Question

The Farmers Trust is a discretionary trust (not a “family trust” as defined in the Tax Acts) that was set up on 1 July 2014 and operates a sports clothing business. For all relevant years, the trust has had the same trustee, JGB Pty Ltd.

John and Carly each hold one share in JGB Pty Ltd and no other shares have been issued to this date. No beneficiaries hold fixed interests in the trust.

The assessable income of the trust for the year ended 30 June 2018 is $180,000. In the year ended 30 June 2016 the trust incurred a loss of $20,000 and for the year ended 30 June 2017 the trust incurred a loss of $30,000.

However, for the year ended 30 June 2015 the trust had a tax net income of $50,000. This tax net income was distributed to John- 20%; Carly-20%, Bob-20%, Gary-20% and Edwin 20%. The only other beneficiary, Doris, did not receive any distribution in that year.

For the year ended 30 June 2018, the trustees propose to distribute a third of the trust tax net income to each of John, Carly and Doris.

Required

Can the trust deduct its losses for the years ended 30 June 2016 and 2017 respectively to reduce the trust tax net income for the year ended 30 June 2018?

Answer 1

Whether a trustee can deduct its losses for the previous years to reduce the trust tax net income for the year in future is governed by trust loss provisions in Schedule 2F to the Income Tax Assessment Act 1936. According to these provisions, it depends on whether it passes the following tests:

i) Patterns of distribution test (Subdivision 269-D of Schedule 2F to the ITAA 1936) :

The test applies if the non-fixed trust has distributed income or capital in the income year in which the deduction is claimed (or within two months after its end), and in at least one of the six earlier income years

A trust passes the POD test for an income year if, within two months after the end of the income year:

• the trust distributed directly or indirectly to the same individuals, for their own benefit, more than 50% of every 'test year distribution of income’ (see section 269-65), and
• the trust distributed directly or indirectly to the same individuals, for their own benefit, more than 50% of every 'test year distribution of capital’ (see section 269-65).

ii) 50% stake test

The 50% stake test only applies to a non-fixed trust where, at any time in the test period, individuals have more than a 50% stake in the income or capital (or both) of the trust.

iii) Control test

iv) Income injection test

Let's look at each of them one by one:

>> The 2014-15 income year is the closest income year before the loss year in which distributions were made and is within six years of the 2017-18 income year in which the trust seeks to deduct the tax loss. Thus, the condition of passing the test applies for claiming the deduction.

Now let's look at distribution of net income between different beneficiaries in test years for 2015 (actual) and 2018 as per proposed distribution ( 1/3 rd each to John, Carly and Doris)

	Year ended 30 June 2015	Year ended 30 June 2018
	Share of net income	Share of net income	Minimum of both
John	20%	33.33%	20%
Carly	20%	33.33%	20%
Bob	20%	0%	0%
Gary	20%	0%	0%
Edwin	20%	0%	0%
Doris	0%	33.33%	0%
		Total=	40%

Thus, it can be seen from the above that, only 40% of test year income was distributed to the same individuals, for their own benefit. As this is less than 50% threshold, the trust fails the Patterns of distribution test. Hence, it can't deduct its losses for the years ended 30 June 2016 and 2017 to reduce the trust tax net income if goes ahead with the proposed distribution for 2018.