Title: asset revaluation by discretionary trust

Subject: TAX

Credits: 1

Ref: 39460

Submitted Date: 19/04/2021 5:00:24 PM

Submitted By: Christopher Leech

Question by: Christopher Leech

Good Aftenoon,

i was about to revalue some assets in a discretionary trust when another accountant said it is not  a good idea as there are tax consequences.

This is the scenario:

Discretionary Trust - for 2020 only one beneficiary.

 

Investment portfolio has increased by $100K during the 19/20 FY

 

Expected entry: DR Portfolio $100K

                        CR Asset rev reserve. $100K

The trust also had net invetmet income for the year of say $50K

Total income for the year as per P & L $150K

1) In the financial statements I assume the whole $150K is distribted to the beneficiaries

2)I assume in the trust tax return $100K is added back to leave an amount to be disctrubuted of $50K for tax purposes

3) Assuming the trust had $200K cash it will pay/make a physical distribution of $150K to the beneficiaries being $50K profit and $100K from Assets Revaluation Reserve.

4) Theindividuals returns would only reflect $50K Trust dist.

Question: Is there any tax consequence on the $100K, is the other Accountant correct saying dont bring the correct value assets onto the balance Sheet as there are tax consequences.

Thankyou

Chris Leech

cleechtax@bigpond.com

M 0439 930 370

Answer by: Clifford Hughes

Good morning Chris,

 

Asset revaluation reserves (AARs) in discretionary trusts and subsequent distributions from those reserves to beneficiaries are an area where many advisors claim to know about but which, in reality, they are blindly ignorant of the true technical details.

 

The following comes with the warning that I have no accounting qualifications.

 

What you have described is flawed and not a correct application of the concept.

 

In the 2000s there was a concerted effort by the ATO (backed by some academic papers) to claim that a distribution to a beneficiary from an ARR was subject to CGT in the year of distribution, despite the fact that there was not an actual disposal of the asset in question. As a result, some ignorant advisors (who have not done the technical reading) claim there are "tax issues" with ARRs by a discretionary trust.

 

However, potential taxation issues can arise when the actual asset is eventually sold. The reason being that in order to satisfy the post-Bamford requirement for "specific entitlement" in Div 115-C, the beneficiary who receives the present year ARR distribution will be liable for CGT on that proportion of the gain, irrespective of who receives the actual cash. Further, if that beneficiary has died or for some other reason is no longer a beneficiary of the trust, there can are significant problems (and tax issues) for all remaining beneficiaries. Therefore an ARR exercise should not be undertaken without providing the client/beneficiary with specific and clear written advice on future possible implications in order to protect yourself.

 

The validity of ARRs by discretionary trusts was confirmed by the High Court in 2016 in Fischer v Nemske. The provisos being (as specified by the High Court) that there must be a specific power in the trust deed for the trustee to be able to revalue assets and also to then make distributions. Further, the distribution resolutions need to be carefully drafted to utilise those powers in order to make the distribution effective. Finally, in addition to all of the above, in order for the trustee to be able to utilise its powers to revalue an asset the revaluation must satisfy the requirements in AASB 1041.

  

Problems with you proposal

 

  1. You say there is only 1 beneficiary. That cannot be the case otherwise the trust likely cannot exist.
  2. Effectively, ARRs can only occur in a discretionary trust where the relevant asset is held on capital account. That being the case, the revaluation cannot be recorded in, nor should it impact upon, the P&L.

 

Regards

 

Cliff

 

Clifford Hughes CTA   

Accredited Specialist - Taxation Law 

Accredited Specialist - Business Law (Qld)

Accredited Specialist - Wills & Estates Law (Vic)

SMSF Specialist Advisor ™

Principal

Clifford Hughes & Associates

Revenue, Structuring & Succession

Liability limited by a scheme approved under professional standards legislation.

M  - 0404 88 21 66

E   - chughes@chalegal.com.au

 

 

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