Chapter 2 Trusts National Core Accounting Publications 1
Chapter 2 Trusts © National Core Accounting Publications 1
Overview Definition of a trust A trust is established whenever there is a separation of the legal ownership from the beneficial or real ownership of an asset. It is established under State law. Trusts are not defined by the ITAA. A trust of property or income may be described as a fiduciary obligation imposed upon a person (trustee) to hold property or income for a particular purpose, or for the benefit of others (beneficiaries). © National Core Accounting Publications 2
Overview Trusts are created for many purposes and come in many forms such as: • trusts created to hold investment assets separately from personal or business assets, to provide staff and/or equipment, or to act as an employer entity. • trusts set up under a will to ensure that the members of the deceased's family are provided for from the deceased's estate. • superannuation (trust) funds established to provide superannuation benefits. • property trusts used to hold property for the benefit of unit holders. © National Core Accounting Publications 3
Trust Terminology The following terms need to be understood in relation to trust law: § § § Settlor Trust property Trustee Beneficiaries Trust deed Corpus Trust estate Legal disability Present entitlement Trust inter vivos Will trusts Vesting day © National Core Accounting Publications 4
Trust Terminology Settlor is the person who creates the trust. also called the creator. Trust property is the property to which trust obligations arise. may consist of money, real estate, shares, or personal property. © National Core Accounting Publications 5
Trust Terminology Trustee Has legal title to trust property under the terms of the trust instrument, but does not derive any benefit from that property. A trustee may be a natural person or a company. Owes a duty of care to the beneficiaries in relation to that property. © National Core Accounting Publications 6
Trust Terminology Beneficiaries Are the persons, objects or purposes nominated to receive the benefit of the trust property. A beneficiary does not have to be a person. e. g. A trust could be established for the purpose of providing "care and attention for lost dogs“. © National Core Accounting Publications 7
Trust Terminology Trust deed Is the written document that sets out various matters relating to the trust. e. g. name of the settlor, trustee, beneficiaries, powers of the trustee. Corpus Is the capital of the trust. Trust estate Is the trust property from which income may be derived. © National Core Accounting Publications 8
Trust Terminology Legal disability exists where a beneficiary: is a minor (infant) i. e. under 18 years is an undischarged bankrupt is certified as insane is serving a prison sentence cannot demand their share of trust income because of a condition of the trust instrument © National Core Accounting Publications 9
Trust Terminology Present entitlement For a beneficiary to be presently entitled to trust income the following two conditions must be satisfied: i. the trust income must be legally available for distribution to the beneficiary (i. e. the beneficiary has the right to demand immediate payment). ii. the beneficiary must have an indefeasible and absolute interest in possession in the trust income. © National Core Accounting Publications 10
Trust Terminology Trust inter vivos Is a trust created during the life of the settlor and operates during that period. e. g. a discretionary trust established to conduct family business. Will trusts • arise from the death of the taxpayer. • the income and assets (corpus) of the deceased estate are distributed in accordance with the terms of the will. © National Core Accounting Publications 11
Trust Terminology Vesting day Vesting Day is the day that the Trust is to terminate, as stipulated in the Trust Deed or at such earlier date as determined by the Trustee. On Vesting Day the beneficiaries appointed by the Trustee in accordance with the terms of the Trust Deed are entitled to the whole of the Trust Fund. © National Core Accounting Publications 12
Liability of the Trustee A trustee has legal title to trust property, but does not derive any benefit from that property. Under tax law, a trustee is answerable as the taxpayer for the doing of all things required in relation to income derived by the trustee in a representative capacity. A trustee is not personally liable for taxes payable by the trustee in a representative capacity, except to the extent of any failure to retain sufficient moneys to pay them. © National Core Accounting Publications 13
Liability of the Trustee A trustee is answerable as the taxpayer for the doing of all things required in relation to income derived by the trustee in a representative capacity, including its tax obligations. The trustee may become liable for damages for any failure to comply with the terms of the trust deed. A trustee is not personally liable for taxes payable by the trustee in a representative capacity. Any liability to pay tax will be met from the trust estate income. © National Core Accounting Publications 14
Types of Trusts Discretionary trusts The trustee has the discretion to vary proportions passed on to beneficiaries, or even vary the beneficiaries. Fixed trusts The beneficiaries receive specific proportions of the trust estate. The trustee has no authority to vary these proportions. Unit trusts Are a variation of fixed trusts. The beneficial ownership of the trust property is divided into a number of fixed units (e. g. property or cash management trusts). © National Core Accounting Publications 15
