Default beneficiaries beware – you may have an unexpected tax bill!

By Tony Nunes & Lishi Huang, Kelly + Partners Chartered Accountants

The High Court of Australia's recent decision in Commissioner of Taxation v Carter highlights the risks of being a default beneficiary of an Australian discretionary trust. While a beneficiary can later disclaim their trust entitlement, this case demonstrates that the disclaimer may not be effective for tax purposes.

The facts in this case are complex, but can be summarised as follows:

• The trustee failed to validly distribute the income of the trust before the end of the income year (30 June). The trust resolutions were not prepared in accordance with the trust deed and therefore were held to be invalid.
• The trust deed provided that where the trustee failed to exercise their power, the income of the trust would be distributed to the default beneficiaries specified in the deed.
• The default beneficiaries only became aware of their trust entitlements after 30 June and sought to disclaim their trust entitlements. The disclaimers were ultimately held to be valid.

The High Court confirmed that a beneficiary who is presently entitled to trust income on 30 June is taxable on that entitlement, even if they later disclaim that entitlement. This is because the legislation is drafted to tax beneficiaries at a point in time. Whoever is legally entitled to the income of the trust just before midnight on 30 June is taxable, even if a later event revokes that entitlement. In this case, the default beneficiaries were held to be taxable even though they had no knowledge of their trust entitlement until after 30 June. They were assessed with additional income because of amended assessments that increased the taxable income of the trust, even though they never received any income from the trust.

The disclaimers made after 30 June were effective for trust law purposes but did not change the application of the tax law. This resulted in a lose-lose situation for the default beneficiaries as they were no longer able to call on their trust entitlements to pay their tax liabilities.

This case is a cautionary tale for trustees, beneficiaries, and their advisers. It highlights the importance of reading the trust deed and making sure that trust resolutions are made in accordance with the trust deed and before 30 June each year. Otherwise, there may be unexpected and devastating tax consequences for beneficiaries, especially default beneficiaries.

The trustee should make beneficiaries aware of their trust entitlements promptly, where possible before the resolutions are made. This would give the beneficiary sufficient time to determine whether they wish to accept or disclaim the trust entitlement.

It is important that beneficiaries obtain advice before disclaiming their trust entitlements. They do not want to be caught with an unwanted tax bill and no rights to demand payment of the income owed to them.

Tony Nunes

GGI member firm
Kelly + Partners Chartered Accountants
Advisory, Auditing & Accounting, Corporate Finance, Tax, Fiduciary & Estate Planning
Sydney, Australia
T: +61 2 9933 8866
E: This email address is being protected from spambots. You need JavaScript enabled to view it.
W: kellypartners.com.au

Kelly + Partners Chartered Accountants is a specialist chartered accounting business that assists private businesses, private clients, and families to manage their business and personal financial affairs. The Kelly + Partners Tax Consulting practice is respected as one of the foremost tax advisory firms in Australia and offers the full range of direct, indirect, and international tax services.

Tony Nunes has over 22 years’ experience in providing tax advice. He has extensive experience in advising clients on issues affecting cross-border transactions, acquisitions, and restructures, and in all aspects of structuring the ownership and financing of corporations and their operations.

Lishi Huang

GGI member firm
Kelly + Partners Chartered Accountants
Advisory, Auditing & Accounting, Corporate Finance, Tax, Fiduciary & Estate Planning
Sydney, Australia
T: +61 2 9933 8866
E: lishi.huang@ kellypartners.com.au
W: kellypartners.com.au

Lishi Huang has over 10 years’ experience advising large corporates and private groups on tax matters and disputes, particularly on land and property transactions and global expansions. She has worked in both private and public sectors, which gives her a unique perspective when advising clients.

Published: Trust & Estate Planning Newsletter, No. 11, Spring 2023 l Photo: OzPhotographer - stock.adobe.com