Private ruling: Trust losses and franking credits
Date of advice: 17 April 2018
Published: July 2018
Ruling period: Income year ending 30 June 2017
Date scheme commenced: 30 June 2017

Ruling: Q1: Will the trust loss rules in Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) prevent Trust X from offsetting carried forward trust losses with a fully franked dividend paid by Company Z? | A1: No | Q2: Can Trust X distribute the fully franked dividend to the primary beneficiary (Taxpayer Y), after applying carried forward losses, which will carry the relevant franking credits under Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes

Relevant facts and circumstances: Company Z Company Z is an Australian resident company that for many years operated a successful business. Company Z original shareholders were Taxpayer Y and Taxpayer Z. Taxpayer Z passed away during the 2016 income year and the ordinary share was transferred to Taxpayer Y. Subsequently during the same income year Taxpayer Y’s two ordinary shares in Company Z were transferred to Company X as trustee for Trust X. In the income year ended 30 June 2016, Company Z paid dividends and franking credits to both Taxpayer Y and the Executor for Taxpayer Z’s Estate. Trust X The Trustee of Trust X is Company X and Taxpayer Y is the sole shareholder. Trust X is a family trust and the primary beneficiary of Trust X is Taxpayer Y. Trust X has made a family trust election (effective since from 1997) in accordance with section 272-80 in Schedule 2F of the ITAA 1936 with Taxpayer Y as the test individual. Trust X owns one rental property and, prior to the passing of the late Taxpayer Z, conducted business activities. In the 2016 and 2017 income years, Trust X derived rental property income and sales from business activities. The business activities of Trust X were controlled and operated primarily by the late Taxpayer Z. Trust X has carried forward losses for the income year ended 30 June 2017. The trust losses have existed for a number of years from the business activities. Proposed Scheme Company Z will pay a fully franked divided to Trust X as at 30 June 2017. Trust X will offset the prior and current year trust losses in full with the receipt of this dividend, as well as repaying the loan to Company Z. The trustee of Trust X has made a determination that Taxpayer Y (the primary beneficiary) will be entitled to 100% of the trust income which includes the fully franked dividend. Taxpayer Y will be presently entitled to net income of the trust estate for the purpose of Division 6 of the ITAA 1936.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 160APHD | Income Tax Assessment Act 1936 subsection 160APHJ(4) | Income Tax Assessment Act 1936 subsection 160APHL(7) | Income Tax Assessment Act 1936 subsection 160APHL(10) | Income Tax Assessment Act 1936 section 160APHM | Income Tax Assessment Act 1936 section 160APHO | Income Tax Assessment Act 1936 Division 1A of Part IIIAA | Income Tax Assessment Act 1936 Division 6 | Income Tax Assessment Act 1936 section 95 | Income Tax Assessment Act 1936 Schedule 2F | Income Tax Assessment Act 1936 Division 270 | Income Tax Assessment Act 1936 subparagraph 207(1)(a)(ii) | Income Tax Assessment Act 1936 subsection 270-10(1) | Income Tax Assessment Act 1936 section 270-15 | Income Tax Assessment Act 1936 paragraph 270-15(a) | Income Tax Assessment Act 1936 subsection 270-25(1) | Income Tax Assessment Act 1936 paragraph 270-25(1)(g) | Income Tax Assessment Act 1936 section 272-75 | Income Tax Assessment Act 1936 section 272-80 | Income Tax Assessment Act 1936 subsection 97(1)(a) | Income Tax Assessment Act 1997 Subdivision 207-B | Income Tax Assessment Act 1997 paragraph 207-50(1)(a) | Income Tax Assessment Act 1997 subsection 207-50(3) | Income Tax Assessment Act 1997 paragraph 207-50(3)(a) | Income Tax Assessment Act 1997 paragraph 207-50(3)(b) | Income Tax Assessment Act 1997 paragraph 207-50(3)(c) | Income Tax Assessment Act 1997 section 207-55 | Income Tax Assessment Act 1997 section 207-55 | Income Tax Assessment Act 1997 subsection 207-150(1)