Types of Trusts Deceased Estate trusts Arise from the death of a taxpayer. Family trusts Distributions are made to a defined set of family members. Testamentary trusts Is a trust established by Will where deceased estate property is held by the trustee on trust for beneficiaries. © National Core Accounting Publications 16
Net Trust Income (NTI) The net trust income of a trust is its assessable income for the year of income less deductions. Note that trust deductions do not include personal expenses incurred or paid by the trustee on behalf of the beneficiaries. Such payments are treated as distributions of s. 95 NTI to the beneficiaries. © National Core Accounting Publications 17
Net Trust Income (NTI) Under s. 95(1) NTI is: Assessable Income less Deductions equals NTI © National Core Accounting Publications 18
Illustration: Calculation of NTI Assume a discretionary trust had the following transactions during the income year: § Gross income - $35, 000 § Operating expenses - $12, 000 § Education expenses paid by the trustee on behalf of the beneficiaries - $5, 000 Required: Calculate s. 95 NTI. Solution: s. 95 NTI is: Gross income of trust less Operating expenses $ 35, 000 12, 000 23, 000 The $5, 000 is treated as a distribution of the $23, 000 NTI. © National Core Accounting Publications 19
Taxation of Trusts A trust is not a separate taxable entity. However, a Trust tax return (Form T) must be lodged for a trust estate irrespective of the amount of income derived by the trust. A Trust tax return requires the completion of a Statement of Distribution. © National Core Accounting Publications 20
Taxation of Trusts A trust is required to determine its net trust income and lodge an income tax return - Form T irrespective of the amount of income derived by that trust. Taxation - Trustee or Beneficiary? The major difficulty lies in determining on whom, and in what circumstances, does the tax burden fall - on the trustee or on the beneficiary? © National Core Accounting Publications 21
Taxing Trust Income Trust income is taxed either to the beneficiary or to the trustee as follows: The beneficiary is assessed if they are presently entitled to income of the trust estate, and are not under a legal disability. The trustee is assessed on behalf of a beneficiary who is presently entitled but is under a legal disability. © National Core Accounting Publications 22
Taxing Trust income The trustee is assessed on net income of the trust estate to which no beneficiary is presently entitled. If income is retained by the trust, the trustee is generally taxed at the highest marginal rate plus Medicare Levy. © National Core Accounting Publications 23
Liability to Pay Tax The trustee is assessed if: A beneficiary is presently entitled or deemed presently entitled (under s. 95 A(2) ITAA 36) but is under a legal disability then under s. 98(1) & (2) ITAA 36 respectively, the trustee is assessed on the share of NTI income on behalf of the beneficiary at ordinary rates of tax. There is income to which no beneficiary is presently entitled the trustee is assessed under s. 99 A ITAA 36 at a special penalty flat rate of 45% for 2013/14. © National Core Accounting Publications 24
Liability to Pay Tax The beneficiary is assessed if: They are presently entitled and not under a legal disability, then are assessed on their share of net trust income under s. 97 ITAA 36 at ordinary tax rates. under a legal disability and are entitled to a share of income from another trust or derives income from other sources, then under s. 100 ITAA 36 that beneficiary must include income from all sources in their tax return and are accordingly assessed. However, the beneficiary is also able to receive a tax credit for tax paid or payable by the trustee under s. 98 ITAA 36. © National Core Accounting Publications 25
Illustration: Calculation of s. 100 Credit and Tax Payable Dave, aged 19, cannot receive his share of net trust income until age 21 under the terms of a trust. His share of the net trust income is $21, 000 and his gross wages are $7, 500 (PAYG $900) for the current income year. Assume tax paid by the trustee under s. 98 ITAA 36 on the $21, 000 is $132. 80 (i. e. tax on $21, 000 ($532) plus Medicare Levy ($45. 80) less Low Income tax offset ($445)). Required: Calculate Dave’s taxable income and tax payable. © National Core Accounting Publications 26
Illustration: Calculation of s. 100 Credit and Tax Payable Solution: Taxable income is: Gross Wages Share of net trust income Tax Payable is: Tax on $28, 500 less Low income tax offset s. 100 credit Medicare Levy less PAYG withheld Balance Payable $ 7, 500 21, 000 28, 500 $ 445. 00 132. 80 1, 957. 00 577. 80 1, 379. 20 427. 50 1, 806. 70 900. 00 906. 70 © National Core Accounting Publications 27
Taxation of Discretionary Trust Income Where a beneficiary is not presently entitled to the net income of the discretionary trust, the tax liability will rest with the trust. This income is taxed at a flat rate of 45% plus Medicare Levy. If the beneficiary is presently entitled and is not under a legal disability, they are liable for tax - s. 97 ITAA 36 at ordinary marginal tax rates. © National Core Accounting Publications 28
