House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 1 - Primary producers' income averaging and farm management deposits

Outline of chapter

1.1 Schedule 1 to this Bill amends Divisions 392 and 393 of the Income Tax Assessment Act 1997 (ITAA 1997) to allow trust beneficiaries to continue to use the primary production averaging (income averaging) and farm management deposits (FMDs) provisions in an income year where the trust does not have any trust law income (trust income) to which a beneficiary can be presently entitled (for example, because the trust has a loss for trust law purposes).

1.2 All the legislative references in this chapter are to the ITAA 1997 unless otherwise specified.

Context of amendments

1.3 On 16 December 2010, the Government announced that it would introduce amendments to the income tax law so that trust beneficiaries can continue to use the income averaging and FMD provisions in a loss year.

Primary producers' income averaging

1.4 The averaging provisions for primary producers smooth out the income tax liability of eligible individuals from year to year. Broadly, this is achieved by providing a tax offset to a taxpayer where their income is higher than average or requiring them to pay extra income tax where their income is lower than average.

1.5 To be eligible for income averaging a taxpayer must (among other things) be an individual who carries on a business of primary production in Australia for two or more years in a row. A beneficiary is taken to carry on a primary production business carried on by a trustee of a trust during an income year if they are presently entitled to all or part of the trust income for that year (subject to a specific anti-avoidance rule designed to prevent exploitation of the averaging rules).

Farm management deposits

1.6 FMDs are a mechanism for primary producers to hold over income from years of good cash flow (deferring the payment of tax on these amounts) and draw down on it in years when additional cash flow is required. Broadly, this is achieved by allowing the primary producer a deduction for the amount of an FMD in the year in which it is made provided the FMD does not exceed their net primary production income for that year (and including the amount in their assessable income in the income year in which it is repaid).

1.7 To be eligible for an FMD deduction, a taxpayer must (among other things) be an individual who carries on a business of primary production in Australia when the FMD is made. An individual is taken to carry on a primary production business carried on by a trustee of a trust during an income year if the individual is a beneficiary of the trust and is presently entitled to a share of the income of the trust for that year.

Australian Taxation Office's administration of the law

1.8 Before the High Court's decision in Commissioner of Taxation v Bamford (2010) 240 CLR 481 (Bamford), the Australian Taxation Office (ATO) regarded a beneficiary as presently entitled to a share of the trust income provided there was some gross trust income and the trustee exercised their discretion in favour of the beneficiary (or in the absence of an appointment or accumulation of income, the trust income had fallen to the beneficiary as a default beneficiary). Further, where there was no gross trust income, the ATO regarded a beneficiary (including a default beneficiary) as presently entitled to a share of trust income where they had a vested and indefeasible interest in trust income and were therefore deemed to be presently entitled to trust income (under subsection 95A(2) of the Income Tax Assessment Act 1936 (ITAA 1936)).

1.9 These views, which were set out in Taxation Ruling TR 95/29, meant that a beneficiary (including default beneficiaries of a discretionary trust) could be taken to carry on a primary production business that was actually carried on by the trustee in a year where the trust had a loss for trust law purposes.

1.10 The effect of this was that such a beneficiary continued to be eligible for income averaging and was not required to have their FMDs repaid to them and included in their assessable income.

1.11 However, Bamford held that a beneficiary cannot be presently entitled to a share of income of a trust if there is no income legally available for distribution. Because of this, the ATO view in Taxation Ruling TR 95/29 was no longer correct at law and the ruling was withdrawn on 30 June 2010 (although the ruling still applies to the 2009-10 and earlier income years).

Summary of new law

1.12 This Schedule amends the income averaging and FMD provisions to broadly reinstate the position that existed before the High Court's decision in Bamford and the ATO's consequent withdrawal of Taxation Ruling TR 95/29. That is, trust beneficiaries can continue to be eligible for income averaging and able to retain their FMDs in an income year where the trust does not have any trust income to which a beneficiary can be presently entitled (for example, because the trust has a loss for trust law purposes).

