Overview
Legislative amendments effective 1 July 2010 permit differential streaming of capital gains and franked dividends by a trust. However, the effectiveness of streaming other classes of income remains unsettled as a result of FCT v Bamford [2010] HCA 10 and FCT v Greenhatch [2012] FCAFC 84 and Treasury failing to publish a view.
The better view is that a trustee can differentially stream all classes of income (other than income under the foreign tax credit provisions). The entitlement to differentially stream under the foreign tax credit provisions remains unclear and legislative amendments similar to those effected for franked distributions should be made.
Legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax Assessment Act 1997 (ITAA 1997) and the Taxation Laws Amendments (2011 Measures No. 5) Act 2011 (TLAM 5 2011).
Streaming
Effective tax planning for trust distributions has involved the appointment of different classes of distributable income and capital with associated tax attributes to those beneficiaries that can benefit most from the tax attributes.
A trustee may wish to differentially appoint to beneficiaries capital gains, franked dividends, non-resident beneficiary income, exempt income, non-assessable, non-exempt income, dividend, interest or royalty income subjected to withholding and foreign tax credits.
Blended Assessable Income
FCT v Bamford held that the assessable income of a beneficiary includes a ‘blended’ amount of all classes of income and capital gains of a trust’s taxable income (FCT v Bamford at [45]; FCT v Greenhatch at [31]).
For capital gains tax (CGT) purposes prior to 1 July 2010, FCT v Greenhatch held that the reference to ‘part of the trust amount attributable to the trust gain’ was a proportional concept and there was nothing in the language of the provision for going behind the proportionate share to determine, in a causative sense, the components of the assessable income (FCT v Greenhatch at [36]).
Accordingly, unless a specific provision goes behind the proportionate share (a ‘blended’ amount) to determine the component (class) of assessable income, differential streaming cannot occur of that class of income. The trustee’s attempt to differentially distribute trust law income to differentially stream assessable income is ineffective.
In FCT v Greenhatch, the concepts of ‘part’ and ‘attributable’ did not determine the component (class) of assessable income for CGT purposes.
For franked distributions (dividends) purposes prior to 1 July 2010, Treasury considered there was uncertainty whether the reference to the beneficiary’s share of a franked distribution being ‘so much’ of the franked distribution of the trust ‘as is taken into account in working out’ the amount assessed to the beneficiary effectively determined the component (class) of assessable income despite the example in s. 207-35(3) ITAA 1997 of differential streaming of franked distribution (Improving the taxation of trust income March 2011 at [3.1])
The concepts of ‘so much’ and ‘taken into account’ the ‘amount assessed to the beneficiary’ could be interpreted proportionately or as determining the component (class) of assessable income. Commentators assert the later interpretation is obvious by reference to the differential streaming example in s. 207-35(3) ITAA 1997.
TLAM 5 2011 amended the CGT and franked distribution provisions to include in a beneficiary’s assessable income ‘the amount’ of the capital gain or franked distribution to which the beneficiary is ‘specifically entitled’ (received, reasonably expected to be received and referable to the capital gain) and a proportionate share of any capital gain or franked distribution amount to which no beneficiary or trustee is specifically entitled (ss. 115-227 & 207-58 ITAA 1997).
The reference to ‘amount’ (a non-proportionate concept) goes behind the proportionate share and ‘specifically entitled’ establishes, in a causative sense, the capital gain and franked distribution component (class) of assessable income of the beneficiary.
While the amendments corrected the law for CGT purposes and clarified the law for franked dividends, the amendments also enacted new policy considerations and restrictions. The review into the taxation of trust income may be more concerned with enacting new policy considerations and restrictions than clarifying the entitlement to stream.
Other components (classes)
The manner and clarity in which the legislation establishes a causative relationship to the components of assessable income varies significantly.
The dividend, interest and royalty provisions provide the clearest causative relationship.
A beneficiary who is presently entitled to a dividend, to interest or to a royalty (on which withholding tax has been paid) included in the income of a trust shall be deemed to have derived income consisting of that dividend, interest or royalty at the time of becoming so presently entitled (ss. 128A & 128AF ITAA 1936 and see also the deeming in s. 6B ITAA 1936).
The concept of ‘present entitlement’ relates to the legal rights created by the trustee in trust law income by the distribution resolutions (Harmer v FCT [1991] HCA 51 at [8]). By referring to ‘present entitlement’ to trust law income rather than assessable income, the language of the provision goes behind the proportionate share to determine, in a causative sense, the components of the assessable income as connected to the dividend, interest or royalty.
Although expressed differently, s. 97 ITAA 1936 also provides a relatively clear causative relationship for the classes of the assessable income of a non-resident beneficiary, and the exempt income and the non-assessable, non-exempt income of the beneficiary.
The assessable income of a non-resident beneficiary includes ‘so much of the individual interest of the beneficiary in the net income of the trust’ (ss. 97(1)(a) & 98A ITAA 1936).
The exempt income of a beneficiary includes ‘so much of the individual interest of the beneficiary in the exempt income of the trust’ (s. 97(1)(b) ITAA 1936)
The non-assessable, non-exempt income of the beneficiary includes ‘so much of the individual interest of the beneficiary in the non-assessable, non-exempt income of the trust’ (s. 97(1)(c) ITAA 1936)
In each of these provisions, the concepts of ‘so much’ could be interpreted proportionately or as determining the component (class) of income. However, the better view is that the reference to ‘the individual interest of the beneficiary in’ establishes, in a causative sense, the component (class) of assessable income of the beneficiary so differential streaming is effective.
The foreign tax credit provision are the least clear regarding streaming.
A beneficiary is entitled to a credit for foreign tax paid on income derived by a trust from a foreign source to the extent that the taxed amount is taken, because of s. 6B ITAA 1936 to be attributable to another amount of income of a particular kind or source (ss. 770-130(3) and 770-10 ITAA 1997).
An amount of income to which a beneficiary is presently entitled is deemed derived from a particular source if the amount of income can be attributed, directly or indirectly, to income derived from that source (ss. 6B(1)(b), (1A)(b), (2)(b), (2A)(b) & 6B(3) ITAA 1936).
The concepts of ‘the extent’ and ‘attributable’ to income of a particular kind or source’ suffers from the same type of uncertainty identified by Treasury in respect of franked distributions. Unlike the example in s. 207-35(3) ITAA 1997 for franked distributions, the example in s. 770-130(3) ITAA 1997 is not illustrative of differential streaming. In the example, all foreign and Australian source income is distributed to the sole beneficiary.
Conclusion
FCT v Greenhatch establishes the test for going behind the proportionate share (‘blended’ income) rule to determine, in a causative sense, the components (class) of the assessable income.
When the test is applied, the better view is that a trustee can differentially stream all classes of income (other than income under the foreign tax credit provisions). Legislative amendments to clarify the law are unnecessary.
The entitlement to differentially stream under the foreign tax credit provisions remains unclear. The uncertainty would be settled by amendment similar to those effected for franked distributions by TLAM 5 2011.