Private ruling: Trust income - disclaimer
Published: July 2014
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Did you, in your capacity as trustee of the X Trust (the Trust), validly disclaim the trust's entitlement to income from the Y Trust, with the result that the income purported to be allocated to the Trust does not form part of the taxable income of the Trust? | A1: Yes

Relevant facts and circumstances: The applicant (You) are the trustee of the X Trust (the trust), a discretionary trust established several years ago. You are the sole beneficiary to receive income from the X Trust for the year ended 30 June 2013. For several years preceding the income year ended 30 June 2013, the trust had, in addition to deriving income from its business, received income from the Y Trust, due to you being one of the principals of the practice conducted by the trustee of the Y Trust. The Y Trust is a non-fixed unit trust, that is, a hybrid trust. During the first quarter of the 2012-13 income year, the trustee and the voting unitholders of the Y Trust entered into an agreement (the Unitholders' Agreement) setting out, among other things, the payment of salaries to the principals of its practice. Later in the 2012-13 income year, you ceased to be a principal of the practice and ceased to hold voting rights in the Y Trust. The Unitholders' Agreement provided that changes to the distribution of trust income did not require the consent of all voting unitholders, but that other changes, such as the variation, amendment or alteration of any rights or entitlements attaching to an existing class of Units (including payment of salaries to the principals), did require that consent, which was not given prior to your cessation from the practice. No further unitholders' meeting was property convened prior your departure to consider any amendments to the Unitholders' Agreement. A clause of the Unitholders' Agreement states, in part that the consent of not less than 75% of all Unitholders must be obtained by the Trustee before it resolves to deal with the net income of the Trust in each financial year, in any order other than set out in another clause relating to entitlement to trust distributions. The clause of the Unitholders' Agreement relating to entitlement to Y Trust distributions states, in part, that at the end of each financial year the accounts of the trust shall be prepared and the Trustee shall distribute the net income of the trust to the Beneficiaries of each Unitholder, according to the Fixed Profit of the relevant unitholder. Pursuant to the Shareholders' Agreement, 'Fixed Profit' means, in relation to a Unitholder, either: a) the amount specified as such for that Unitholder in a Schedule attached to the Agreement; or b) such other amount as is determined by the Trustee from time to time. This clause also states that unless otherwise agreed by a majority of the unitholders, the net income of the Trust will be distributed by the Trustee at such times during the financial year when cash flow permits. During the part financial year commencing on 1 July 2012 and ending on your departure date, you received drawings (loan) on behalf of the Y trust in anticipation of there being future trust income to which the trust would be entitled. At a later date, you were provided with copies of draft financial accounts for the part financial year prior to your departure which you did not agree with. You became aware of the Trustee of the Y Trust purportedly exercising its discretion to distribute income to the trust, by way of resolution, during mediation relating to your legal proceedings. You did not receive any notice or written advice of the distribution. You were advised that the Y Trust changed the definition of income from an accounting definition (resulting in a loss position), to a tax definition whereby they made a (notional) distribution to you. You are of the opinion that the Trustee did not have the power to do this under the Unitholders' Agreement. You expect that the final version of accounts for the Y Trust will rectify these omissions and will instead reflect the terms of the Unitholders' Agreement. If the accounts of the Y Trust for the part financial year are adjusted, the trust could be expected to make a significant trading loss and have no net income.to distribute. You were concerned to cover the possibility that the final accounts may not be adjusted and therefore, in your capacity as the trustee of the X Trust, you executed the 'Deed of Disclaimer' to irrevocably disclaim any vested , indefeasible or any other interest in any further income, capital or other benefit from the Y Trust. On the same date (as your disclaimer), in your capacity as trustee for X Trust, you repaid to the Y Trust the drawings you had received during the part financial year.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 97 | Income Tax Assessment Act 1936 Subsection 97(1)

Reasons for decision: Summary: A person who is considered to be presently entitled to a share of the net income of a trust (a beneficiary) is required to include that share in their assessable income for the income year [subsection 97(1) of the ITAA 1936]. A distribution by the trustee of a unit trust is included in the assessable income of a unitholder in the year of income in which the unitholder is presently entitled to a share of the income of the unit trust, rather than the year in which the distribution is received by the unitholder. Until disclaimer, a beneficiary's entitlement to income of a trust is operative for the purposes of section 97 of the ITAA 1936 from the moment it arises notwithstanding that the beneficiary has no knowledge of it (see Vegners v. FC of T 91 ATC 4213 at 4215; (1991) 21 ATR 1347 at 1349). When a trustee exercises their discretion to distribute trust income, until the amount is actually paid over to the beneficiary, an unpaid entitlement is created for the benefit of that beneficiary. The beneficiary has an equitable claim against the trustee for immediate payment of the unpaid share ( Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199. The unpaid income distributions are taxable to the beneficiary once the trustee of a discretionary trust has exercised their discretion in favour of the beneficiary. In your case, by making a resolution to distribute notional income to the trust, the trustee conferred present entitlement to trust income on the trust. A beneficiary may disclaim an entitlement on its coming to their knowledge and will not be regarded as presently entitled to income of a trust if they have made a valid disclaimer. A disclaimer does not need to be effected by a formal deed, however the beneficiary must do some act to show their dissent - mere silence or inactivity is not sufficient to establish that the interest has been disclaimed (see Federal Commissioner of Taxation v. Cornell (1946) 73 CLR 394; 8 ATD 184; 3 AITR 405). An effective disclaimer, once made, operates retrospectively and not merely from the time of disclaimer. To be effective, a disclaimer must be made within a reasonable time of the beneficiary becoming aware of their entitlement and it must be disclaimed in its entirety (see Commissioner of Taxation v. Ramsden [2005] FCAFC 39; 2005 ATC 4136; (2005) 58 ATR 485 ( Ramsden )). Once a beneficiary has knowledge of the interest, a failure to disclaim within a reasonable period may indicate that the interest has been tacitly accepted. Further, to be effective, an act of disclaimer must generally occur before any act constituting assent to the distribution. A disclaimer of an interest constitutes a rejection of that interest and the actual receipt and use of that interest is not consistent with a disclaimer of the benefit: Bence v. Gilpin (1868) L.R. 3 Exch. 76. In your case, we are of the view that the disclaimer was valid and the X Trust is not assessable on the trust distribution from the Y Trust in respect of the disclaimed income.