Trust Distributions and the Donkin Case

Published June 2020

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In this video, John Jeffreys, Tax Counsel, discusses the recent decision in a case that examined the effect of trust distribution minutes where the ATO made significant adjustments increasing the taxable income of the trust after year end. Who was to be assessed on the extra taxable income?


And now I want to go on and talk about Trust Distributions. And there is a recent case called Donkin, which is of interest, and I do recommend that you read the notes on this because it's an important issue particularly at this time of the year in relation to the way trust distribution minutes are made.

Now the issue in this case was whether increased amounts of net income, and here I'm talking about taxable income. Whether increased amounts of the taxable income of a trust should be assessed to a default beneficiary, which was a corporate beneficiary, or to the beneficiaries that originally were presently intitled to the income of the trust in the same proportions that those beneficiaries originally received that income. So the situation here, sorry I'll just go to that in a moment, now the taxpayer lost the case, and the commissioner won by saying that those proportions which were originally given in the trust distribution minute are the ones that should be used. And there was a question also here of penalties, again, 50% penalties, and should they be applied and in this case the tribunal decided that those penalties should not apply. And so that's interesting also.

So let's look at the facts of the case. This actually involved an accountant and an accounting firm at least that's was where the source of the money came from. So there was an accounting firm called Strategic Accounting Advisers Trust which I assume was a unit trust and its sole beneficiary was Joshline Family Trust. And the Joshline Family Trust then distributed its income to five individual beneficiaries at various times over the course of about four years. Now the balance beneficiary or the residual beneficiary was the trustee itself in its own right. And we'll look at the minute in a moment, which is the important part of the case. So this is what's happened, so originally there was these distributions to these individuals.

Now on the next slide we show you what they originally were, and then what the tax office changed the assessable income to be. So originally, take 30 June 2010, the taxable income of the trust as first returned was $81,958. The tax office came along and then made adjustments by denying some fairly significant tax deductions. Now we're not told what those tax deductions were and any of the information behind them, but it's just simply an accepted fact that those adjustments were correct. And the tax office made them. So you can see there that the new taxable income has increased to $377,912 on the 30th of June 2010 and so on in the other years there are also quite significant increases.

So the debate in this case was the question of, with this extra assessable income, who gets taxed on it? Does it get taxed to those individuals in the same proportions that they originally received, or does that excess get taxed to the corporate beneficiary in accordance with the distribution minute, which we're just about to go through?

Now this is an example of one of the distribution minutes and I've set it out here in full and I'm going to read it in full because it's important to understand the process that has been gone through by the trustee and the legal advisor to the trustee. So first of all, there is the determination of the trust law income. Okay, now I emphasise there the trust law income, not the taxable income of the trust. That can later be said to be that, but the first duty that a trustee has, when they're determining their trust distribution for a particular year, is to work out what is the trust law income of that trust. Now the way that has to be done, and the only way it can be done, is by referring to the deed of that trust to work out how the trustee, in respect of that particular trust, is given the powers to determine what is in, and what is out, of the trust law income. I know many accountants will simply default to the assessable income or the taxable income under Section 95 of the 1936 Act. And some deeds indeed do that, but you can't take that just as an assumption. The proper way to do it is first of all to determine what is the trust law income of the trust, and that's what they're doing here. So under the heading "Determination of income it was resolved that, in exercise of the power under Clause 6.5, (so that's good, they've gone to the deed and they've actually read the clause that gives the trustee the power to do this) in the definition of income in Clause 1 of the Trust Deed, the trustee determines that the income of the Trust for the year ending 30 June 2012 comprises all those amounts being income for purposes of the accounting records of the trust (now so the accounting records, okay), less the expenses and outgoings of the trust for the year ending 30 June 2012 attributed to those amounts for the purposes of the Accounting Records (in each case whether recorded in the Accounting Records) by or after 30 June 2012.

So I'll just stop there for a moment. So what's happened here is that the trustee has said: Okay, what is my trust law income for this year that I can distribute, and they would have been given certain powers, now what they've done is they've decided to say, basically, that it's what's in the accounting, not taxable income, what's in the accounting profit and loss. And that's a very valid thing to do. So just appreciate that to start off with, is that the trust law income, for this trust, is deemed to be the accounting profit if you like. That's my short-hand term for describing what they're saying. Now the next step in the process is having determined that accounting profit, how do I as a trustee distribute that to whomever I want to distribute it to.

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So under the heading of "Distribution of Income”, “It was resolved that in accordance with clause 3.1 and 3.2 of the deed of trust of The Joshline Family Trust (again, tick for that, we're going to the clause in the deed and we're saying, this is what's giving me the power to do this) that the income of the trust (remember that's been defined above) be distributed as follows: The necessary proportion of income such that the following amount is distributed" and then there's these four beneficiaries mentioned. So the first one is to child, Adeline, and "so much of the trust law income (which has been defined above) as is required to equate to $416 of assessable income."

So what this trust minute is doing is directly applying the Section 97 proportioned view, which was confirmed by the Bamford case back in 2010. So what they're saying is to work out the taxable income of a beneficiary, what you do is you work out the trust law income, and then you say "what proportion of that trust law income is the beneficiary getting?" Now that gives you a percentage. You multiply that percentage by the taxable income of the trust, or the net income under Section 95, and that gives you the amount which the beneficiary is to be assessed on. And so that's what this minute is doing. It's saying so much of that trust law income, which we defined under accounting principles, we want to give Adeline that proportion, which means that she ends up with $416 of assessable income, and so on for the other beneficiaries. Now it must have been that the taxable income of this trust was very near the total of those four amounts that are on the particular distribution minute, and my understanding from the case is that Joshline investments actually received nothing when their distribution was initially made.

So you can see that that's the way they've done it. And on the face of it, there's nothing wrong with this distribution minute. It is well-worded, and you've got a balanced beneficiary, and all of that's fine. But then, later on the tax office came along and adjusted the taxable income of the trust, and they got a result that they didn't want.

So the Commissioner argued that what should occur is that the excess that has been determined by the Commissioner, that is the excess taxable income, should flow to those individual beneficiaries in the same proportions that they originally received it. And that the corporate beneficiary shouldn't get any of it. And the tribunal agreed with the Commissioner. The tribunal said "yes, we think that's right", and what persuaded them is that when the trustee makes its first decision to distribute to the various beneficiaries, there needs to be a certain degree of finality to do, well, certainty and finality, to do with that decision. And so if we have the situation where the corporate beneficiary, after the events, gets a large amount of assessable income, and didn't get any in the first place, that doesn't sound like it was a certain decision in the first place. So therefore, the tribunal held in favour of the commissioner. So I would recommend that you think through that decision, and just think about the way your distribution minutes are drafted. Now one of the things that I do warn against to tax agents and accountants is using standard distribution minutes across your practice. That's fine if you've got the same trust deed for all of your clients, but if you use the same trust distribution minutes, particularly when you start talking about issues of specific entitlements, you're really heading down the path of making an error with your trust distributions.

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