Making Effective Distributions – (Trust Distributions Guide Booklet Chapter 3)

Trust Distributions Guide

Below is Chapter 3 of our ‘Trust Distributions Guide’ booklet. To read the other chapters of our booklet, click the links below:

Distributing trust law income 

IMPORTANT: The distribution minutes must always clearly say that they are distributing trust law income, as that concept is defined in the trust deed. 

The distribution minutes should not attempt to distribute accounting income, tax law net income, or any other concept, other than the concept of trust law income (as defined in the trust deed). 

Unless it is specified otherwise in the trust deed, the trustee may distribute trust law income to beneficiaries by way of a percentage or proportion of trust law income, or by referring to a specific amount, with the balance being appointed to another beneficiary. 

e.g. $10,000 to mum, $20,000 to dad, and the balance of trust law income to a family company.  Alternatively, 10% to mum, 20% to dad and 70% to a family company. 

 

What happens to the assessable net income? 

Tax is imposed with reference to the beneficiary’s assessable income.  A beneficiary’s assessable income includes their share of any trust’s tax law net income to which the beneficiary is presently entitled. 

As noted above, a beneficiary is not able to be presently entitled to tax law net income.  The beneficiary can only be entitled to trust law income.  This is the heart of the problem with taxing trusts. 

It requires a ‘link’ to be made between trust law income (which a trustee can distribute, and which a beneficiary can be entitled to), and net income (the theoretical concept defined in Tax Act 36). 

The link takes the form of the ‘proportionate approach’.  The proportionate approach is the principle which is used to link a trust law concept with a tax law concept.  The proportionate approach says that a beneficiary who is entitled to a proportion of trust law income will be entitled to the same proportion of tax law net income. 

e.g. if trust law income is $3,000, and net income is $1,800, then a beneficiary entitled to $2,000 of trust law income (two-thirds of trust law income) will be taken to be entitled to $1,200 of net income (two-thirds of net income) and taxed on that amount. 

 

What happens if there is no trust law income (or there is a trust loss), but there is positive net income or credits? 

If there is no trust law income, or negative trust law income (i.e. a trust loss), then it is not possible for the trustee to make any distributions.  The trustee cannot distribute something that does not exist at law. 

However, even if the trust has no trust law income, it may nevertheless still have positive tax law net income for tax purposes.  This may be because net income includes something that is not included in the common law definition of trust law income, for example, franking credits, foreign tax credits, and capital gains. 

If this occurs, then the tax law net income will get ‘stuck’ in the trust.  This is because, if there is no beneficiary with an interest in trust law income, then the corresponding proportion of net income is ‘nil’.  That means no beneficiary will be taken to be entitled to any proportion of net income for tax law purposes. In this case, the trustee is taxed on everything at the top marginal rate. 

People get around this problem by defining trust law income to include these ‘notional’ tax law amounts (i.e. net capital gains, foreign tax credits, and franking credits).  This will make trust law income positive, and enable a distribution that will take with it the relevant proportion of tax law net income through to a beneficiary. 

TR 2012/D1 was issued on 28 March 2012. This Ruling (which remains in ‘draft’ format, many years later) is about the meaning of ‘income of the trust estate’ in Division 6, i.e. trust law income.  Paragraph 13 of this Ruling states that notwithstanding how a particular trust deed may define trust law income, the meaning of the ‘income of the trust estate’ for Division 6 purposes cannot exceed ‘real income’. Can you believe this – another concept for income of a trust! 

The ATO’s purpose in taking this position is to prevent a trustee from including notional amounts (such as franking credits etc.) in the calculation of trust law income.  It is arguable whether the ATO is right about this without a fundamental change to trust law.  However, in relation to franking credits and capital gains, this uncertainty has been alleviated by the specific streaming provisions (see below). 

 

Dealing with ‘categories’ of trust law income? 

For some time, trustees have sought to distribute certain discrete ‘categories’ of trust law income to specific beneficiaries in specific proportions – for example, to distribute foreign income, dividends, capital gains and other income to different beneficiaries.  These categories of trust law income usually match a particular category of assessable income.  This has been referred to as ‘streaming’. 

AMENDMENT: Streaming is only possible for trust law purposes if the trust deed allows for the streaming of trust law income.  This requires the trust deed to provide the trustee with authority to identify, separately account for and separately distribute these different components of trust law income. 

Up to 2011, the ATO generally accepted that, if the trust deed allowed for streaming of different categories of trust law income, then this would be accepted for tax law purposes.  The ATO accepted that streaming could be effective for notional amounts, such as franking credits, foreign tax credits, withheld tax, capital gains tax concessional amounts etc., and could take place either absolutely or proportionately (i.e. one beneficiary could get all of a particularly category of trust law income, or a number of beneficiaries could share in a proportion of a particular class). 

The ATO later changed its views about this, which triggered Parliament to introduce the Tax Laws Amendment (2011 Measures No. 5) Act 2011) to clarify the tax law position.  These amendments were only intended to be ‘interim’ in 2011, pending a full rewrite of the Division 6 rules, but they remain the same today. 

The amendments clarified that streaming can happen but only for certain limited categories of net income – namely, net capital gains and franking credits.  This has not changed the trust law position.  But because most streaming is tax-driven, the changes to the tax law have impact. 

This means that, from 2011, only dividend income and capital gains can be subject to effective streaming for tax law purposes. The amendments worked by removing capital gains and franked distributions from being assessed to a beneficiary under the normal Division 6 rules, and now have them assessed under subdivision 115-C (capital gains) and subdivision 207- B (franked distributions) of the Income Tax Assessment Act 1997 (Cth) (Tax Act 97).  Dealing with capital gains and franked distributions under these separate subdivisions means they are now assessed to a beneficiary of a trust regardless of whether the trustee streams them or not. We are getting into Frankenstein territory at this stage! 

 

How is a ‘capital gain’ effectively distributed? 

First, the capital gain must be calculated by the trustee. The trustee can then either distribute the capital gain to all its chosen beneficiaries as part of a ‘general distribution’, or the trustee can elect to stream capital gains to one or more specific beneficiaries (subject to the authority in the trust deed). 

To effectively stream under subdivision 115-C of the Tax Act 97, the trustee must distribute a real financial benefit equal to the total of the underlying capital gain – before concessions.  It is not possible just to distribute the net assessable gain without also giving them the actual cash (i.e. you cannot allocate the taxable gain to one beneficiary, but give the cash to a different beneficiary). 

For trust law purpose, it is also important that the entitlement to a particular income stream is recorded in the books of the trust, and that the trust minutes accurately record the character of the trust law income being streamed. 

 

Whether you are a trustee, advisor, or beneficiary, our team can help you understand your rights and responsibilities and avoid costly mistakes. Call us on 1300 654 590 or email us to make your trust distributions smarter, safer, and more strategic.

The information contained in this post is current at the date of editing – 22 August 2025.

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