Present entitlement and trusts – what does it mean?

Part III, Division 6 of the Income Tax Assessment Act 1936 (Cth) (Act) contains provisions that determine who must pay the income tax in respect of the net income of a trust estate.  One of the features of Division 6 is the notion of ‘present entitlement’ (which curiously is not defined) and as such the Courts have had to determine its meaning.  This article discussed how the High Court interpreted the meaning of “present entitlement” and discusses when a person is considered to be presently entitled to trust assets in different circumstances.

How did the High Court interpret the term ‘present entitlement’?

The issue of present entitlement was first considered in the case of FCT v Whiting (1943) 68 CLR 199.

In this case the testator had created a trust under his will and the terms included that after the estate’s liabilities and debts had been paid, the residue was to be paid to the testator’s wife and children.  A decade later the estate liabilities had still not been finalised, however income had been credited to the beneficiaries.

The High Court held that the beneficiaries were not presently entitled to the income at the time it was credited to them, because they were not able to call upon the trustees to pay them the residue as the payment of liabilities had not been finalised.  To be presently entitled, a beneficiary must be able to demand immediate payment of trust income.

When vested interest or ability to demand payment is affected by personal circumstances

The meaning of ‘present entitlement’ has been examined in several cases that clarified where a person would be presently entitled when they have a disability or is the subject of an ongoing trial:

• In the case of Taylor & Anor v Federal Commissioner of Taxation (1970) 119 CLR 444 the beneficiary had a legal disability. It was held that the term presently entitled refers to an interest in possession in an amount of income that is legally ready for distribution so that the beneficiary would have a right to obtain payment of it if he were not under a disability.
• In the case of Harmer v Federal Commissioner of Taxation [1991] HCA 51 the Commissioner determined that the parties’ solicitors were assessed on the interest derived on the basis that no beneficiary was presently entitled to such income since, pending the outcome of a trial the beneficiaries were subject to, they had no vested and indefeasible interest. This decision was later upheld by the High Court.

Criteria to be met to be presently entitled

In order for the Courts to consider a person presently entitled to assets of the trust estate there are two (2) criteria that must be met:

• the beneficiary must have a vested beneficial interest in the trust distribution (as opposed to merely a contingent interest); and
• the beneficiary must (or would be but for a legal disability) be able to demand payment of the trust income from the trustee.

The High Court adopted this criteria for present entitlement in the case of Commissioner of Taxation v Phillip Bamford & Ors, Phillip Bamford & Anor v Federal Commissioner of Taxation [2010] HCA 10.

The application of s 95A of the Income Tax Assessment Act 1936

If the Courts were to use this logic, it would make sense that once a beneficiary had been paid their share of the trust assets, they would no longer have a present entitlement because they are no longer in a position to demand payment.  To overcome this issue, s 95A of the Act was introduced, which makes it clear that a beneficiary will still have a present entitlement to trust estate income notwithstanding that the income has been paid to the beneficiary or applied to their benefit.

The impact of trust resolutions on present entitlement

In the case of Lewski v Commissioner of Taxation [2017] FCAFC 145 the Court considered if the applicant was presently entitled to income of the trust estate where a trust deed authorised the making of resolutions.  The Court considered a ‘distribution of trust income’ resolution and a ‘variation of income’ resolution and found that both were interdependent and dealt with the same subject matter, which was the distribution of income of the trust for a particular year of income.

The Court held that the applicant was not presently entitled to the share of the net income of the trust estate because one of the resolutions was invalid and severance was not available, meaning both resolutions would fail.  As such, the applicant was not presently entitled to the share for the financial years in question.

When the trustee exercises discretion to pay or apply income

With regard to discretionary trusts, s 101 of the Act provides that a beneficiary, in whose favour the trustee of a discretionary trust exercises its discretion to pay or apply income, is deemed to be presently entitled to that income.  For s 101 to apply, the trustee has to exercise discretion to pay or apply such income for the beneficiary’s benefit before the end of year income.  If the trustee cannot specify exact amounts due to it being prior to the end of year when the trust accounts have been completed, it is sufficient for the trustee to specify the proportions or shares in which the income is to be distributed.

What about when the beneficiary is unaware of the existence of the trust?

In the case of Vegners v Federal Commissioner of Taxation (1991) 21 ATR 1347 an individual was unaware of the existence of a trust where they were presently entitled to trust income.  The Court held that s 101 of the Act applied and the person was presently entitled, as the trustee exercised their discretion and this is not contingent upon the beneficiary being aware of this.

It is important to note that if a beneficiary of a discretionary trust repudiates the benefit of the trust once they become aware of their entitlement, the disclaimer would have a retroactive effect and this would result in any property transfer being void ab initio.

Takeaways

In order to be considered to have a presently entitled to trust assets a beneficiary must have a vested beneficial interest in the trust income or capital and must be able to demand payment from the trustee.

Links and further references

Cases

Commissioner of Taxation v Phillip Bamford & Ors, Phillip Bamford & Anor v Federal Commissioner of Taxation [2010] HCA 10

Federal Commissioner of Taxation v Whiting (1943) 68 CLR 199.

Harmer v Federal Commissioner of Taxation [1991] HCA 51.

Taylor & Anor v Federal Commissioner of Taxation (1970) 119 CLR 444.

Legislation

Income Tax Assessment Act 1936 (Cth)

Further information about present entitlements and trusts

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Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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