Q&A: Passive income from trust distributions



Article from The Taxpayer, published April 2019

 A query that has come up a number of times from members relates to whether a trust distribution received by a company beneficiary will be treated as passive income. This is important to determine whether the company will be eligible for the 30% company tax rate or the 27.5% rate applicable to base rate entities.

Scenario

A company’s aggregated turnover is less than $25 million for the 2017-18 income year, with two sources of income:

  1. interest income of 4% of total income, and
  2. business income from a trust distribution (96% of total income).

Question

Will the company be classified as a base rate entity and be taxed at 27.5% for the 2018 financial year?

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Guidance

A corporate tax entity will qualify for the lower corporate tax rate if less than 80% of its assessable income is income of a passive nature, and for the 2017-18 income year it has an aggregated turnover of less than $25 million. (For the 2018-19 income year this threshold has been increased to $50 million.)

Reviewing the revised explanatory memorandum of the Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017, para 1.16 indicates that “…an amount that flows through a trust to a corporate tax entity (that is, directly from the trust to the corporate tax entity) will retain its character for the purposes of determining whether or not the amount is base rate entity passive income of the corporate tax entity”. It then goes on to say “if an amount derived by a trust is, for example, trading income which passes directly from the trust to a beneficiary that is a corporate tax entity, then the amount will not be the base rate entity passive income of the corporate tax entity because the trust distribution is directly referable to the trading income of the trust”.

Example 1.1 from the EM provides an example that includes a distribution via two trusts to a company:

Terrace House Pty Ltd is the sole beneficiary of the Mountain Trust. The Mountain Trust is the sole beneficiary of the Apples Trust.
The Apples Trust owns and operates a large orchard in the Victorian Alps. In the 2017-18 income year the Apples Trust produced $1 million in trading income and distributes all of its income to the Mountain Trust. The Mountain Trust then distributes all of its income to Terrace House Pty Ltd.
The trust distributions retain their character as trading income as they flow through the Apples Trust and the Mountain Trust.
Therefore, the trust distributions from the Mountain Trust to Terrace House Pty Ltd are not base rate entity passive income because they are indirectly referable to the trading income of the Apples Trust.


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