Complex tax laws make losses harder for trustees

In these difficult times many businesses and property owners are suddenly seeing income disappear while costs remain. Sales go down, rents have to be reduced or temporarily waived and sadly many face losses for the next few months if not longer. Being able to benefit from carrying these losses forward to offset future income for tax purposes is not much benefit but all the same it is some help.

Unfortunately, this has been made harder for a trustee of a loss making trust than for anyone else. Trust losses do not always just carry forward for tax until there is profit in the future. Trust losses cannot always be offset by distributions from another trust.

This is because of the ‘Trust Loss’ provisions first announced in 1995 by the then Labor Government, which became law in April 1998 under the then Liberal Government. These provisions set out tests a trustee must meet to claim tax deductions for losses incurred or bad debts written off. This means that a trustee might have to pay tax as soon as profits start being made which will not help with the post virus recovery.

For the trustee of a discretionary trust there are four tests that all have to be passed before a loss can be claimed of a bad debt recognised for tax. These are:

  • A 50% stake test that requires where there are any holders of a fixed stake in the trust at least 50% of those holders must be the same people from before the loss was made until after it is recouped. 
  • A distributions test must also be met if there were any distributions from the trust in the previous six years. This test looks at the proportions distributed to each beneficiary. Over 50% each year must go to the same beneficiaries. The definition of distribution for this test is very broad and can include almost any benefit provided by a trustee including the use of trust property.
  • The third test is the control test. This test requires that no new person starts to control the trust from before the loss was made until after it is recouped. A person controlling a trust would generally include the trustee, the appointor and any person able to control either of them. So just changing trustee is enough to fail this test.
  • Finally, there is the income injection test. This test is what prevents a trustee with a profit distributing to a trustee with a loss and having the amount offset.

This is only a very general description of some very complicated legislation but it gives an idea of just how hard it is for a trustee to manage a tax loss. The way most trustees deal with all these tests is to make a family trust election (‘FTE’).

A trustee can make a FTE if the trust is controlled by a particular person and members of his or her family on the last day of the financial year. The trustee has to specify a particular person whose family will be considered the only people who can benefit from that trust in the future without penalty tax being incurred.

Once the FTE is made the trustee can carry forward losses without passing all the complicated tests and any other trustee in the same family group or a company wholly owned by the family can distribute to the trustee with losses and the amount will be offset.

If you think your trust may make a loss in these very difficult times make sure you get the advice you need so that those losses can be offset against income from your other investments or carried forward until the crisis is over and you start to make profits again.