Net income of the trust estate (distributable trust income)

• Taxable income may differ from the reported accounting net profit. The latter (Accounting profit – Label A) is calculated in accordance with the terms of the trust deed (distributable trust income) whereas the Net income (Taxable income – Label S) of the trust estate is calculated pursuant to sec 95 for taxation purposes.

Discrepancies between the accounting and taxation “net income” of the trust occur where, for example:

• items of assessable income, such as capital gains, are treated as corpus under trust law or the trust deed;
• expenses according to trust law or the trust deed are either non-deductible for taxation purposes or deductible to a lesser extent;
• taxation law provides for special incentives which are deductible but not shown as expenses for accounting purposes; and
• the basis used for valuing trading stock or depreciating assets for trust accounting purposes is different from the basis used for income tax purposes.

• Where the taxable “net income” as calculated under sec 95 is greater than the accounting distributable (Net income of a trust estate), it remains to be determined under which section, and to what extent, the trustee (or the beneficiary who is presently entitled and not under any legal disability) is assessable for tax.

Two possibilities arise:

• the beneficiary is taxed on net income (his share of net trust income); or
• the beneficiary is only taxed on the distributable trust income received, since the trustee is not able to distribute any more than that sum, and the difference is taxed to the trustee under sec 99 or 99A.

The problem centers around the word “share” in sec 97. Does “share” mean proportion of the net income of the trust or the actual amount?

If the word “share” means proportion of net income, then the beneficiary will be taxed on his share (100%) of the sec 95 net income.

This view assumes that the function of the first part of sec 97 is merely to determine the proportionate interest of a beneficiary in the income of the trust, and once this proportion has been determined it is applied to the net income of the trust estate as calculated under sec 95.

Each beneficiary is then assessed on his or her proportion of the “net income of trust estate” as determined by sec 95, whether it be greater or less than distributable income.

This approach was adopted by the AAT in Case C36, 71 ATC 156 and Case (1954) 5 TBRD 429 and followed by Hill J in Davis v FC of T 89 ATC 4377 by Sundberg J in Zeta Force Pty Ltd v FC of T 98 ATC 4681.

The other view is that a beneficiary can only be “presently entitled” within the meaning of sec 97 to such amount of income as he is entitled, or will be entitled, to receive. This view implies that the word “share” in sec 97 does not mean a proportion but rather “an amount” or “an allocated amount”. This view mean that the beneficiary could not be assessed on an amount greater than the amount to which he is presently entitled. This means the excess would be assessable to the trustee under sec 99A, unless the Commissioner exercises his discretion to apply sec 99.

Support for this view can be found in Case L55 (1960) 11 TBRD 327 (No 1 Board) and in obiter dicta in Taylor v FC of T 70 ATC 4026 (per Kitto J at p 4030) and in  Richardson v FC of T97 ATC 5098 (Merkel J at p5113)The Commissioner will accept returns on the basis that once the share for the beneficiary is determined the entire taxable income is assessed under either sec 97 or 98 as the case may be.

The issue of tax-free sums becomes more complex when the difference between the sec 95 net income of the trust and accounting net income can be treated as a return of capital.

Current Tax Office practice is to assess to a capital beneficiary any excess of net trust income over trust accounting income due to a capital gain.

• As with above point, there are two views on assessment where sec 95 net trust income is less than distributed accounting trust income. The two views are:

(a) The beneficiary will only be taxed on his share of sec 95 net income and the excess accrues to corpus.

(b) The beneficiary is taxed under sec 97 on net income and the beneficiary is taxed under sec 26(b) on the remaining balance when derived.

Currently, the Commissioner only taxes the beneficiary on his share of sec 95 net trust income, although it could be argued that the beneficiary could be assessed on the amount distributed in excess of the sec 95 net trust income under either sec 99B or 26(b).

• Note that where a trustee pays a non-assessable amount to a beneficiary in respect of an interest or units in a trust, the cost base or indexed cost base of the interest or units acquired after 19 September 1985 is reduced, except to the extent that the amount is attributable to a deduction for building allowance under Div 10C or 10D of Pt III ITAA36 or Div 43 ITAA97, where the building was acquired before 7.30pm on 13 May 1997. For buildings acquired after that date, sec 160ZJA requires that the cost base of the asset be reduced by the extent to which a deduction is allowed or allowable for expenditure included in the cost base.