1.13 Beneficiaries of non-discretionary trusts are eligible for income averaging and able to retain their FMDs where a trust has no trust income for an income year to which a beneficiary could be presently entitled, if they would have been presently entitled to trust income if the trust had some trust income for that year that was legally available for distribution.

1.14 Beneficiaries of discretionary trusts are eligible for income averaging and able to retain their FMDs where there is no trust income for an income year to which a beneficiary could be presently entitled, if they are chosen by the trustee. The trustee may choose not more than the greater of:

•

twelve beneficiaries; and

•

the number of individual beneficiaries that for the previous income year were taken to carry on a primary production business carried on by the trustee for the purposes of the relevant provisions.

Comparison of key features of new law and current law

Detailed explanation of new law

1.15 A beneficiary of a trust, the trustee of which carries on a primary production business, will be taken to carry on that business and therefore be eligible for income averaging and to retain their FMDs, in the circumstances outlined below.

Primary producers' income averaging

A trust with trust income to which a beneficiary can be presently entitled

1.16 There is no change to the existing treatment of a beneficiary of a trust where the trustee carries on a primary production business and there is an amount of trust income to which a beneficiary can be presently entitled. A beneficiary of a trust that carries on a primary production business in Australia is generally taken to carry on a primary production business carried on by the trustee of the trust where they are presently entitled to a share of the trust income for the income year. A beneficiary is not, however, taken to carry on the primary production business carried on by a trustee if they are presently entitled to less than $1,040 of the trust income, unless the Commissioner of Taxation (Commissioner) is satisfied that their interest was not acquired or granted wholly or primarily to enable access to the income averaging provisions. [ Schedule 1, item 1, subsection 392-20(1 ) and item 2, subsection 392-20(2 )]

A primary production business which is carried on by a trust with no trust income

1.17 Where a trustee of a trust carries on a primary production business in Australia, but the trust has no trust income for the income year to which a beneficiary can be presently entitled, the beneficiary is taken to carry on that primary production business if specified conditions are met. The necessary conditions depend on whether the trust:

•

has certain entitlements - commonly called a fixed trust; or

•

does not have certain entitlements - commonly called a discretionary trust.

Trusts with certain entitlements

1.18 A beneficiary is taken to carry on a primary production business carried on by the trustee of a trust if the trust does not have any trust income to which a beneficiary could be presently entitled, and:

•

at all times during the income year, the manner or extent to which each beneficiary of the trust can benefit from the trust is not capable of being significantly affected by the exercise, or non-exercise, of a power ( certain entitlements ); and

•

if the trust had trust income for the income year the beneficiary would have been presently entitled to a share of this income.

[ Schedule 1, item 1, subsection 392-20(1) and item 2, subsection 392-20(3 )]

1.19 The certain entitlements requirement is broadly similar to the no material discretionary elements approach in Subdivision 126-G (CGT roll-over relief for the transfer of assets between fixed trusts) of the ITAA 1997, which was enacted by the Tax Laws Amendment (2009 Measures No. 6) Act 2010 .

1.20 The certain entitlements requirement must be satisfied by each of the beneficiaries of the trust. Each beneficiary of the trust must have an interest in the trust that is of a sufficiently definable quality and extent as to be capable of measurement without the exercise or non-exercise of a power (in the sense discussed in Gartside v Inland Revenue Commissioners [1968] 2 WLR 277). The quality or extent of each beneficiary's interest should not be capable of being defeated or substantively altered by the exercise, or non-exercise, of a power. The requirement has regard to the exercise, or non-exercise, of a power by any entity, and not just the trustee of the trust.

1.21 For these purposes, a power includes both trust powers (that is, powers that must be exercised but which allow discretion as to when or how they are exercised) and mere powers (that is, discretions), but does not include trustees' duties. A trustee duty is a thing a trustee must do as prescribed, or refrain from doing, to avoid being in breach of trust (refer to the discussion in Jacobs' Law of Trusts in Australia , 7th ed., Heydon and Leeming at [1606]).

