Taxation – Distributing fully franked dividends to a trust with net losses.
Question
A family discretionary trust has received a fully franked dividend during the year of $70,000.00 (attached credit of $30,000.00). Before taking the dividend and credit into account, the trust has a net loss of $20,000.00. Other beneficiaries eligible for the whole of the credit (assume the franking credit trading rules do not apply adversely). Would the position be any different if the net loss was $85,000.00?
Answer
When franked distributions have been made to partnerships and trustees of trusts (and the entity is neither a corporate tax entity nor a complying superannuation fund when the distribution is made), the assessable income of the partnership or trust estate includes the franking credit on the distribution (section 207-35).
The question then is whether the beneficiaries are entitled to the whole of the franking credits attached to any dividend received by the trustee of the trust.
In our example, the net income of the trust on ordinary accounting concepts is $50,000 ($70,000 dividend less net loss of $20,000). Are the beneficiaries entitled to the whole of the franking credits even though the net income of the trust ($50,000) is less than the amount of the dividend ($70,000)? You sometimes hear it suggested that in this type of case the beneficiaries are only entitled to 5/7ths of the franking credits since that is the proportion of the dividend that is included in net income. At first blush, the legislation may appear to support such a conclusion providing that a beneficiary's share of the credit is so much of the franked distribution as is included in the beneficiary's share amount. However, on tracking through the provisions, that is not the case.
The short answer is that provided the trust has an amount of net income (which is the case - $50,000) and the beneficiaries are presently entitled to the whole of the net income of the trust, then (assuming the franking credit trading rules are satisfied) the beneficiaries will be entitled to all of the franking credits even though the net income is less than the amount of the dividend.
In the varied example on ordinary accounting concepts, the trust has a net loss of $15,000 ($70,000 dividend less net loss of $85,000). On the other hand, for taxation purposes the net income is $15,000 ($70,000 dividend plus $30,000 credit less net loss of $85,000). In this case, unless the trust deed has a special meaning for income, the trust will not have a positive amount of net income and therefore the beneficiaries will not be entitled to the franking credits attached to the dividend, even though the taxable income is a positive amount.
To address this anomaly, the deed could be amended to provide that income of the trust shall be determined in accordance with taxable income.
Taxation – Division 7A and the treatment of loans from companies for income producing purposes
Question
A client's company has made a loan to a trust for income producing purposes, the loan has been applied by the trust to acquire a commercial property used for rental. You have taken the view that because the loan is for income producing purposes, Division 7A doesn't apply. Is that right? Would the position be any different if the loan had been made to an individual?
Answer
Under the Income Tax Assessment Act 1936, any amounts paid, lent or forgiven by a private company to a shareholder or the shareholder's associate (which includes trusts) are treated as deemed dividends under Division 7A, unless they come within the specified exclusions outlined in Section 109H. The fact that the loan is for income producing purposes does not fall within any of the exclusions and as such it will be deemed to be a dividend. The position would not be any different if the loan had been made to an individual, as Division 7A targets shareholders and associates, which includes individuals.
Personal Services Income and Income Splitting
Question
The doctor (or any other kind of professional person or operator of a services business) operates its practice through a medical practice entity (company or trust). The practice has many customers (in excess of 100) and is expected to be a personal services business for the purpose of the PSI rules. The practice does not have enough employed professionals for the income to be business income. Is there anything preventing the splitting of income of the medical practice entity with family members or other related entities?
Answer
The Personal Services Income ("PSI") regime is contained in Part 2-42 of the Income Tax Assessment Act 1997. It will not apply in a number of situations, one of them is when income is derived as part of a Personal Services Business ("PSB"). There are then various tests for determining whether a PSB is being conducted (Section 87-15).
However, even if the doctor's medical practice is expected to be a PSB, it is important to be aware that the PSI regime does not overrule or replace the operation of the general anti-avoidance rules contained in Part IVA of the Income Tax Assessment Act 1936.
This means the Commissioner may seek to apply Part IVA where the income is generated is income of a personal services business and the dominant purpose of the arrangement is income splitting (TR 2001/8). The Commissioner has also stated in IT 2121 that Part IVA can apply to arrangements where an individual attempts to split their personal exertion income amongst family members by diverting it to a family company or trust, which, if the Commissioner is successful in applying Part IVA, will result in the individual being assessable on the gross payments made to the family company or trust for services rendered by them.
It is also clear from judicial authorities that arrangements involving interposing entities may be struck down where income from the practice is split between family members. Such was the case in FC of T v Gulland; Watson v FC of T; Pincus v FC of T 85 ATC 4765 where the High Court held that the doctors' attempts to split their incomes to their family members through an unit trust was void as its purpose or effect was to alter the doctors' incidence of income tax and relieve them from their liability to pay tax.
