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Advanced Taxation: Income Tax Assessment Act

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Question:

Discuss about the Advanced Taxation for Income Tax Assessment Act.

 

Answer:

Introduction

According to the Income Tax Assessment Act 1997, TR2012/D1 income from the trust estate is distributable to the beneficiaries as per the clauses mention in the trust deed. As contained under section 53A, income generated from the trust estate is computed according to the terms and conditions of the trust deed. Such distributable income is taxable in the hands of beneficiaries at the rate specified under the provision of Australian Taxation System (Hoynes, Miller and Simon 2015). As per TD 2001/26 if a beneficiary of the trust estate has interest in the value of assets and the income for the allocation of the assets then the beneficiaries can renounce their interest in the trust. As per section 98(3) and 98(4), income from trust estate is liable for taxation in the books of trustee with respect to the share of income on part of its beneficiaries (O'Connor 2016).  

In the given case, Bruce the sole executor of Pam’s estate that was created under a testamentary trust managed business tax loss amounted to $20,000 during the year 31 August 2014. On the contrary, the testamentary trust incurred profit during the year ending 30 June 2015 amounted to $200,000 whereas the taxable income during the same period is $180,000. Considering the terms and conditions of the trust, Bruce allocated the trust income earned to the beneficiaries during the year 2015 on the basis of allocated percentage (Doidge and Dyck 2015). Bruce distributed the amount $40,000 to one of the beneficiaries Ronda whereas 50% of the balance i.e. 50% ($200,000- $40,000) = $80,000 to Rani as well as $80,000 to himself as 50% of the balance income. Further, Bruce distributed 20% of the income to the beneficiaries from the sale of premises since the balance income was meant for further investment. However, the income from the sale of premises was distributed to Gina as per the clause of capital distribution on 18 July 2015, which was recorded on 29 August 2015 (Harrison 2015).

According to the Australian Taxation System rules of section 102- 25 is applicable to the income arising from the capital asset of the discretionary trusts. As per the data provided for the BCL Ltd income from the capital assets are taxable in the books of the company as distributed to the beneficiaries (Chua and Bedford 2015). Given that, the selling value of the premises is $2,400,000 whereas the cost of the premises is 800,000, which was acquired on 23 October 1999. Therefore, income on sale of premises amounted to ($2,400,000- $800,000) = 1,600,000 that is taxable as per the taxation rules. As per the taxation ruling of ITAA97 tax on the income $1600,000 at the rate of 45% amounted to $720,000. Since, Bruce distributed the part of income to one of the beneficiaries at 20% and the rest of the amount is used for investment purpose therefore the taxability of $720,000 is subjected to the discounting method at 50%. However, the business loss amounted to $190,000 incurred during the year 2012-13 would be carried forward to till the year 2015. During the financial year 2015, loss of amount $190,000 can be set off with the income earned during the year amounted to $200,000 which will minimize the tax liability of the assessee (Neuman, Omer and Thompson 2015).

Income distributed to Ronda $40,000 is entitled to tax liability during the year 2015 at the rate specified in the taxation system of Australia. As per the taxation rules, distribution of income from the trust estate is taxable in the hands of trust distributor at the rate of 45%. Hence, the income of $40,000 is taxable in the books of Bruce at the specified rate. Similarly, income distributed to Rani amounted to $80,000 is taxable in the books of Bruce during the year 2015. However, income with respect to capital distribution amounted to 20% of would be taxable during the financial year 2016 because the amount has been allocated to the beneficiaries after the end of financial year 2015 (Kousky and Shabman 2015).

Considering the consequences of taxation of income from trust, Bruce is required to pay taxes on the income from trust as well as income from capital assets during the year 2015. However, the taxability of the income is subjected to the deduction of discounting method with respect to the capital income. On the other hand, current income from the trust will be taxable by deducting the amount of total loss of $170,000 incurred during the year 2013 since it was incurred from the business operation of the assessee (Doidge and Dyck 2015). 

 

Part A

In the given situation, Lawrence Dixon and Sonya Dixon formed a family trust whose trustee was the accountant of the family Mac Bury. The trust was created as a discretionary while the beneficiaries of the trust were the creator’s children. It has been provided that the trust acquired a rental property and securities in two listed companies. During the year 2015, total receipt of the trust amounted to $26,000 whereas the expenses amounted to $26,000 along with the depreciation charges of $3,000 as per section 40- 25 ITAA97 (Tucker 2015). Further, amount of $8,000 as an interest expense was in terms of the securities of AMP Ltd for acquisition of shares.

In case of discretionary trust, beneficiaries are not entitled to have fixed interest income in the funds of the trust. Under the category of discretionary trust beneficiaries are eligible to determine the income as capital or revenue as well as the percentage at which the income is to be received. For the purpose of establishment of the trust, there must be four important roles in the form of creator, trustee, appointor and beneficiaries. Trustee is considered to be the legal owner of who maintains all the transactions having the authority to sign the documents and other relevant applications for approval (Feuer 2016). On the other hand, beneficiaries of the trust are the individuals for whose advantages of the trust property is acquired. However, it is important that the beneficiaries should not acquire any substantial interest in the trust assets but they can have the right to access the share income from the securities of the trust. Discretionary trust is formed to utilize the benefit of tax liability, asset protection, estate planning and holdings of land with respect to the investments, real estates and sources of fixed assets. As per the TR in ITAA97, assessees are eligible to claim exemption of 50% from the capital gain taxation provided the beneficiaries are individuals and not business organizations (Feisee and Randall 2015).

