Introduction
A previous article published in December 2013 focused on the potential pitfalls with trust deeds and the methodical approach which should be adopted when preparing trust distributions.
Regardless of whether a distribution is otherwise permissible, there are a number of particular types of distributions that should be carefully considered before they are made.
The three most relevant categories in this regard are as follows:
(a) trust to trust distributions;
(b) distributions to non-resident beneficiaries; and
(c) distributions to companies.
Each of these distributions are considered in turn below.
Unless otherwise flagged, all references to trusts in this article should be read as a reference to a ‘typical’ family discretionary trust with a range of beneficiaries including a wide range of family members and related trusts and companies.
Distributions from trust to trust
All Australian jurisdictions except for South Australia have a statutory perpetuity period of 80 years. In Victoria, Tasmania, Western Australia and the Northern Territory, the common law perpetuity period may also be adopted, that is ‘a life in being plus 21 years’.
Despite South Australia essentially abolishing the rule against perpetuities, section 62 of the Law of Property Act 1936 (SA) allows the court to dispose of any remaining unvested interests after 80 years on the application of a beneficiary.
Generally, when trust to trust distributions are made, the vesting date of both trusts should be considered. Where the recipient has a vesting date which is later than the distributing trust, the risk that the rule against perpetuities is breached is a relevant issue.
Historically, many advisers believed that if the vesting date of the recipient trust was later than the distributing trust, then this automatically caused a breach of the rule against perpetuities, making the purported distribution void.
However, the case of Nemesis Australia Pty Ltd (formerly Steve Hart Family Holdings Pty Ltd) v Commissioner of Taxation (2005) 225 ALR 576 confirmed that the ‘wait and see rule’ in section 210 of the Property Law Act 1974 (Qld) can be relied on in a situation where a trust distributes to another trust with a later perpetuity date.
The ‘wait and see’ rule means the initial distribution will not be void when made, and will not become void until such time as there is a failure to distribute out of the recipient trust before the vesting date of the original distributing trust.
Distributions from trust to non-resident beneficiary
When making trust distributions to non-resident beneficiaries, it is important to consider the interaction between section 128A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) in relation to withholding tax for non-residents and the general provisions of Division 6 ITAA 1936 in relation to the taxation of trust distributions.
Withholding tax will be payable on all dividends, interest or royalties included in the income paid by a resident trust to a non-resident beneficiary to the extent that the non-resident beneficiary is presently entitled to the relevant amount.
To the extent income is caught by the withholding tax provisions, section 128D ITAA 1936 excludes it from being treated as assessable income, which will potentially impact the Division 6 treatment of the relevant trust distributions.
For example, if a resident trust distributes income to beneficiaries in the United States (who are non-resident beneficiaries), then:
(a) under the withholding tax system, a flat rate is deducted from the source of the income before the income is sent overseas;
(b) each part of the income (depending on whether it is interest, dividends or royalty distribution) will be taxed on the relevant withholding tax rate, ranging between 10% and 15%; and
(c) if the beneficiary is not presently entitled to the distribution the withholding tax rules will not take effect.
For trust income distributions to non-residents where withholding tax does not apply, the amount will be taxed to the trustee under section 99 or 99A ITAA 1936, as outlined earlier in this article.
Distributions from trust to corporate beneficiary
Caution is required when distributing to a corporate beneficiary, in particular if it may result in the creation of an unpaid present entitlement (UPE) owing from a trust to the company.
Tax Ruling 2010/3 (TR 2010/3) and Practice Statement Law Administration 2010/4 (PSLA 2010/4), outline the ATO’s view that it is possible for a Division 7A loan to in effect arise from UPEs created after 16 December 2009.
Specifically, the Commissioner takes the view in TR 2010/3 that a UPE falls within the ‘financial accommodation’ definition of a Division 7A loan unless the terms of the arrangement fall within certain safe harbours.
While detailed comments about Division 7A are outside the scope of this article, some of the practical considerations relating to corporate beneficiaries are as follows:
(a) all pre 16 December 2009 UPEs should be ‘quarantined’ to ensure that they are not treated as Division 7A loans;
(b) trust deeds should be reviewed to ensure no clauses operate to deem or automatically convert UPEs into loans; and
(c) for post 16 December 2009 trust distributions to corporate beneficiaries, documentation that complies with the Commissioner’s stance under TR 2010/3 and PSLA 2010/4 should be implemented (for example, appropriate loan or sub-trust arrangements).