Taxation of Discretionary Trust Income Where a beneficiary is presently entitled, but is under a legal disability, the trustee will be liable to pay tax on the beneficiary’s behalf - s. 98 ITAA 36. The Trustee may determine in a particular year not to distribute any proportion of the net income of the trust, but to accumulate that income as an addition to the Trust Fund. In these circumstances, the Trustee is liable to pay tax on the net income of the trust at the highest personal marginal tax rate. © National Core Accounting Publications 29
Discretionary Payments Under s. 101 ITAA 36 where a trustee is given discretionary power to make payments out of trust income to benefit a beneficiary such payments are deemed to be distributions of income to which the beneficiary is presently entitled. e. g. school fees, medical expenses. © National Core Accounting Publications 30
Discretionary Payments Such payments are assessed by: s. 97(1) ITAA 36 - beneficiary is assessed (when the beneficiary is not under a legal disability). or, s. 98(2) ITAA 36 - trustee is assessed (when the beneficiary has a legal disability). © National Core Accounting Publications 31
Summary of Tax Liability When a Beneficiary will be Taxed In most cases a beneficiary will be assessed on trust estate income if they are: § Presently entitled to any of the net income of the trust, § Are not under a legal disability, and § Are a resident for tax purposes for the year of income. © National Core Accounting Publications 32
Summary of Tax Liability When a Trustee will be Taxed A trustee will be assessed on trust estate income when: § A beneficiary is presently entitled to any of the income of the trust estate, but is under a legal disability. § A beneficiary is deemed to be presently entitled to trust estate income (i. e. vested interest) but is not yet entitled to a distribution. § A beneficiary is a non-resident for tax purposes for the year of income but is presently entitled to income of the trust estate. § The trust is a revocable trust. © National Core Accounting Publications 33
Deceased Estates A deceased estate is a trust comprising: • assets of a deceased person (the trust property), • beneficiaries (usually those named in the deceased's Will), and, • the executor (usually the legal personal representative) appointed in the Deceased's Will. © National Core Accounting Publications 34
Deceased Estates Role of Executor The executor is responsible for: § the collection of the deceased's assets § payment of any outstanding debts § making distributions to the beneficiaries in accordance lodging a Form I tax return for income derived by the deceased up to the date of death § lodging a Form T for the income derived by the deceased estate © National Core Accounting Publications 35
Deceased Estates Administration period § Is the time period between the deceased’s date death and the granting of probate. § Until the administration of the deceased estate is complete, any income derived by the trust estate is regarded as income to which no beneficiary is presently entitled and is assessed under s. 99 or s. 99 A ITAA 36. § Generally, assessable income accrued at the date of the taxpayer's death, but which is received after that date is assessable to the trustee under s. 101 A ITAA 36. © National Core Accounting Publications 36
Deceased Estates Probate § Probate is granted by the Supreme Court in the State or Territory in which the will is lodged. § Granting of probate means that the court recognises the Will as being both valid and authentic. © National Core Accounting Publications 37
Illustration: Determination of administration period Assume date of death is 31 July and probate is granted on 1 October. Required: Determine the administration period. Solution: The administration period is 1 August to 30 September. © National Core Accounting Publications 38
Deceased Estates Post Probate § Once probate has been granted the assets of the deceased estate should be distributed to the beneficiaries without delay. § Any income derived post-probate is legally available for distribution. © National Core Accounting Publications 39
Deceased Estates Taxation of Deceased Estates © National Core Accounting Publications 40
Deceased Estates Taxation of Deceased Estates © National Core Accounting Publications 41
Tax Rates for Deceased Estates Beneficiary not presently entitled First three income years For the first three tax returns, the deceased estate income to which no beneficiary is presently entitled is taxed at the general individual rates, with the benefit of the full tax-free threshold – s. 99 ITAA 36. No Medicare Levy is payable. Fourth income year and later For deceased estates with prolonged administration that extends beyond the concessionally taxed three year period, there are special progressive trust tax rates that apply. However, no Medicare Levy is payable. © National Core Accounting Publications 42
Tax Rates for Deceased Estates Beneficiary presently entitled and not under a legal disability Where a beneficiary is presently entitled and not under a legal disability, that beneficiary is liable for any tax payable - s. 97 ITAA 36. © National Core Accounting Publications 43
Tax Rates for Deceased Estates Beneficiary presently entitled but under a legal disability Where a beneficiary is presently entitled, but is under a legal disability, the trustee will be liable to pay tax on the beneficiary’s behalf - s. 98 ITAA 36. The trustee will be assessed separately for each beneficiary in this category. The general individual tax rates apply. Normally, unearned income of minors is subject to tax at higher rates and a lower taxfree threshold. However, for distributions from a deceased estate, the ordinary tax rates apply. © National Core Accounting Publications 44