Example 1.1: Trusts in which beneficiaries have certain entitlements

The trustee of the Wilson Trust carries on a primary production business during the 2010-11 income year. At all times during this income year, the manner or extent to which each beneficiary of the trust can benefit from the trust is not capable of being significantly affected by the exercise, or non-exercise, of a power.

Kevin is a beneficiary of the Wilson Trust. Kevin's interest in the trust entitles him to receive 20 per cent of the trust's income for the income year.

In the 2010-11 income year the Wilson Trust has a loss for trust law purposes. As the trust meets the certain entitlements requirement and as Kevin would have been presently entitled to a share of the trust income had the trust had some trust income for the income year, Kevin is taken to carry on the primary production business carried on by the trustee of the Wilson Trust for the purposes of income averaging and FMDs.

1.22 Examples of powers that may be capable of significantly affecting the manner and extent to which a beneficiary can benefit from a trust were set out in the explanatory memorandum to the Tax Laws Amendment (2009 Measures No. 6) Bill 2009 in paragraph 1.34. That explanatory memorandum also set out examples of powers that would not be regarded as significantly affecting the manner and extent to which a beneficiary can benefit from a trust in paragraphs 1.35 and 1.36.

Trusts without certain entitlements

1.23 Trustees of trusts that do not meet the certain entitlements requirement may, for an income year for which the trust has no trust income, choose a certain number of beneficiaries to be taken as carrying on the primary production business carried on by the trustee of the trust for that income year. The trustee may choose not more than the greater of:

•

twelve beneficiaries; and

•

the number of individual beneficiaries that for the previous income year were taken to carry on a primary production business carried on by the trustee for the purposes of the income averaging provisions.

[ Schedule 1, item 1, subsection 392-20(1), item 2, subsection 392-20(4) and item 3, subsections 392-22(1 ) and ( 2 )]

1.24 A choice is made for an income year and needs to be in writing and signed by the trustee and the beneficiary chosen. The choice must be made before the lodgment of the trust's income tax return for the income year for which the choice is to apply, unless the Commissioner allows extra time for a choice to be made. A choice cannot be varied and is irrevocable. [ Schedule 1, item 3, subsections 392-22(1 ) and ( 3 ) to ( 5 )]

Example 1.2 : Trusts in which beneficiaries do not have certain entitlements

Aaron, Elizabeth, Michael and Daniel are beneficiaries of the Bennett Trust. The Bennett Trust does not meet the certain entitlements requirement. The trustee of the Bennett Trust carries on a business of primary production during the 2010-11 income year, however, the trust has a loss for trust law purposes for this income year.

The trustee chooses Aaron, Elizabeth, Michael and Daniel for the purposes of the income averaging provisions for the 2010-11 income year. They are therefore treated as carrying on the primary production business carried on by the trustee of the Bennett Trust for the purposes of these provisions and their primary production income for the income year is nil (they do not have any primary production income from any other source).

Aaron and Elizabeth also hold FMDs during the 2010-11 income year. The trustee also chooses them for the purposes of the FMD provisions for the income year. They are therefore taken to carry on the primary production business carried on by the trustee of the Bennett Trust for the purposes of these provisions and are able to retain their FMDs for the income year.

Michael and Daniel have not been chosen by the trustee for the purposes of the FMD provisions and are therefore not taken to carry on the primary production business carried on by the trustee of the Bennett Trust for the purposes of these provisions.

Example 1.3: Choice of beneficiaries by trustees of trusts in which beneficiaries do not have certain entitlements

The trustee of the Swain Trust carried on a business of primary production during the 2009-10 income year. During that income year Bruce, Judith, their six children, and their children's six spouses, were all presently entitled to a share of trust income and were therefore taken to carry on the primary production business carried on by the trustee for the purposes of income averaging and FMDs.

The trustee of the Swain Trust carries on a business of primary production during the 2010-11 income year, however, the trust has a loss for trust law purposes for this income year. The Swain Trust does not meet the certain entitlements requirement. As there were 14 beneficiaries that were taken to carry on the primary production business carried on by the trustee for the purposes of income averaging and FMDs in the 2009-10 income year, the trustee is able to nominate not more than 14 beneficiaries for the purposes of income averaging and FMDs for the 2010-11 income year. The trustee need not nominate the same beneficiaries, or even the same number of beneficiaries, for both the income averaging and FMD provisions.

