5 Things Your Family Trust Needs To Do Before 30 June

5 Things Your Family Trust Needs To Do Before 30 June

Every year your accountant slips you a document says something about Bamford, and sends you an invoice. Ever wondered what that’s about? Well wonder no more.  Here’s the 5 things every family trust needs to do before 30 June (and the 5 things you’ve been outsourcing to your accountant and probably not realising);

  1. Read the Deed
  2. Define income of the trust fund
  3. Calculate the expected income (as defined)
  4. Decide who will get a distribution and how much
  5. Document that decision

 

  1. Read the deed

You know that 80 page document that you had to sign when your accountant or lawyer set everything up?  Yeah, that thing is important.  Think of it as the rules of the trust, it prescribes what you can and can’t do and what powers the trustee, and other positions have.

One of the sections of that document will talk about definition of income.  If you’re not an accountant or lawyer, that’s going to make no sense.   What do you mean define income? Income is income right?

Well, no. You see, because we like to make things complicated, and trust law dates back hundreds of years (Australia also refers way back to English case law at times), and the fact that there is no Trust Act, like there is Corporations Act, plus we also have another piece of legislation being the Income Tax Act,  the definition of income is…fluid…

Alright, this next bit isn’t going to be the most enjoyable thing you’ll ever read, but it’s important, and I’ve tried to cut all the boring shit out so stick with me.

  1. Define income of the trust fund

In basic terms, “income” includes;

a) Income according to ordinary concepts

This is the logical idea of income. My business is buying & selling widgets.  I sell a widget to you. You pay me in money. That money is income as everyone knows it (aka income according to ordinary concepts).

b) Statutory Income

This is when a piece of legislation says something is income even though you may not ordinarily think of it as income. The best example is when you sell an investment.  g You bought an investment property 10 years ago in Sydney. You sell said property now and make a squillion dollar gain. That gain doesn’t fall into income as you would normally think of it (because you’re not in the business of buying and selling property. It was just an investment, as in it was capital, not income). But the tax act, says nah, bugger that, that’s income, because when it’s income we can tax it. So statutory = statute = legislation. Income because the law says it is.

c) Accounting Income

This is the income you would see on a profit and loss statement, it would include both income according to ordinary concepts and statutory income, but then subjects all that to the accounting standards. This income figure can look vastly different to the underlying cash or business performance due to the operation of the accounting standards which includes things like revaluation of intangible assets like goodwill that effect the net profit number. So when it says Myer made a $500mil loss, $450mil of that was decreasing the value of goodwill, not a loss on selling clothes.

d) Taxable Income

Everyone’s heard of this one and it includes all 3 of the above, but then applies the Tax Acts (yes there are 2 income tax acts) to work out the income that you pay tax on (for example, the revaluation of goodwill in the accounting standards is not taxable income nor a tax deduction).

You still with me?

Good, because it’s going to get weird in a second. Buckle up.

So even though we have the different types of income above, trust’s can just do whatever they like when they write the deed. They can give the trustees the discretion to determine what income is going to be. So for example, the trustee could if the deed allowed it, say that selling widgets is not income this year, but the sale of the investment property was. Weird right? Why would you do that? Basically to screw around with what the beneficiaries get paid (are entitled to get paid) because and now this really important, the beneficiaries are only entitled to what the trustees say they are. So it doesn’t matter what the taxable income is or how much, the beneficiaries are only entitled to their portion of the income the trustees have determined is income.

Clear as mud? let’s try an example;

Example 1

Income according to ordinary conceptsStatutory IncomeAccounting IncomeTaxable IncomeIncome of the Trust Fund
Sale of widgets $100,000 $             –    $100,000    $100,000 $100,000
Profit on sale of Investment Property $            – $2,000,000 $2,000,000 $1,000,000 $           –
Increase in value of Goodwill $           – $              – $    500,000 $              – $           –
 $100,000 $ 2,000,000 $ 2,600,000 $1,100,000 $100,000

In the example 1, the beneficiaries of the trust, would only be paid $100,000 being the income of the trust fund, even though, they are going to get taxed on a far larger amount ($1.1mil – assuming they are eligible for the CGT 50% discount).

Example 2

Income according to ordinary conceptsStatutory IncomeAccounting IncomeTaxable IncomeIncome of the Trust Fund
Sale of widgets $100,000 $             –    $100,000    $100,000 $           –
Profit on sale of Investment Property $          – $2,000,000 $2,000,000 $1,000,000 $2,000,000
Increase in value of Goodwill $         – $           – $   500,000 $             – $           –
 $100,000 $2,000,000 $2,600,000 $1,100,000 $2,000,000

In example 2, the beneficiaries of the trust, would be paid $2,000,000 being the income of the trust fund, even though, they are only going to get taxed on $1.1mil (if they are eligible for the CGT 50% discount).

Now do you see why its important to read your deed? Most recent deeds will have a clause that says, unless the trustee resolves otherwise, the income of the fund will be the same as s95 of the Income Tax Act. S95 is the section that defines taxable income, but every deed is different. Even from the same accounting/law firm, they get updated for changes in law, or they may have wanted special things included or excluded when they got set up. Either way, you need to read the deed of your specific fund.

  1. Calculate expected income (as defined at 2) for the year

Either add it up yourself if its easier enough, or pay someone (like um us) to do it. This is a component of “Tax Planning” that everyone should do.

  1. Decide who will get a distribution and how much

Again, the deed holds the keys to who is eligible to receive a distribution. If they aren’t part of a class of beneficiaries in the deed, then they can’t be paid anything. E.g your trust can’t pay me that $2mil gain on the Sydney property (unfair I know) unless you’ve added me as a beneficiary to your deed (and if you would like to do that, you’re most welcome as long as you give me the cash).

You should consider here things like how much cash has the trust got, and the tax implications of making a distribution to each beneficiary.

Note if you fail to make a valid determination or don’t distribute all of the income, then the trustee gets to keep it. Oh and pay tax at the top marginal tax rate on it. Nice.

  1. Document that decision

Accountants  and lawyers throw around the term “trustee distribution resolution” or something similar to that. It’s a fancy way of saying document what you’ve done in Steps 1 to 4 above, then sign and date that documentation.

There you have it. That wasn’t too painful was it?  Just 5 little things you need to do with your family trust before 30 June.

If that’s too much hassle give us a call and we can sort it out 07 3067 3017.

About the Author

Nathan Watt
Managing Director at Watson & Watt

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