Accordingly, in the present situation discretionary trust has been formed which earned total income of $26,000 while the expense were also $26,000. As per TD 2001/26, income from the assets and securities earned by trust is taxable even if such income is distributed to the beneficiaries. Therefore, income earned as dividend from the shares of AMP Ltd, CBA Ltd amounted to $12,000, and $8,000 respectively shall be taxable in the books of the trust created by Dixon. Further, deduction on the interest expenses is available to the trust amounted to $8,000 as well as the depreciation charges amounted to $3,000. However, beneficiaries are exempted from the tax liability on the since the beneficiaries are individuals and have no substantial interest in the assets of the trust (Tool, Williamson and Whittenburg 2015). On the contrary, expenses on rent for the property amounted to $18,000 are entitled for deduction from the income earned during the current taxation year.

Part B

  1. The present case highlights the consequences of tax losses earned by the discretionary trust as well as from the business employing two part time workers. Owner of the business organizations are Ken and Barb acquiring equal holding of shares whereas the trustee of the trust is KB Pty Limited. However, the beneficiaries of the trust were the owners, their children along with other relatives. As per the terms and conditions of the trust, taxable distribution of income to the beneficiaries were at 28% to Ken, 56% to Barb and the balance to the other relative during the year 2010-11. As per the taxation ruling under ITAA 97, loss on business from the trust is measured according to the loss determined under the capital gains. As per ITAA 97, section 36-10 loss on business income is computed by deducting the loss incurred by the trust and the balance income is taxable at the specified rate (Crawford 2016). Therefore, the income of the trust during the year 2010-11 amounted to $170,000 would be taxable in the books of trustee KB Limited at 45%. However, the deduction of 50% cannot be claimed since, the trustee of the discretionary trust is a company and not individual. Further, the income of trust during the financial year 2011-12 amounted 120,000 would have the same implication as the income taxed during 2010-11.

Since the trustee did not make election as per section 272-80(1) in schedule 2F of ITAA 1936, therefore the income of the trust distributed to beneficiaries would be taxable in the hands of the trustee. Moreover, the tax loss amounted to $26,000 during the year 2012-13 whereas the amount of loss $34,000 during the year 2013-14 would be carry forward to the next succeeding year for set off from the income $80,000.

  1. Elections from family trust as per section 272-80 of schedule 2F, ITAA 1936 impose the trustee to deduct the tax losses incurred in the previous years as well as deduction of certain expenses and debts. As per the taxation ruling ITAA 97, income from the trust distributable to the beneficiaries is taxable in the hands of trustee as per the distribution proportion. On the contrary, loss incurred from the business is eligible for deduction from the income in the subsequent years. Therefore, in the present case if the trustee made an election under section 272- 80(1) in schedule 2F, ITAA 1936 then the income is taxable in the hands of the trustee based on the distribution proportion (Ward 2016). During the year 2010-11 income $170,000 would be taxable in the hands of KB Ltd at the rate of (28%+ 56%) = 84% whereas 61% of total income $120,000 during the year 2011-12. However, the business loss incurred during the year 2012-13 and 2013-14 amounted to $26,000 and $34,000 respectively shall be allowed for deduction in the next year 2014-15 from the total income $80,000. Whereas the balance income i.e. $20,000 ($80,000- $26,000+ $34,000) shall be taxable in the hands of trustee in proportion to the 54% since Ken and Barb are equal shareholders of the trustee company.
 

Reference List

Chua, H.S. and Bedford, O., 2015. A qualitative exploration of fear of failure and entrepreneurial intent in Singapore. Journal of Career Development, p.0894845315599255.

Crawford, B.J., 2016. Valuation, Values, Norms: Proposals for Estate and Gift Tax Reform. Boston College Law Review, 57.

Doidge, C. and Dyck, A., 2015. Taxes and corporate policies: Evidence from a quasi natural experiment. The Journal of Finance, 70(1), pp.45-89.

Feisee, R.A. and Randall, R.L., 2015. Counseling Clients on Their IRA Beneficiary Designation Options: The Impact of the Recent US Supreme Court Case, Clark v. Rameker. Journal of Financial Service Professionals,69(1), pp.57-62.

Feuer, A., 2016. Life Insurance and Retirement Plan Benefits: Are Your Clients Achieving Their Intended Goals?. NYSBA J, 28.

Harrison, L., 2015. Property investment through discretionary trusts.Taxation in Australia, 50(2), p.84.

Hoynes, H., Miller, D. and Simon, D., 2015. Income, the earned income tax credit, and infant health. American Economic Journal: Economic Policy,7(1), pp.172-211.

Kousky, C. and Shabman, L., 2015. Understanding Flood Risk Decisionmaking: Implications for Flood Risk Communication Program Design. Resources for the Future Discussion Paper, pp.15-01.

Neuman, S.S., Omer, T.C. and Thompson, A.M., 2015. Determinants and Consequences of Tax Service Provider Choice in the Not?for?Profit Sector.Contemporary Accounting Research, 32(2), pp.703-735.

O'Connor, D., 2016. Trusts: Practical solutions for real-life problems.Taxation in Australia, 50(7), p.392.

Tool, H.R., Williamson, J.E. and Whittenburg, G.E., 2015. Impact of Recent Tax Legislation on Small Business. Journal of Small Business Strategy,8(2), pp.79-91.

Tucker, J., 2015. Tax files: Interpreting the land tax act. Bulletin (Law Society of South Australia), 37(2), p.28.

Ward, M., 2016. IRA Transfers from Estate or Trust. Journal of Financial Service Professionals, 70(2), pp.38-41.

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