Trusts are widely used for investment and business purposes.
A trust is an obligation imposed on a person or other entity to hold property for the benefit of beneficiaries. While in legal terms a trust is a relationship not a legal entity, trusts are treated as taxpayer entities for the purposes of tax administration.
The trustee is responsible for managing the trust's tax affairs, including registering the trust in the tax system, lodging trust tax returns and paying some tax liabilities.
Beneficiaries (except some minors and non-residents) include their share of the trust's net income as income in their own tax returns. There are special rules for some types of trust including family trusts, deceased estates and super funds.
Trustees and beneficiaries
The trustee is liable for the debts and obligations of the trust. A beneficiary’s share of the trust is assessable income.
Trustees
The trustee(s) (there may be more than one) of a trust may be a person or a company (the latter is known as a corporate trustee). In either case, the trustee must be legally capable of holding trust property in their own right. The trustee holds the trust property for the benefit of the beneficiaries.
Where the trust is established by deed (which in the case of a deceased estate is the will), the trustee must deal with the trust property in line with the intentions of the settlor as set out in the trust deed. They must also act in accordance with the relevant state or territory law regulating trusts, and with any other applicable law, including tax law.
Under trust law, trustees are personally liable for the debts of the trusts they administer and entitled to be indemnified out of the trust property for liabilities incurred in the proper exercise of the trustee's powers (except where a breach of trust has occurred). Under tax law, the trustee is responsible for managing the trust's tax affairs, including registering the trust in the tax system, lodging trust tax returns and paying some tax liabilities.
Beneficiaries
A trust beneficiary can be a person, a company or the trustee of another trust.
The trustee may also be a beneficiary, but not the sole beneficiary unless there is more than one trustee.
Beneficiaries may have an entitlement to trust income or capital that is set out in the trust deed or they may acquire an entitlement because the trustee exercises a discretion to pay them income or capital.
Generally, the beneficiaries are taxed on the net income of a trust based on their share of the trust's income – regardless of when or whether the income is actually paid to them.
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Trust Income
Work out how the net income of a trust is taxed.
How income is treated
The net income of a trust (effectively its taxable income) is its assessable income for the year less allowable deductions worked out on the assumption that the trustee is a resident (even if the trustee is actually a non-resident).
Because the income of a trust is determined in accordance with the trust deed and its net income is determined in accordance with tax law, the two amounts are often different.
Generally, the net income of a trust is taxed in the hands of the beneficiaries (or the trustee on their behalf) based on their share of the trust's income (that is, the share they are 'presently entitled' to) regardless of when or whether the income is actually paid to them.
For example, if the beneficiary has a 50% share of the trust's income, they are assessed on a 50% share of the trust's net income. This is referred to as the proportionate approach.
Special rules apply to franked distributions and capital gains included in the trust's net income.
A beneficiary is presently entitled to trust income for an income year where they have, by the end of that year, a present or immediate right to demand payment from the trustee. The entitlement will depend on the trust deed and any discretion that the trustee has under the deed to allocate income between beneficiaries.
The trustee will need to provide each beneficiary with details of their share of the net income, so that the beneficiaries can include this amount in their tax returns.
Tax Rates
Adult and company beneficiaries pay tax on their share of the trust's net income at the tax rates that apply to them.
The trustee pays tax on behalf of non-resident beneficiaries and those who are minors, based on their share of the trust's net income. These beneficiaries may need to declare their share of the trust's net income in their own income tax returns, and can claim a credit for the tax paid on their behalf by the trustee.
Higher rates of tax apply to most trust distributions to minors.
If there is any part of the trust's income for which no beneficiary is presently entitled, the trustee is taxed on the corresponding share of net income. If there is no trust income the trustee is taxed on any net income.
The trustee is generally taxed on the trust income at the highest marginal rate that applies to individuals except for some types of trusts (including deceased estates), which are taxed at modified individual rates.
Franked Distributions
Unless prevented by the trust deed, a beneficiary may be made specifically entitled to a franked distribution, resulting in the beneficiary being taxed on the franked distribution. In this way, franked distributions can be streamed to particular beneficiaries for tax purposes.
If no beneficiary is specifically entitled to a franked distribution, it's taxed proportionately to all beneficiaries based on their entitlement to the trust income (with some modifications) – that is, in much the same way as the other net income of the trust.
If a beneficiary qualifies for a franking credit offset, they are also required to include the amount in their assessable income.
If the trust is not a family trust, a beneficiary without a fixed entitlement to the franked distribution is generally not entitled to use the associated franking credits unless their total franking credits from all sources for a year is $5,000 or less.
Losses
A loss made by a trust in an income year can't be distributed to beneficiaries. However, it can be carried forward and used to reduce the trust's net income in a later year.