5 Key Questions for Trustees: Ensuring Smart Year-End Trust Distributions by 30 June 2024

As the 2024 financial year draws to a close, trustees of discretionary trusts must prepare trust resolutions to allocate the net income of the trusts they administer and consider how to distribute capital gains. These resolutions are crucial for effectively distributing benefits to trust beneficiaries. With most trust deeds mandating this task by 30 June annually, the time for action is now.

In this article, we consider the key questions all trustees should be asking.

1. Who can I distribute to?

Beneficiaries: Identifying the beneficiaries of a trust requires a careful review of the trust deed and any amendments. Common mistakes include:

• Definition of “descendant”: Trust deeds often refer to descendants, children, or issue of certain persons. Does this include only bloodline relatives, or can it include spouses, their family members, adopted and step-children?
• Disclaimed beneficiaries: Trustees should notify beneficiaries before 30 June of intended distributions should those beneficiaries intend to disclaim their interest for any reason. Disclaimers or renunciations must be correctly drafted and executed prior to the end of financial year. As seen in Commissioner of Taxation v Carter [2022] HCA 10, disclaimers made after the income year were ineffective for tax purposes. Alternatively, if the Trustee is aware of any intention of a beneficiary to disclaim their interest, they might reconsider the distributions accordingly.
• Incorporation of corporate beneficiaries: Ensure corporate beneficiaries are incorporated before 30 June and qualify as beneficiaries due to having the required shareholding or satisfying the criteria specified in the trust deed. If not, these beneficiaries cannot receive distributions.
• Family Trust Elections/Interposed Entity Elections: FTEs and IEEs do not prevent distributions to certain parties. However, distributions outside of the relevant family group dictated by those FTE and IEEs can trigger family trust distribution tax at 47% for the trustee. If trustee is a company, its director(s) are jointly and severally liable for that tax with the trustee. Careful review of the breadth of a family group is a must.
• Distributions to excluded beneficiaries: Many trust deeds contain provisions excluding foreign beneficiaries, often to address potential duty and land tax consequences of having such beneficiaries. It is important to carefully review trust deeds and any amendments for the inclusion of such provisions. If such provisions exist, distributions cannot be made to foreign beneficiaries. Additionally, trustees should be mindful when distributing to other trusts to ensure they have the same exclusions as where they do not they will also be a foreign beneficiary.

It is important when distributing to beneficiaries that “real and genuine consideration” is given. As we reported last year, in Owies v JJE Nominees Pty Ltd [2022] VSCA 142 (Owies) the Victorian Supreme Court of Appeal determined that trust distributions were voidable (ie capable of being set aside) on the basis that the trustee had failed to give “real and genuine consideration” to the specified beneficiaries of the trust.

A trustee must actively inform itself of the material financial needs, health and circumstances of the trust’s beneficiaries, particularly primary or specified beneficiaries prior to making distributions. This should minimise the risk of a costly and protracted court challenges to the validity of distributions, which can occur immediately or many years after distributions have been made. Further, the founder(s) of the trust risks being displaced from control of its trustee or the office of trustee, unless such real and genuine consideration is undertaken annually.

2. What can I distribute?

A trustee must understand the distributable income or taxable capital gains of its trust. Determining these amounts requires a careful review of the trust deed. Upon reviewing the trust deed the trustee must then:

• Understand what constitutes the trust’s distributable income (including any franked or unfranked dividends), taxable capital gains (concessional, discount or non-discount), available losses, and whether outgoings can be applied in any particular order.
• Check for any obligations on the trustee to make distributions (eg by a certain date), whether the income can be streamed, whether the trustee can accumulate income or recoup prior year losses (or not recoup them in order to make distributions).
• Prepare and sign distribution minutes that align with the requirements of the trust deed and are completed by midnight on 30 June of the subject financial year, after hopefully satisfying the Trustee’s duties including those under the Owies

Failing to prepare appropriate resolutions on time may result in the trustee paying tax at the highest marginal rate on any retained income and gains (including loss of the 50% CGT Discount on discountable capital gains which are accumulated). Additionally, beneficiaries may challenge the trustee’s actions (or inactions) concerning the accumulations if it leads to a higher tax burden.

Trustees should also be aware of the Commissioner’s recent decision impact statement (DIS) on Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 (Minerva). This case concerned the application of the anti-avoidance provisions (Part IVA of the Income Tax Assessment Act 1936) to trust income distributions following a restructure to facilitate an IPO, which was aborted, apparently due to the GFC. Although Part IVA did not apply in Minerva, the ATO states in its DIS that this conclusion was based on the specific facts of that case. An objective review of a scheme must be conducted on a case-by-case basis and Part IVA can even apply to the exercise of a trustee’s discretion to distribute income.

