Family trusts can be a very effective vehicle for tax planning. A family trust does not pay income tax or capital gains tax. Instead, the income and/or capital gains a family trust earns must be distributed to a beneficiary who pays the tax.
The tax effectiveness is achieved by distributing to low tax rate beneficiaries and even distributing different income classes to different beneficiaries. This is called “streaming”.
The new streaming rules can be complex, so let’s look at some questions we have been asked:
1. What is the streaming rule?
There is no set rule. The trust deed usually includes a clause regarding what income can and can’t be streamed and how to calculate it.
If the deed is old, it may be silent concerning streaming (i.e., not include a clause re-streaming).
The ATO has stated that the new streaming rules do not give the trustee the power to stream if they did not already have that power under the trust deed.
If there is no power to stream trust income in the trust deed, the deed can be changed – but significant care and legal advice are required.
2. What income can be streamed?
Franked dividends
- Distributing franking credits to resident beneficiaries can be more beneficial than to non-resident beneficiaries.
- Franking credits can be wasted if distributed to a lost company or trust.
- Franking credits can be more tax effective to a low tax rate beneficiary than a higher one.
Capital gains
- One beneficiary could have a capital loss that the capital gain could be offset against.
- The benefit of a discounted capital gain is lost when the capital gain is distributed to a company or a non-resident (after 8 May 2012).
3. What other income can be streamed?
Foreign source income
- Distributing to a non-resident beneficiary may not be taxable in Australia.
- However, the ATO has stated that only franked dividends and capital gains can be streamed. Other income is required to be distributed on a proportionate basis amongst all the income beneficiaries.
4. What happens if the franked dividends aren’t streamed?
Trust income doesn’t have to be streamed to different beneficiaries. If it is not, then the franked dividends and attached franking credits are split amongst the income beneficiaries on a proportionate basis. (e.g. 25% each to 4 beneficiaries). Note that there are also rules for the trust to be able to distribute the attached franking credits, which require the trust to have positive net income and taxable income.
5. Can franking credits be lost?
Yes.
The trust deed can determine how the income of the trust is calculated. This can result in an additional trust income to taxable income, which determines whether the franking credits can be distributed to beneficiaries, either by streaming or by using the proportionate method.
If there is trust income but no taxable income of the trust, the franking credits remain in the trust and are effectively lost (they aren’t refundable to the trust and can’t be carried forward).
If there is no trust income (or there is a trust loss) but there is taxable income of the trust, the franking credits also remain in the trust and are effectively lost.
Even if the trust has positive trust income and taxable income, there can be circumstances that still risk the franking credits being trapped in the trust. (e.g., where the reason the trust has positive trust income is that a capital gain is included).
In this instance, it may be beneficial NOT to distribute all the capital gain to one beneficiary.
We will provide more FAQs concerning trust distribution streaming in the next edition of S & W Insight. If you have any queries, don’t hesitate to contact your client manager.
Kreston Stanley Williamson Team
*Correct as of March 2017
Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.
