Preamble
No. A beneficiary is not entitled to a deduction under section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) for an amount of unpaid present entitlement (UPE) that the beneficiary purports to write off as a bad debt. This is because the amount of the unpaid entitlement is not included in the beneficiary's assessable income. Rather, the entitlement is used to determine the amount (if any) of the net income of the trust (as determined under subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936)) included in the beneficiary's assessable income under Division 6 of Part III of the ITAA 1936. Consequently, the requirement in paragraph 25-35(1)(a) of the ITAA 1997 cannot be met.
In this Determination, a reference to a UPE is a reference to a beneficiary's right to receive an amount of trust income and/or capital that: (a) arises as a result of the beneficiary having been made presently entitled to that amount, and (b) has not been satisfied (including by being paid to or as directed by the beneficiary, or by being effectively converted into a loan from the beneficiary) or effectively disclaimed.
Archie is a beneficiary of the Woof Family Trust. In the 2009 income year, the trustee, Doggo Pty Ltd, derived $1,000 interest income. Pursuant to a power in the deed, Doggo Pty Ltd also chose to treat a $9,000 increase in the value of a trust asset as income of the trust for that year. Archie was made presently entitled to all of the income of the trust ($10,000). As a result he was assessed on all of the net income of the trust in that year ($1,000) under section 97 of the ITAA 1936.
The $10,000 entitlement was not paid to Archie but was recorded as a UPE. During the 2013-14 income year, Doggo Pty Ltd advised Archie that there was no likelihood his entitlement would be paid to him as the relevant asset is now worthless and the trust had no other property.
Archie determined that the $10,000 UPE was a bad debt and wrote it off. He cannot claim a deduction under section 25-35 of the ITAA 1997 for any part of the UPE. No part of his trust entitlement (his UPE) was included in his assessable income. Rather, Archie included his share of the net income of the trust in his assessable income.
The deed of the Meow Trust provides the trustee with a discretion to pay, apply or set aside the income, or any part of the income, to or for the benefit of the beneficiaries. Further, where the trustee resolves to distribute income, the deed provides that the payment, application or setting aside of income may be effectively made: (i) by paying the income to the beneficiary or to such person on behalf of the beneficiary as the beneficiary may authorise or direct; or (ii) by setting the income aside to a separate account in the books of the Trust in the name of the beneficiary whereupon such monies will constitute a loan at call.
The trustee resolved to appoint all of the income of the Meow Trust for the 2011 year ($20,000) to Tio. No amount was paid to Tio. The effect of the deed is that any income appointed, but not paid, to Tio is loaned back to the trustee.
Tio included all of the net income of the trust ($20,000) in his assessable income.
Tio cannot claim a deduction under section 25-35 of the ITAA 1997 in respect of the $20,000 owed to him by the trustee if he later concludes that the loan is bad and he writes it off. The loan was not an amount that Tio included in his assessable income.
This Determination applies to years of income commencing both before and after its date of issue. However, this Determination will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).
Appendix 1 - Explanation
You can deduct a debt (or part of a debt) that you write off as bad in an income year if it was included in your assessable income for that year or an earlier income year: paragraph 25-35(1)(a) of the ITAA 1997.
The equitable obligation on a trustee to pay the amount of a UPE to a beneficiary is not generally a debt at law. [1] However, regardless of whether or not the reference to a 'debt' in section 25-35 of the ITAA 1997 is intended, in context, to extend beyond common law debts to include relevant obligations due merely in equity, [2] a deduction is nonetheless not available under that section for a UPE that has been 'written off'. This is because paragraph 25-35(1)(a) of the ITAA 1997 requires the relevant debt to be included in the taxpayer's income in that year or in an earlier income year. [3]
Where a beneficiary is presently entitled to a share of the income of a trust estate, that income of the trust estate is not included in their assessable income under subsection 97(1) of the ITAA 1936. Rather, under that subsection the beneficiary's assessable income includes that same share or proportion of the trust's net income (subject to special rules concerning the streaming of capital gains [4] and franked distributions [5] that apply for the 2011 and later income years).
As the High Court recognised in Commissioner of Taxation v. Phillip Bamford & Ors; Phillip; Bamford & Anor v. Commissioner of Taxation, [6] a trust's 'income' and 'net income' are two subject matters which do not correspond. [7] 'Once the share of the distributable income to which the beneficiary is presently entitled is worked out, the notion of present entitlement to trust income has served its purpose, and the beneficiary is to be taxed on that share (or proportion) of the taxable income of the trust estate'. [8]
Even if the amounts of income and net income are the same numerically, it is not their share of trust income that is included in a beneficiary's assessable income. As the Full Federal Court observed in FC of T v. Greenhatch: Consistently with the approach of Sundberg J in Zeta Force ... once the trust law distribution gave the share, it should not be used to determine, in a causative sense, the components of the s 97(1)(a) assessable income. [9]
Note: the views expressed in this Determination are provided in the context of section 25-35 of the ITAA 1997. They should not be taken as expressing any view on whether a payment to a beneficiary from a trustee is of a non-assessable amount in the different statutory and policy setting of CGT event E4 in section 104-70 of the ITAA 1997.
Compendium
The ATO published responses to 3 submissions on this ruling in TD 2016/19EC. Outcome labels are heuristic — read the ATO response for the detail.
1The reasoning expressed in TD 2015/D5 around a section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) 'amount' is highly questionable. Strictly, even trade debts are never themselves included in assessable income - only ever the amount of the sales income derived, which if not paid also gives rise to a (trade) debt, is captured by the relevant income tax provision (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). As subsection 25-35(1) of the ITAA 1997 expressly refers to '(or part of a debt)', there is no reason why the part of a debt that continues to represent (per Pope v. FC of T [2014] AATA 532 (Pope)) previously assessed - by whatever mechanism under the tax law - but unpaid amounts, should not be eligible for deductibility under section 25-35. In other words, a blanket exclusion for UPEs, based on the tax law mechanics of how trust income is assessed, is not needed or supportable. Instead, section 25-35 of the ITAA 1997 is to be interpreted as being concerned with the amounts to which debts relate - not with an overly technical focus on how those amounts flow into assessable income. Otherwise, to be workable even for trade debts, section 25-35 should instead refer to the 'unpaid income represented by debts' as having been included in assessable income. On this basis, why does it matter if a present entitlement amount, equal to or less than the UPE debt, has been included in assessable income by section 97 of the ITAA 1936, rather than section 6-5 of the ITAA 1997? Like sales income and an outstanding amount of that income represented by a trade debt, the test is instead whether there is a sufficiently clear nexus between an assessed present entitlement and a debt representing that UPE. Where the debt (UPE) amount is less than (rather than more than, per Example 1) the amount included in assessable income, it would follow that only the lesser irrecoverable debt (UPE) amount could be deducted as a bad debt. This approach would deal with the situation in Example 1 (by limiting any deduction to the $1,000 income assessed) - without unnecessarily denying bad debt deductions for actual amounts assessed and receivable but which later become irrecoverable.