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ATO Widens its Attack on Trusts

December 1999 (Further reviewed October 2000)

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On 11 October 2000, the government released an exposure draft of its proposed legislation for implementing entity taxation for discretionary trusts and the application of a "Profits First Rule" and a "Slice Rule". Under these proposed changes, further restrictions are to apply in relation to discretionary trusts and there are additional tax risks that will need to be considered for anyone wishing to establish a discretionary trust.

First came 109UB, Then came 102UB, Now you be good!"

Accountants and clients may require specific advice from Baldwins on how to deal with new Division 6D of the ITAA 1936, which was gazetted as law on 8 July 1999. Division 6D begins from Sec. 102UB.

Division 6D applies for June 1999 financial year tax returns (and subsequently) whenever any "closely held trust" distributes or creates a "present entitlement" (at any time from 13 August 1998) in favour of another trust. Nearly all private unit trusts and discretionary trusts will meet the definition of a "closely held trust", including even unit trusts that have a superannuation fund as a unit holder, and THE LEGISLATION CONTAINS DRACONIAN PENALTIES !!

The introduction of Division 6D comes on top of other moves by the Australian Taxation Office to clamp down on trusts: See our article on the ATO's Recent Anti-Trust Weaponry.

The law imposes an obligation on the trustee of the distributing trust to complete and lodge an "Ultimate Beneficiary Statement" (UBS) with the Australian Taxation Office (ATO) detailing each present entitlement amount plus the identity and tax file number of the "ultimate beneficiary". Up until now, it was sufficient for a trust tax return to identify a recipient trust without specific identification of a particular beneficiary as the "ultimate beneficiary". The UBS is required irrespective of whether the distribution by the distributing trust ("head trust") to the second trust is comprised of "assessable income" or "tax preferred" (ie tax concessionary or tax exempt) income, and even applies for distributions of capital that would not have been taxable.

Failure to identify the so-called "ultimate beneficiary" or any incorrect identification will result in the strict imposition of a new tax called "Ultimate Beneficiary Non-Disclosure Tax" at the rate of 48.5% on the amount of the allocated assessable income. Moreover, directors of the trustee of the head trust will also be held personally, jointly and severally, liable to pay this tax. In the case of non-disclosure or incorrect identification of the ultimate beneficiary in relation to a capital entitlement or "tax preferred income" entitlement the directors will nonetheless become liable for hefty fines or to imprisonment for up to 12 months per offence.

Where a Unit Trust is assessed for Ultimate Beneficiary Non-Disclosure Tax, one effect is that a unit holder who has borrowed to buy units could be denied a tax deduction for interest on the borrowing because the net distributed income will be treated as "non-assessabe income". Also, franking credits on dividends included in trust distributions are to be lost.

Trusts claiming capital losses may need to tread carefully due to the potential conflict between s102UE(4) and s102UM(2). Accountants should take specific legal advice if they are unsure who to identify as the ultimate beneficiary or if identification of the ultimate beneficiary is likely to be difficult or delayed.

WARNING: Specific legal advice should be sought for each client's own situation. All the above information relating to trusts and tax laws is provided as a useful guide but is not client specific and must therefore not be relied upon for any act or omission.

For further information, contact Joe Lederman at BALDWINS, Australian Lawyers & Consultants.

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