Can a beneficiary disclaim their entitlement to Family Trust income?

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Can a beneficiary disclaim their entitlement?

Each financial year your Family Trust gets an income. It may be from passively renting out property. It may be from operating your business. Someone has to pay tax on that income. Every year you get the choice of which beneficiary pays tax on the income. But can a beneficiary disclaim their entitlement?

The beneficiaries that you distribute to never actually see or get any of the money. You are just using up their low marginal tax rates. (The money owing to beneficiaries are called Loan Accounts or Unpaid Present Entitlements. Each year the children or beneficiaries sign a Debt Forgiveness Agreement to reduce the money the Family Trust owes them to zero.)

Can a beneficiary disclaim their entitlement to Family Trust income?beneficiary disclaim their entitlement

Let’s say you made a distribution to your mum. But now realise that it affects her Centrelink benefits. Can she renounce? The Trust Distribution Statement can’t be changed from 30 June. That is a problem. However, the ATO states that:

‘A beneficiary may disclaim an entitlement to trust income or capital arising from a resolution within a reasonable time of becoming aware of their entitlement.

If a beneficiary has made a valid disclaimer, you (the trustee) may be assessed on a share of the trust’s net (taxable) income.’ Trustee resolutions QC 25912

Legal Consolidated believes that the ATO is correct. We base our opinion on these cases:

Federal Commissioner of Taxation v. Cornell
(1946) 73 CLR 394
8 ATD 184
3 AITR 405

Commissioner of Taxation v. Ramsden
[2005] FCAFC 39
2005 ATC 4136
(2005) 58 ATR 485

Nemesis Australia Pty Ltd v. FC of T
[2005] FCA 1273
2005 ATC 4881
61 ATR 119

Vegners v. FC of T
91 ATC 4213
(1991) 21 ATR 1347

Until disclaimed, a beneficiary’s entitlement to trust income operates under section 97  ITAA1936. This is from the moment it arises. This is the case even if the beneficiary has no knowledge of it: Vegners v. FC of T 91 ATC 4213 at 4215; (1991) 21 ATR 1347 at 1349.

A beneficiary may disclaim an entitlement when they find out. A disclaimer does not need a formal deed. However, the beneficiary must do some act to show their dissent. Silence or inactivity is not sufficient to disclaim the interest: Federal Commissioner of Taxation v. Cornell (1946) 73 CLR 394; 8 ATD 184; 3 AITR 405).

An effective disclaimer, once made, operates retrospectively: not merely from the time of disclaimer.

Tax Office v Ramsden

To be effective, a disclaimer must be made within a reasonable time of the beneficiary becoming aware of the relevant gift. The gift must be disclaimed in its entirety: Commissioner of Taxation v. Ramsden [2005] FCAFC 39; 2005 ATC 4136; (2005) 58 ATR 485.

Identify clearly the disclaimed gift. The whole gift is disclaimed – not just some of it. In Ramsden, the ATO argued that the entire income earned in the Family Trust was a single gift. The Court said that was silly.

The ATO then argued that a beneficiary who had assented to a gift of income in a previous year could not make a disclaimer for a subsequent year. Also false.

The Court found that each entitlement was a separate gift – the subject matter of that gift being the income for that year. Further, the Court found that the interest of a default beneficiary was a separate gift arising by operation of the trust deed. The beneficiary was not prevented from disclaiming this gift merely because they had accepted gifts from the trustee in the past.

In this case, the beneficiary validly disclaimed their entitlement to the trust’s income. This is because they advised the trustee that they had no desire to receive the income appointed to them. This was upon becoming aware of their entitlement.

Accordingly, the beneficiary was not presently entitled to a share of the income of the trust for the purposes of section 97 ITAA 1936. Thus it was not assessable on any of the trust’s net income for that year.

If the Minutes are deficient the income is then assessed to the trustee: see Nemesis Australia Pty Ltd v. FC of T [2005] FCA 1273; 2005 ATC 4881; 61 ATR 119. However, if the Minutes are correctly structured then the next group of beneficiaries named in the Minute gets the assets. Our Minutes achieve this.

But your Trust Distribution Minutes must allow it. Our Trust Distributions allows for disclaiming and renouncing.

Can beneficiary disclaim their entitlement? Yes, but only if the Trust Distribution Minutes allow.

But I won’t know the income of my family trust until after 30 June

The ATO has stated that:

‘your resolution does not need to specify an actual dollar amount for the resolution to be effective in making a beneficiary presently entitled…’ (Trustees Resolutions QC 25912).

The Resolution you are building states that a beneficiary gets the income up to their marginal tax rate, and then to someone else up to their marginal tax rate. As the ATO states:

‘A resolution is effective if it prescribes a clear methodology for calculating the entitlement …’

Why build Distributions Statements for each financial year?

Since 1994, as a tax lawyer, I have provided a Family Trust Distribution Statement for each financial year. I attend a lot of ATO audits. My doctorate was in tax. The tax laws change. The ATO changes its mind. We prepare the Distribution Statements that reflect those particular rules for each unique financial year.

Does a resolution have to be in writing?

Read your Trust Deed to find out. Do you have a Brett Davies Lawyers or Legal Consolidated Family Trusts Deed? All our Deeds allows for the Distribution Minute to be in writing or oral. Whether the resolution must be recorded in writing depends on your trust deed. However, a written record provides better evidence of the resolution and avoids a later dispute. You don’t want fights with the beneficiaries and the ATO.

A written record is essential to stream capital gains and franked distributions. A beneficiary is specifically entitled to franked dividends or capital gains if this entitlement is recorded in writing.

For more legal advice on building a Family Trust Distribution Statements contact us.beneficiary disclaim their entitlement

Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
National Australian law firm beneficiary disclaim their entitlement beneficiary disclaim their entitlement

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