To ensure compliance and avoid pitfalls, consult your tax advisor about distributions, especially if the deed is unclear or your group has undergone (or is planning) a restructure. Stay updated on trust and tax law developments by subscribing to KHQ’s Tax & Structuring updates.

3. What are the tax implications of distributions?

Discretionary trusts can allow income splitting, distributing to persons on lower tax rates. However, trustees should be mindful of:

• Minors: special rates of tax apply to income distribution to minors (under 18 years old) from discretionary trusts. The penalty rates are detailed by the ATO each year here.
• Foreign residents: many may incorrectly assume that simply because a beneficiary is foreign, distributions to them will fall outside of the Australian tax net. Cases such as Peter Greensill Family Co Pty Ltd (Trustee) v FCT [2021] FCAFC 99 highlight that this is not the case. In that case a capital gain from the sale of shares in an Australian company was distributed to a foreign beneficiary. The Court considered that the relevant taxpayer was the trust estate, not the foreign beneficiary, and therefore tax was payable on the gain in Australia.
• Small business CGT concessions: Trusts that have triggered capital gains during the income year which are eligible for the small business CGT concessions should give careful consideration to the drafting of resolutions. The drafting may materially affect how gains are distributed and how effective they may be. Consultation with a tax advisor is recommended.

4. When is my trust’s vesting date?

Distribution time is a good time to consider vesting dates. An extension of a vesting date in accordance with a court order or proper exercise of a power under the trust deed will not trigger a resettlement (see Tax Determination 2012/21). However, once the vesting date has passed, the trust has vested and the interests in the trust property become fixed at law (see Taxation Ruling 2018/6).

This does not mean that the trust will end. In the case of Re McGowan & Valentini Trusts [2021] VSC 154 the Court held that despite a vesting date passing, the language of the original trust deed did not prevent its continuation after the vesting date.

The absence of an appropriate variation or other power to extend trust dates (subject to the law against perpetuities if applicable) requires an application to the Supreme Court. The recent case of the Gengoult-Smith Family Trust [2024] VSC 189 offers a pertinent example. Established in 1974, this discretionary trust with significant real estate investments and substantial annual income faced vesting in 2024. The beneficiaries successfully applied to the Supreme Court of Victoria to extend the vesting date to 2054, preventing a $10 million CGT liability.

Key steps involved ensuring all current beneficiaries, including charitable ones, consented to the variation and the Court’s consideration of the rights of minor and unborn beneficiaries. The Court approved the extension, emphasising that tax considerations should not impede such amendments. The attitude of the ATO to such a change is another matter, requiring detailed consideration and strategic planning.

5. Are resolutions the final step?

In short, no. There are several considerations that continue to apply after the resolutions are prepared. Key areas of focus for the ATO in the current financial year include:

• Subdivision EA (Division 7A): These rules apply to circumstances where a trustee creates an UPE in a private company and transfers the underlying cash (or property) to a shareholder or an associate of a shareholder by way of certain payments or any loans, or by the forgiveness of such loans. However, in the absence of those circumstances (eg when the trustee retains the cash for use in the trust) Subdivision EA will have no application. Subject to how the Commissioner’s appeal in Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 progresses, Subdivision EA may come under greater scrutiny.
• Section 100A: This section is an anti-avoidance provision which seeks to target arrangements whereby distributions are made to a low taxed beneficiary, but the benefit of the distribution (ie the cash) is in fact provided to a different beneficiary who would, if distributed directly to, be assessed at a higher rate of tax. It is important for trustees to consider proposed arrangements in light of the ‘green zone’, ‘red zone’ or ‘other’ arrangements outlined in Practical Compliance Guide 2022/2 to understand the potential for ATO compliance in respect of resolutions.

Takeaways

As the 2024 financial year draws to a close, trustees of discretionary trusts face critical decisions regarding trust distributions. These decisions, guided by the trust deed and legal requirements, can have significant tax and legal implications. By asking the right questions—Who can I distribute to? What can I distribute? What are the tax implications? When is my trust’s vesting date? Are resolutions the final step? — trustees can ensure compliant and effective distributions.

It is imperative to review the trust deed, consult with tax advisors, and stay informed about recent legal developments. Properly addressing these issues can minimise risks and avoid costly mistakes. For expert guidance, reach out to KHQ’s specialist Tax & Structuring team. Our team can assist you in navigating these complex issues to ensure smart and compliant year-end trust distributions.