(traditional music)
When trusts incur losses,
they cannot be distributed to beneficiaries
and are locked in the trust.
However, to be able to carry forward the trust losses
and offset them against future trust income
involves satisfying certain tests
under schedule 2F of the ITAA36,
so as to maintain the integrity of the system.
Some trusts, certain excepted trusts,
are not subject to trust loss rules at all.
Generally, different tests apply
to different types of trusts, depending on
whether they are fixed, non-fixed that is discretionary,
or family trusts.
Different tests will impact upon different trusts.
All of the tests apply to non-fixed trusts,
which are the most widely used.
Fixed trusts only have two of the tests to satisfy,
while family trusts must only satisfy
the income injection test.
Bill, Bob, and Peggy are a group of individuals
all of whom control and benefit
from two separate discretionary trusts,
neither of which is a family trust.
The first trust is A - Loss Trust,
which incurred a loss in the previous year.
The other trust is B - Income Trust,
which is profitable and is expected
to continue to derive trust income in the future.
A - Loss Trust, is also a beneficiary of
the B - Income Trust.
During the income year, the trustee of the B - Income Trust,
exercised it's discretion to allocate the net income
of the Income Trust to the A - Loss Trust.
The distributable income of the B - Income Trust,
is not actually paid to the A - Loss Trust,
but is rather converted into a loan from the A - Loss Trust,
into the B - Income Trust.
The terms of the loan are not evidenced in writing
and interest is charged well below the market rate.
Does the income injection test apply here
and deny the recovery of losses in the A - Loss Trust?
The requirements of section 270-10(1)(b) are met,
because under the scheme,
the A - Loss Trust, has derived assessable income
because of the allocation of the net income by
the B - Income Trust.
The B - Income Trust, the outsider,
has provided a benefit to the A - Loss Trust
by allocating net income to the trust.
The A - Loss Trust, has provided a benefit to
the B - Income Trust, by loaning back an amount
equal to its income allocation.
The requirements of section 270-10(1)(c) are also satisfied,
on the basis that the net income allocation has been made to
the A - Loss Trust,
so that the income tax will not be payable
on that net income.
However, the B - Income Trust has retained use of the income
through the low interest loan
on terms that are not commercial.
Consequently, it appears that the assessable income
was derived by the A - Loss Trust,
and the benefits were provided by
the two trusts to each other, wholly or partly,
because of the prior year loss deductions
in the A - Loss Trust.
And the connection would appear
to be more than merely incidental.
In this case, the income injection test
would operate to increase the net income of
the A - Loss Trust to equal the amount of
the net income allocation from the B - Income Trust.
Where the test is failed, no deduction would be allowable
in the income year against the scheme assessable income,
with the result that the net income of the A - Loss Trust
is increased to equal at least the amount of
the scheme assessable income of $800,000.
In addition, to the extent that any deduction is incurred
in deriving scheme assessable income,
the deduction is not allowable.
It should also be noted, that even if the loan back of
the net income allocation was on commercial terms,
the scheme could still be subject
to the income injection test, as it was more than incidental
that by allowing the loss, the B - Income Trust
would have less income and pay less tax as a result.
To recap, in order for a trust to carry forward losses
to offset against future income,
it will need to pass certain tests.
Depending on the type of trust,
if a particular test is failed,
then the carry-forward of losses will be denied.