Division 6 ITAA36 is the foundation for the taxation of trusts. Everything else – be it minors in Division 6AA, streaming in Division 6E or losses Schedule 2F or be it the very targeted provisions in Division 6AAA, 6B or 6D – all wrap around Division 6.
Division 6 ITAA 36
Div 6 of ITAA36 (ss 95 to 102) is the key to understanding the taxation of trusts. We could just tell you how to handle this and that situation. But looking at the legislation itself is a lot more useful to you.
So we want to give you an overview of the structure of Division 6, so that you will find your way around it. Understanding Division 6 will give you the foundation you need to build your case.
Division 6 jumps backwards and forwards between different topics and issues. Kind of confusing. But doable. Just takes a bit of time to find your way around.
Section 95
It all starts with a list of definitions. It is not a long list. But really important.
Net Income
The most important one is the definition of net income. It tells you to determine the trust’s taxable net income as
s95:…total assessable income of the trust estate calculated…as if the trustee were a taxpayer…and were a resident
This is a crucial point. It touches on everything you do around the taxation of trusts. Exempt income and NANE follow the same pattern.
s95: …exempt income of the trust estate calculated as if the trustee were a taxpayer who was a resident.
s95:…non-assessable non-exempt income of the trust estate calculated as if the trustee were a taxpayer who was a resident.
Residency
s95 also determines whether a trust is a resident trust or not. A trust is either resident or non-resident. There is no in between.
s95:…resident trust estate…if a trustee of the trust estate was a resident …or the central management and control of the trust estate was in Australia at any time during the year of income.…a trust estate that is not a resident trust estate….is…a non-resident trust estate.
Division 6 Percentage
And then there is the definition of the Division 6 percentage for streaming trust income.
Every beneficiary has a Division 6 percentage based on their share of income. And the trustee has one too. That one is usually zero unless there is income with no present entitlement.
If the trust income is zero, the beneficiaries’ Division 6 percentage is 0% and the trustee has 100%.
s95: However, if the income of the trust estate is nil, a beneficiary…has a Division 6 percentage of …0% and the trustee….has…100%
Section 95 A
Whether you have received payment or another benefit for your present entitlement or not doesn’t affect that you had a present entitlement.
s95A (1): …where a beneficiary…is presently entitled…, the beneficiary shall be taken to continue to be presently entitled…notwithstanding that the income is paid…
But in (2) there is something else that is important. A vested and indefeasible interest is good enough. You don’t need present entitlement. If you got a vested and indefeasible right, you are deemed to have present entitlement, even if you don’t.
s95A (2): …where a beneficiary has a vested and indefeasible interest…but is not presently entitled…, the beneficiary shall be deemed to be presently entitled…
s97 (2) refer and s98 (2) refer back to this vested and indefeasible interest.
Section 95 B
A presently entitled beneficiary is not under a legal disability where the beneficiary acts as trustee for another trust estate. Sounds confusing, but luckily reasonably rare.
Section 96
Section 96 just tells you that usually trustees don’t pay income tax on income of the trust, except when ITAA36 specifically says so. So not exactly an earth shattering revelation.
s96: Except as provided in this Act, a trustee shall not be liable as trustee to pay income tax upon the income of the trust estate.
Section 97
Section 97 (1) is crucial. It is the gateway to everything else in Division 6.
s97 (1): …where a beneficiary …not under a legal disability is presently entitled…, the assessable income of the beneficiary shall include:…that share of the net income… attributable to …when the beneficiary was a resident and …that share of the net income… when the beneficiary was not a resident and is also attributable to sources in Australia
and then it uses the same approach for exempt and NANE income. Beneficiaries assessed under s97 are taxed at their ordinary marginal tax rates.
s97 (2) is about the vested and indefeasible right per s95A (2). The beneficiary doesn’t get assessed on that income per s97 (1). That is what s97 (2) is telling you. Instead, the trustee gets assessed on that income per s98 (2). So s97 (2) is just making sure that the income goes into the right pot.
And s97 (3) covers relatively rare and very specific scenarios. It is about beneficiaries who are tax exempt bodies, associations, funds or organisations.
Section 98
So now here are the scenarios where a share of net income hits the trustee’s assessable income.
s98 (1) assesses the trustee on trust income where beneficiaries have a present entitlement to income but are under a legal disability. A legal disability might be a person under 18 years of age or an undischarged bankrupt.
s98 (2) assesses the trustee on trust income where the natural person beneficiary has a vested and indefeasible right per s95A(2).
s98 (2A) assesses the trustee on trust income of a non-resident and tells you to tax it as per s98 (3). It uses the same concept as in 97 (1) – word for word.
…that share of the net income… attributable to …when the beneficiary was a resident and …that share of the net income… when the beneficiary was not a resident and is also attributable to sources in Australia
s98 (3) tells you to tax a corporate beneficiary at its company tax rate and a non-corporate beneficiary …as if it were the income of an individual…
And s98 (4) is again about a beneficiary being the trustee of another trust estate.
Section 98 A
Tax assessed to a trustee in relation to a non-resident beneficiary is generally not a final tax.
If s98 (3) assesses the trustee in respect of an individual or company beneficiary, the beneficiaries don’t walk away unscarthed. They still include their share of net income in their assessable income under s98A(1). But will receive a credit under s98A(2) for the tax he trustee paid. Special rules apply income subject to withholding tax.
Section 99
This section assesses the unallocated portion of trust net income to the trustee at ordinary marginal rates.
Section 99 only applies if the Commissioner determines not to apply s99A. So s99 is the one you want, since marginal rates is much better than top marginal rates.
Section 99 A
A special rate of tax applies trust to income with no present entitlement. The applicable tax rate is the highest marginal rate of tax for resident individuals. However, there are some exceptions.
For example s99A (2) provides that the special rate of tax will not apply to a trust estate that resulted from a a will if the Commissioner is of the opinion that it would be unreasonable for the special rate of tax apply to that trust income. If this is the case, more concessional rates of tax will apply under s99.
In forming his opinion, the Commissioner must have regard to the matters listed in s99A (3). These matters include situations where an attempt has been made to increase the assets of the trust by, for example, granting of special rights or privileges to the trust, the transfer of the property to it or the making of loans to it.
Section 100
Do you remember how the trustee and not the beneficiary is assessed under s98 when there is a legal disability of a presently entitled beneficiary or when the beneficiary is only deemed to be presently entitled per s95A? If in this scenario the beneficiary is a beneficiary in more than one trust estate, or derives income from any other source, the section essentially provides that the beneficiary (and not the trustee) is to pay tax on the income. But the beneficiary might receive a credit for the tax the trustee paid in respect of the same income.
Section 100 A
This is an anti-avoidance provision. Where a beneficiary without a legal disability holds a present entitlement and that entitlement is linked either directly or indirectly to a reimbursement agreement, the beneficiary is deemed not to be presently entitled to the income. Trust distributions which fall within s100A are assessed to the trustee under s99A as reimbursement agreements.
Section 101
If the trustee in a discretionary trust has the discretion to allocate income and they exercise this discretion and allocate the income to you, then you are presently entitled. That is all it says. If the trustee says that this share of the income is for you, then you have present entitlement.
Conclusion
So that was a lot of details. The most important sections to understand are s95, 97, 98, 99 and 99A.
You calculate the taxable income per s95, assess beneficiaries per s97 and the trustee on anything else per s98 and then calculate the tax either at ordinary marginal tax rates per s99 or top marginal tax rates per s99A.
That is Division 6 in one sentence.
MORE
Who Pays the Income Tax for a Trust
Example 1 – How to Stream Trust Income
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 23 March 2020