Illustration: Deceased estate Joseph Money died on 1 April 2013. Administration of the estate was completed before 30 June 2013. Estate records for the year ended 30 June 2014 were as follows: Receipts Professional fees - services rendered prior to death Interest income Net rental income Unfranked dividends $ 9, 000 1, 200 11, 600 Payments Legal expenses (collection of unpaid professional fees) Medical expenses - paid by Trustee on behalf of the deceased’s daughter out of her entitlement 1, 300 600 The will provides that Joseph’s widow is entitled to one-half of the net income of the estate; his daughter is to receive $5, 000 per annum, and the remainder is to accumulate for the benefit of his son until the son reaches the age of 21 years. The daughter, aged 21 years, is certified insane and the son is aged 19 years. Required: (a) Calculate s. 95 Net Trust income. (b) Describe how the net trust income will be distributed and assessed. © National Core Accounting Publications 45
Illustration: Deceased estate Solution: (a) s. 95 NTI is: Assessable Income Professional fees Interest Net Rental income Unfranked Dividend less Deductions Legal expenses $ 9, 000 1, 200 11, 600 $ 22, 400 1, 300 21, 100 (b) Amount legally available for distribution is: s. 95 NTI less * Net Professional fees = 9, 000 – 1, 300 © National Core Accounting Publications $ 21, 100 7, 700 13, 400 46
Illustration: Deceased estate Beneficiary Presently Entitled Yes Legal Disability No Amount $ 6, 700 ITAA Section s. 97 Tax Liability Beneficiary Daughter Yes Deemed by s. 101 Yes 4, 400 600 s. 98 Trustee Son Yes Deemed by s 95 A(2) Yes 1, 700 s. 98 Trustee Residue No n/a 7, 700 s. 99 Trustee Widow 21, 100 © National Core Accounting Publications 47
Trust Losses Trust losses are retained in the trust and are not distributed to the beneficiaries. Trust losses must be carried forward and offset against future trust income. © National Core Accounting Publications 48
Trust Losses Special trust loss tests apply to certain types of trusts such as discretionary and fixed trusts. These tests must be satisfied before a carry forward trust loss can be deducted against current year trust income. The tests are: § § 50% Stake test Income Injection test Pattern of Distributions test Control test © National Core Accounting Publications 49
Beneficiary with No Interest in Capital A life tenant is a beneficiary with an interest in the income of the trust for the duration of their life, but with no interest in the capital of the trust. If the trust includes a beneficiary who is a life tenant or a beneficiary with no interest in the capital of the trust, a deduction for tax losses of earlier income years cannot be claimed in calculating the share of those particular beneficiaries in the net income of the trust if the tax losses of previous years are required to be met out of corpus. © National Core Accounting Publications 50
Illustration: Beneficiary with no interest in capital The Rice Family Trust has trust losses of $2, 000 from previous income years. In 2013/14 its net income is $20, 000, excluding the past year losses. There are two presently entitled beneficiaries of the trust, each with a 50% interest in the income of the trust. Under the terms of the trust, losses are to be met out of corpus. One of the beneficiaries, Basmati, is a life tenant (i. e. has no interest in the trust capital (corpus)). The other beneficiary, Jasmin, has an interest in the capital of the trust. Required: Calculate s. 95 Net Trust Income and each beneficiary’s share. © National Core Accounting Publications 51
Illustration: Beneficiary with no interest in capital Solution: s. 95 NTI is: Net income less Trust losses brought forward (50% x 2, 000) Beneficiary’s shares are: Basmati: 50% x 20, 000 (Note 1) Jasmin: 50% x 18, 000 (Note 2) $ 20, 000 19, 000 $ 10, 000 9, 000 Note 1 – In calculating the net income of the trust for a life tenant’s share, no account is taken of earlier year losses. Note 2 – In calculating Jasmin’s share of net trust income, earlier losses are taken into account. © National Core Accounting Publications 52
Dividends Miscellaneous Franking credits are included in the calculation of s. 95 NTI. Beneficiaries of a trust who are presently entitled to a part of the trust income that is attributable to franked dividend income are entitled to a franking tax offset for this income. Trust Capital Gains/Losses Capital gains/losses are included in the calculation of s. 95 NTI. Trusts have access to both the general 50% CGT discount and the small business entity capital gains tax concessions where applicable. © National Core Accounting Publications 53
Illustration: Trust capital gains/losses The Windsor Family Trust had net trust income of $80, 000 for the year ended 30 June 2014. This included an assessable capital gain of $10, 000 (calculated after application of the 50% discount) and $70, 000 royalties. Charles, aged 61, is a beneficiary of the Windsor Family Trust and is entitled to a 40% share of net trust income. He also derived $90, 000 gross wages, and had a $1, 700 capital loss from sale of shares. Required: Calculate Charles’ taxable income. © National Core Accounting Publications 54
Illustration: Trust capital gains/losses Solution: Assessable Income Gross Wages $ 90, 000 Share of Net Trust Income (other income) 28, 000 (70, 000 x 40%) Net Capital Gain (10, 000 x 2 x 40% less 1, 700) x 50% 3, 150 Taxable Income 121, 150 © National Core Accounting Publications 55
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