Haunted by Default Beneficiaries

Acis, current as of: 12 April 2017.

If accounting professionals use a trust deed in the belief that it provides the comfort of a default income mechanism, they are going to be sadly let down when it fails to properly specify default beneficiaries. A fault like this makes the entire strategy of using a deeming provision to save the trustee from an assessment meaningless.

The failure of a trust deed to nominate a default beneficiary removes the safety net when there is undistributed income in a financial year. This can happen where more income comes to light after resolutions are prepared or, in rare cases, the trustee does not distribute trust income until after June 30.

Even though we have previously published commentary on the subject of default beneficiaries, the issue continues to haunt us. We recently came across a significant flaw in a discretionary trust deed supplied by an automated online document provider.

In the case of this particular trust deed, the default beneficiaries were named as primary, secondary or tertiary beneficiaries as selected by the trustee. The problem lay in the fact it was not a mandatory default provision, and the decision was left at the trustee’s discretion to make a choice when it would already be too late to make a selection. In its current form, the deed simply doesn’t work to deliver the safety net that default beneficiaries are intended to provide.

Why have default beneficiaries?

The benefit of having default income beneficiaries lies in a deemed distribution of any remaining income to those default beneficiaries where there is any trust income not paid or set aside for any beneficiary.

Where a trust has undistributed income, the trustee is assessed on the part of the income which is not distributed. The trustee will be taxed at the top marginal rate, making undistributed income problematic if not dealt with properly. More tax can be assessed than would otherwise be the case, throwing tax planning into disarray.

A flawed trust deed delivers flawed outcomes

To illustrate how much of an impact a trust deed can have on the operations of a trust, imagine the following scenarios:

  • Undistributed income is assessed to the trustee because default beneficiaries were not nominated;
  • Default beneficiaries are nominated but are taxed at the highest marginal rate, meaning there is no benefit in nominating them in the first place;
  • Default beneficiaries are minors and may be taxed on undistributed income at penalty rates;
  • The trust deed doesn’t deal properly with the identification of default beneficiaries, as was the case in the deed we’ve mentioned.

This highlights the importance of:

  • Making sure distribution minutes are accurate and achieve what you intend;
  • Selecting default beneficiaries who are on a low tax rate; and
  • Determining that the terms of your trust deeds are sufficiently certain to ensure a default mechanism works in the way in which it is intended.

The Acis point of view

In the current Acis trust deed, where default beneficiaries are named, they will receive any undistributed income. Where no default beneficiaries are named, the trustee accumulates undistributed income and the trustee is taxed on that amount.

Naming default beneficiaries also works to avoid the trustee being assessed where some income remains undistributed. There are easily implemented ways, when preparing annual trust resolutions, of avoiding the potential of an inadvertent failure of distribution. Where that occurs, the presence or otherwise of default beneficiaries can be largely academic.

For more information contact Legal Services on 1800 773 477.