Bamford clause: is your client’s trust deed out of date?

The High Court’s 2010 decision in Commissioner of Taxation v Bamford [2010] HCA 10 fundamentally changed how trust income is defined and distributed in Australia. If your client’s trust deed was executed before 2010 and has not been amended since, there is a real risk that the deed’s income definition does not align with current tax law, and that distributions are producing unintended tax consequences year after year.

The core issue is the distinction between ‘trust law income’ and ‘taxable income’ (called ‘net income’ under section 95 of the ITAA 1936). Before Bamford, many practitioners assumed they could simply distribute a particular type of income, capital gains, for example, to a specific beneficiary and achieve the intended tax result. Bamford confirmed that this assumption was wrong. A beneficiary’s share of the trust’s net income follows their proportionate share of trust law income, not the other way around. Since the 2011 amendments, capital gains and franked distributions are carved out of this rule and can be streamed to beneficiaries who are specifically entitled to them, if the deed allows.

The practical impact depends entirely on how the trust deed defines ‘income’. If the deed defines income in a narrow, accounting sense, which most pre-2010 deeds do, then capital gains, franked distributions, and certain other amounts may fall outside the definition of trust law income. When the trustee attempts to distribute capital gains to a specific beneficiary, the distribution may not have the tax effect the accountant intended because the beneficiary’s proportionate share of the trust’s net income is calculated by reference to their share of trust law income, not by reference to the resolution.

Post-Bamford, quality trust deeds include a broad and flexible income definition that gives the trustee power to treat capital gains, franked distributions, foreign income, and other amounts as income of the trust for distribution purposes. This is commonly called a ‘Bamford clause’ or an ‘expanded income definition’. The clause does not change how the trust is taxed. It changes the trustee’s power to characterise amounts as income, which in turn affects how the tax follows the distributions.

The risk is not theoretical. Pre-2010 deeds with an inadequate income definition are common. Symptoms include: inability to effectively stream capital gains to a specific beneficiary, franked distributions being allocated proportionately because no beneficiary was validly made specifically entitled to them, and distributions that the accountant treats as income of a particular character being recharacterised under the deed. Each of these can result in additional tax liability for the beneficiary and potential penalties for incorrect lodgement.

Streaming of capital gains and franked dividends is where the problem is most acute. Under Subdivision 115-C and Subdivision 207-B of the ITAA 1997, capital gains and franked distributions can be streamed to particular beneficiaries who are made specifically entitled to them, provided the deed gives the trustee that power (expressly or by implication) and the entitlement is recorded on time. Where the deed is unclear, the streaming may fail and the amounts are then allocated proportionately, and the ATO may assess the beneficiaries on a different basis than what was lodged.

A Bamford deed amendment updates the income definition and trustee powers to align with current ATO guidance and case law. The amendment broadens the definition of income to include capital gains, franked distributions, foreign source income, and other amounts at the trustee’s discretion. It also confirms the trustee’s power to stream specific types of income to specific beneficiaries. The amendment is structured as a deed of variation that sits alongside the existing trust deed, minimising the risk of resettlement.

At CoSec Partners, Bamford amendments are drafted and signed off by Key Legal, an independent external law firm we work with, and typically take two to three business days. If your client’s trust was established before 2010, we recommend reviewing the income definition as a priority, particularly before the end of the financial year when distribution resolutions are being prepared. Contact us for a quote or to discuss your client’s specific deed.