Reasons for decision: Summary: Schedule 2F of the ITAA 1936 would not deny any part of the tax losses for Trust X to be offset with the receipt of a franked dividend. | Detailed Reasoning - Detailed reasoning: TRUST LOSSES AND OTHER DEDUCTIONS | Detailed Reasoning - Family Trusts: All legislative references are to Schedule 2F of the ITAA 1936, unless stated otherwise. Section 272-75 provides that a trust is a family trust during the time that a family trust election is active. Section 272-80 provides that trustee of the trust may make an election that the trust is a family trust at all times after the beginning of a specified year. Section 272-80 also provides that the election must be in writing, must specify the individual whose family group is to be taken into account in relation to the election and must satisfy a number of other requirements. In this case, the trustee of Trust X made a family trust election (FTE) during income year ended 30 June 1997. Consequently, section 272-75 is satisfied and Trust X is a family trust. | Detailed Reasoning - Schemes to take advantage of deductions: Broadly, Division 270 prevents trusts from using deductions in certain circumstances where a scheme to take advantage of deductions exists. In general, section 270-15 provides the tax consequences where a scheme has been entered into to take advantage of deductions. Specifically, paragraph 270-15(a) provides that if the requirements of subsection 270-10(1) are met, the deduction related exclusively to the scheme assessable income will be disallowed. Subsection 270-10(1) provides that section 270-15 will be triggered if: a) the trust has an allowable deduction b) under a scheme the trust derives an amount of assessable income (known as scheme assessable income) and an outsider to the trust directly or indirectly provides a benefit to the trustee or beneficiary (or an associate of either) c) the trustee or beneficiary (or an associate of either) directly or indirectly provides a benefit to the outsider to the trust (or an associate of the outsider) d) it is reasonable to conclude that b) and c) occurred wholly or partly, but not incidentally, because the deduction would be allowable, and e) the trust is not an excepted trust under paragraphs 272-100(b), (c) or (d). Consequently, section 270-15 will not apply if the scheme does not involve the trustee or beneficiary providing a benefit to an outsider to the trust (subparagraph 207(1)(a)(ii)). Subsection 270-25(1) provides that an “outsider to the trust” is a person other than: ● the trustee ● a person with fixed entitlement to a share of income of capital ● the individual specified in the family trust election ● a member of the specified individual’s family ● a trust with the same individual specified in its family election ● a company, partnership or trust that made an interposed entity election to be included in the individual’s family group ● a fixed trust, company or partnership that, at all times during the scheme: ● the individual specified in family trust election ● one or more members of the individual’s family; or ● trustees of one or more family trust (provided that the individual is specified in the family trust election of those family trusts) or any combination of the above, had fixed entitlements to all of the income and capital of the entity. | Detailed Reasoning - Application to your circumstances: Taxpayer Y is an individual specified in the family trust election and is therefore not an outsider to Trust X for the purpose of subsection 270-25(1). Company Z’s sole shareholder during the relevant period was Taxpayer Y, followed by the trustee of Trust X, which has a family trust election. Therefore Company Z is not an outsider to Trust X for the purpose of subsection 270-25(1) as it satisfies the paragraph 270-25(1)(g). Under the proposed arrangement, Trust X will receive a franked distribution from Company Z. Trust X will utilise its tax losses to reduce its net income and then make a distribution with associated franking credits to Taxpayer Y. Consequently, Taxpayer Y will have an allowable deduction equivalent to the tax losses. Taxpayer Y will also derive assessable income pursuant to the scheme. The franked dividend is therefore distributed to a shareholder within the existing family group, rather than a recently introduced shareholder or outsider. At all relevant times since incurring the tax losses, Company Z, Taxpayer Y and Trust X have been part of a family group for the purposes of Schedule 2F of the ITAA 1936, accordingly, Schedule 2F would not deny any part of the tax losses in this case. | Summary: The payment of the franked dividend from Company Z flowing indirectly to the primary beneficiary of Trust X, after applying carried forward trust losses, will carry the relevant franking credits under Subdivision 207-B of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subdivision 207-B of the ITAA 1997 sets out the effect of an entity receiving a franked distribution through one or more interposed partnerships or trusts. In certain circumstances, a franked distribution to a trust is treated as flowing indirectly to a beneficiary of the trust (or through the trust as an interposed entity). Paragraph 207-50(1)(a) of the ITAA 1997 directs attention to (relevantly) subsection 207-50(3) of the ITAA 1997 to determine when a franked distribution flows indirectly to beneficiaries. | Detailed Reasoning - Flows indirectly to the beneficiaries: Subsection 207-50(3) prescribes that a franked distribution will be taken to flow indirectly to a beneficiary of a trust in a particular income year if: (a) a franked distribution was made to the trustee of the trust; and (b) during that income year, the beneficiary has a share of the trust’s net income under subsection 97(1)(a) of the ITAA 1936 (whether or not the share amount becomes assessable income in the hands of the beneficiary); and (c) the beneficiary’s share of the franked distribution under section 207-55 is a positive amount (whether or not the beneficiary actually receives any of that share). | Detailed Reasoning - Distribution made to trustee of trust: Under the proposed scheme, paragraph 207-50(3)(a) of the ITAA 1997 is satisfied as the distribution is made from Company Z to the trustee of Trust X. | Detailed Reasoning - Beneficiary has a share amount: Under the proposed scheme, paragraph 207-50(3)(b) of the ITAA 1997 is satisfied as Taxpayer Y (the primary beneficiary) will be presently entitled to the net income in accordance with paragraph 97(1)(a) of the ITAA 1936. | Detailed Reasoning - The beneficiaries' share of the distribution is a positive amount: Section 207-55 of the ITAA 1997 ensures that franked distributions are notionally allocated amongst entities that derive benefits, and that allocation corresponds with the way those benefits are derived. In relation to a beneficiary who is the focal entity (as defined), and if the trust has a positive amount of net income (as defined by section 95 of the ITAA 1936), the share of the franked distribution is the amount to which the focal entity is ‘specifically entitled’. In order for the amount to be a specifically entitled distribution, the amount of the net economic benefit that the beneficiary can reasonably be expected to receive is required to be recorded in its character as referable to the franked distribution in the accounts or records of the trust. These records include the trust deed, statements of resolution or distribution statements. In this case Taxpayer Y will be 100% presently entitled to the income of Trust X and this will be recorded as a franked distribution against the trust’s records Under the proposed scheme, paragraph 207-50(3)(c) of the ITAA 1997 is satisfied. | Detailed Reasoning - Further requirements - qualified persons rule: For a beneficiary of a trust estate to be entitled to a tax offset in respect of a franked distribution that has flowed indirectly to them, subsection 207-150(1) of the ITAA 1997 requires they must be a qualified person in relation to the distribution paid for the purposes of former Division 1A of Part IIIAA of the ITAA 1936. For a beneficiary of a non-widely held trust to be a qualified person for the purposes of former Division 1A of Part IIIAA of the ITAA 1936 (specifically, former section 160APHO of the ITAA 1936), they must hold their interest in shares on which a dividend has been paid at risk for not less than 45 days during the primary qualification period where no related payments have been made. (Trust X in this matter would constitute non-widely held trusts for the purposes of former Division 1A as they would not be a widely held trust as defined in former section 160APHD.) Both the trustee of Trust X and the beneficiary would need to be a qualified person with respect of the shares held by the trustee of Trust X in Company Z. The trust would need to satisfy the qualification period in former section 160APHO of the ITAA 1936 that is Trust X would need to hold its shares in Company Z at risk as described in accordance with former section 160APHM of the ITAA 1936 for a period of at least 45 days. Both the trustee of Trust X and the beneficiary are considered to be qualified persons due to the following. ● The trustee of Trust X will have a long position with a delta of +1 in when it acquire the shares in Company Z (former subsection 160APHJ(4) of the ITAA 1936). ● In relation to the beneficiary the +1 position attributed to them is reduced to nil in certain circumstances (see former subsections 160APHL(7) and 160APHL(10) of the ITAA 1936) However as there is a family trust election in place any additional short positions imposed by subsection 160APHL(10) of the ITAA 1936 will not be deemed. Therefore the beneficiary of Trust X will be a qualified person with respect to the franked distribution that flows indirectly to them. As such, subsection 207-150(1) of the ITAA 1997 would not operate to deny a tax offset entitlement in the circumstances of the distribution described in this ruling. Therefore, Taxpayer Y will be entitled to the tax offsets arising from the franking credits pursuant to Subdivision 207-B of the ITAA 1936.