Farm management deposits

A trust with trust income to which a beneficiary can be presently entitled

1.25 There is no change to the existing treatment of a beneficiary of a trust where the trustee carries on a primary production business and there is an amount of trust income to which a beneficiary can be presently entitled. An individual beneficiary of a trust that carries on a primary production business in Australia is generally taken to carry on a primary production business carried on by the trustee of the trust where they are presently entitled to a share of the trust income for the income year. [ Schedule 1, items 9 and 10, subsections 393-25(3 ) and ( 4 )]

A primary production business which is carried on by a trust with no trust income

1.26 Where a trustee carries on a primary production business in Australia, but the trust has no trust income for the income year, an individual beneficiary of the trust will be taken to carry on a primary production business carried on by the trustee for an income year for the purposes of the FMD provisions in substantively the same way as for the income averaging provisions (see paragraphs 1.17 to 1.24). [ Schedule 1, item 9, subsection 393-25(3 ), item 10, subsections 393-25(5 ) and ( 6 ), item 11, section 393-27 ]

Application and transitional provisions

1.27 These amendments, which are favourable to taxpayers, apply where the income year of the trust is the 2010-11 income year or a later income year. [ Schedule 1, item 14 ]

Special transitional rule

1.28 The current FMD provisions, including subsection 393-25(3), only apply from the 2010-11 income year. For income years before this the FMD provisions were contained in Schedule 2G to the ITAA 1936. To ensure that the amendments allowing a trustee of a trust without certain entitlements to nominate beneficiaries for the purposes of the FMD provisions operate appropriately in the 2010-11 income year, a transitional provision is inserted into the Income Tax (Transitional Provisions) Act 1997 . For the purpose of determining the maximum number of choices that the trustee may make under subsection 393-27(2) for the 2010-11 income year, subsection 393-25(3) is treated as having applied to a beneficiary covered by paragraph (c) of the definition of 'primary producer' in section 393-25 in Schedule 2G to the ITAA 1936 in the 2009-10 income year. [ Schedule 1, item 13, section 393-27 of the Income Tax ( Transitional Provisions ) Act 1997 ]

Consequential amendments

1.29 A consequential amendment is made to repeal subsection 392-20(3) and re-enact it as subsection 392-20(5). This subsection operates to deny income averaging for beneficiaries of corporate unit trusts (Division 6B of the ITAA 1936) and public trading trusts (Division 6C of the ITAA 1936) in respect of their interest in the trust. [ Schedule 1, item 2, subsection 392-20(5 )]

1.30 Consequential amendments are made to insert suitable subheadings before subsections 393-25(2) and (3). A consequential amendment is also made to the FMD provisions to re-enact subsection 393-25(4), which is about the application of Division 393 of the ITAA 1997 and Division 4A of Part VA of the ITAA 1936 to a beneficiary who is no longer under a legal disability, as section 393-28. [ Schedule 1, items 7 and 8, subsections 393-25(2 ) and ( 3 ) and item 11, section 393-28 )]

1.31 A consequential amendment is made to the note to item 1 in the table in section 393-35 to update the references to section 393-25. [ Schedule 1, item 12, section 393-35 ( note to item 1 in the table )]

1.32 A consequential amendment is made to note 2 to subsection 393-5(1) to update the references to section 393-25. [ Schedule 1, item 6, subsection 393-5(1 ) ( note 2 )]

1.33 A consequential amendment is made to the note to section 97A of the ITAA 1936 to update the references to section 393-25. [ Schedule 1, item 4, note to section 97A of the ITAA 1936 ]

1.34 A consequential amendment is made to the note to section 202DL of the ITAA 1936 to update the references to the FMD provisions. [ Schedule 1, item 5, note to section 202DL of the ITAA 1936 ]