts. I encourage all interested stakeholders to make a submission to the consultation".

Final blog for 2010

With the annual leave season starting in earnest over the next couple of weeks and many advisers taking either extended leave or alternatively taking the opportunity to catch up on things not progressed during the calendar year, last week’s blog will be the final formal blog until 2011.

Similarly, the Twitter postings will also take a hiatus until the New Year.

Very best wishes for Christmas and the New Year period and thank you to all of those advisers who have read and the many advisers who have taken the time to provide feedback in relation to the blog postings.

Unpaid present entitlement warning

There can be a number of traps in relation to the provisions of a trust deed in the context of the Tax Office’s approach in relation to unpaid present entitlements (UPEs).

Arguably, the most concerning trust deed provision that we have seen in recent times is a clause in the deed of one provider that on a plain reading of the deed seems to automatically cause any UPE to become a loan at call.

Obviously, this provision can have significantly adverse consequences, particularly for those clients wishing to 'quarantine' UPEs that existed as at 16 December 2009.

Until next week.

Trustee indemnity case - Appeal

Even though the post last week touched on a court case that was relatively widely reported, the importance of the streaming decision meant I felt it appropriate to profile.

This week another court decision caught my eye, even though it was simply in relation to the granting of leave to appeal a previous decision.

Many readers will have noticed the 'Bruton Holdings' case from earlier in the year. In that case, a single court judge held that a corporate trustee was not indemnified by a trust for expenses incurred in (successfully) challenging the Tax Office. The lack of indemnity was largely based on the fact that the expenses were incurred after it had ceased to be trustee of the trust.

An appeal has now been granted against the original decision on the basis that -

(a) the issues are of general importance to the powers and rights of trustees; and
(b) the state of the law regarding the powers and rights of bare trustees is not settled.

Until next week.

Streaming decision released

There was confirmation last week from the Queensland Supreme Court that where a trust deed of a discretionary trust has appropriate powers and the trustee resolutions are appropriately crafted, a trustee can allocate franking credits differentially from net income.
For those interested the full title of the case is 'Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417' (Supreme Court of Qld, Applegarth J, 11 November 2010).
The decision turned to a large extent on the terms of the trust deed and the fact that the trustee:
(a) could treat franking credits as income of the trust capable of distribution;
(b) had discretion to distribute franking credits to different beneficiaries; and
(c) had the power to stream different categories of income between beneficiaries.
In light of the above powers, in brief terms, the key aspects of the decision were as follows:
1. selective allocation of franking credits is possible under section 207-35 ITAA 1997;
2. section 97 ITAA 1936 takes a proportionate approach to the distribution of net income (as set out in the Bamford decision);
3. section 207-35 is an exception to Division 6 (and therefore section 97) ITAA 1936;
4. franking credits need not follow the shares of net income included in a beneficiary's assessable income on an equal footing;
5. net income (under section 95 ITAA 1936) does not need to exceed the franking credits included in assessable income for those credits to pass through to beneficiaries; and
6. the ATO's comments that franking credits may not be able to form part of the income of a trust estate for trust law purposes because they are 'merely a tax concept which do not represent an accretion to the trust fund over and above the distributions to which they attach' could not be accepted;
7. ultimately, franking credits were held to have some attributes of income under the tax legislation, therefore they could be dealt with by the trustee.
Until next week.

What difference does 1% make?

Last week we were walking through an asset protection exercise with a business owner and one of the recommendations was that the family home (currently owned by the wife and husband as joint tenants) should be converted to tenants in common ownership and 49% of the total interest of the house owned by the husband was then to be transferred to the wife.

An earlier post touches on the difference between owning an asset as joint tenants as opposed to tenants in common - a summary of the distinction is available via the 'core services' section of the View Legal website (www.viewlegal.com.au).

Today’s post focuses on the reasons why an at-risk spouse might retain a 1% interest in a property.

The main reasons that an at-risk spouse would retain a nominal percentage interest can include:

1. Protection against spouse or relationship difficulties.

2. Protection against the majority owner seeking to encumber the property. In particular, if there is (for example) a gambling issue that arises, no mortgage may be taken out over the property without the consent of the spouse who owns the nominal interest.

3. For ease of security arrangements – often a financier will prefer to see the at-risk spouse’s name on title documentation, even if their actual ownership interest is nominal.

4. Stamp duty savings. This issue is not as relevant as in days gone by because generally there is no longer any substantial stamp duty benefit, even if both spouses retain an interest in the property.

In relation to stamp duty, it should be noted that in most states there are concessional provisions which apply where one spouse who owns 100% of a family home and transfers 50% (but no more or less) to their spouse and this is another concept that we may deal with in a future post.

Until next week.