Bamford amendments: why your pre-2010 trust deed may be a problem

The High Court’s 2010 decision in Commissioner of Taxation v Bamford fundamentally changed how trust income is taxed in Australia. The Court held that ‘income of the trust estate’ for the purposes of section 97 of the Income Tax Assessment Act 1936 means the distributable income of the trust determined under trust law, including the terms of the trust deed, not taxable income calculated under tax law. In 2011 Parliament amended the law so that capital gains and franked distributions can be streamed to beneficiaries who are specifically entitled to them, provided the deed allows it.

This means the definition of ‘income’ in your trust deed directly determines how much each beneficiary is assessed on. If the deed defines income narrowly (for example, only including ordinary income and not capital gains), the beneficiaries’ shares of net income may not line up with what they actually receive, and streaming of capital gains depends on the deed giving the trustee power to make a beneficiary specifically entitled. If the deed does not give the trustee adequate power to determine what constitutes income, distributions may produce unintended tax results.

Many trust deeds prepared before 2010 contain income definitions that were drafted on the assumption that trust law income and taxable income would be broadly aligned. Post-Bamford, this assumption no longer holds. Common problems include deeds that define income by reference to ordinary accounting concepts (which may not include capital gains or franked dividends), deeds that do not give the trustee explicit power to stream different types of income to different beneficiaries, and deeds that use the phrase ‘net income’ without clarifying whether this means trust law income or taxable income.

The consequence of an inadequate income definition can be significant. In the worst case, a beneficiary may be assessed on more income than they actually receive, or the trustee may be personally assessed on undistributed income at the top marginal rate. ASIC and the ATO do not automatically flag these issues. The trustee and their adviser are responsible for ensuring the deed is current.

A deed of variation can update the income definition and related provisions to reflect post-Bamford best practice. At CoSec Partners, deed variations are drafted and signed off by Key Legal, an independent external law firm we work with. CoSec Partners is not a law firm and does not give legal advice. We recommend all pre-2010 trust deeds be reviewed for Bamford compliance as a matter of priority.