Towards the end of each year trustees of discretionary trust start considering how the trust’s income is going to be distributed. Part of this process involves understanding the tax consequences of distributing the income to the prospective beneficiaries.
Taxation of trust income is an area that has been under significant scrutiny by the ATO for a number of years. While the legislation that deals with taxation of trusts has remained largely unchanged, the ATO has changed its interpretation on how the tax law should be administered. In recent times, there have been some significant case law decisions that have changed the way trust income is dealt with.
Not to mention that there’s the proposed changes arising from the 2026/27 Federal budget, but for now let’s worry about the current year.
There are various elements that a trustee needs to understand when making a resolution to distribute trust income.
This starts with understanding how the trust deed defines “trust income” (assuming it does define it at all), and what powers the trustee may have to treat any other amounts as being included in trust income. The amount of the trust’s taxable income that the beneficiary is going to be assessed on will be proportional to the share of the trust income that the beneficiary is entitled to at year end.
Taking this the next step further, does the trustee have the ability to stream the trust income? Streaming allows the trust to collect certain types of income, record them separately, and distribute that type of income to different beneficiaries. While the trust deed may allow various types of income to be streamed, streaming is generally limited in practice to capital gains and franked distributions as the streaming of these types of income are the only ones that are allowed for tax purposes.
Streaming of capital gains can ensure the 50% discount is retained, while the streaming of franked distributions, and therefore the associated franking credits, to certain beneficiaries can lead to better overall outcomes.
It can be very difficult for the trustee to know with certainty what the trust income will be for the year, and subsequently what the trust’s taxable income will be. Trustees will need to keep open minds about how the trust income will be distributed.
When considering who to distribute the trust income to, the trustee should ensure that the proposed recipient is an eligible beneficiary under the trust deed.
The recent Owies case put the spotlight on the trustee’s duty to understand the current circumstances of its beneficiaries as part of the process of deciding how the trust income is distributed. Consequently, it may be prudent to make those enquiries and document the findings.
Care will need to be taken in the event that the trust has made a Family Trust Election or Interposed Entity Election. Where one of these elections has been made, the trustee may wish to ensure that the trust does not distribute income to an entity does not fall within the “family group”. Doing so could lead to the trustee being liable for a 47% Family Trust Distribution Tax on that distribution.
So, with the above information on hand the trustee can now make a resolution to distribute the trust income. While it is possible that individual trustees (not corporate trustees) could make a binding and effective oral resolution, the trustee have the burden of proof in relation to their tax affairs, especially in the event of a dispute with the ATO. A written record will provide better evidence of the resolution and avoid a later dispute with the ATO as to whether any distribution of income was effectively made by 30 June.
Ideally the relevant resolutions will be well thought through and documented in a way that outlines what powers the trustee has used and states in an unambiguous way who the trustee is distributing the trust income to. This will ensure that it is the beneficiary who will be taxed on the trust’s taxable income instead of the trustee.
There are many more factors, trust-wise and tax-wise, that the trustee will need to be aware of. As tax advisor, please ensure that you consider these factors and are making fully informed income distribution resolutions when advising clients.
If you would like to discuss these matters, please contact Ross Prosper.