The pattern of distributions test only applies to non-fixed trusts without a family trust election. And it only applies in relation to prior year losses or debt deductions, but not current year losses.
Pattern of Distributions Test
It is a qualifying rule for revenue loss usage by discretionary trusts (non-fixed trusts) that are not a family trust.
The pattern of distributions test is one of four tests in the trust loss provisions in Schedule 2F for non-fixed trusts.
All four tests pursue the same gaol. And that is to ensure that whoever incurred the loss is the oe who deducst the loss and nobody else. ‘Whoever’ are the individuals behind the trust.
The characteristic of a fixed trust is that every beneficiary has a fixed entitlement. So it is easier to determine who incurred the loss and who claims it.
But in a non-fixed trust beneficiaries don’t have a fixed entitlement (at least not all of them). So you need to look at other things. The pattern of distributions is one way to determine whether the beneficiaries incurring the loss are basically the same as the ones deducting the loss.
It all starts in Division 267. A non-fixed trust can only deduct a tax loss when it passes the pattern of distributions test.
s267-20 (2): The trust cannot deduct the tax loss unless it meets…the condition in subsection 267-30 (2).
s267-30 (2):…the trust muss pass the pattern of distributions test …
And then a note in fine print underneath this:
To find out whether the trust passes the pattern of distributions test…see Subdivision 269-D.
But before we head to Subdivision 269-D, there is something in s267-30 (1) that is important. The pattern of distributions test only applies if
s267-30 (1) (a): ….the trust distributed inome (i) in the income year…and (ii) in at least one of the 6 earlier income years.
This is important. If there is no distribution in the income year or no distribution at all in any of the six years preceding the income year, then you can stop right here.
But remember that we are talking about trusts, not companies. In a trust all trust income is distributed, either to the beneficiaries or the trustee, in that year. So having no distributions only happens in a loss position or when still recovering from a loss position.
So this is basically saying that if you had a loss in the six years preceding the income year, then you don’t need to worry about the pattern of distribution test.
So now we are in Subdivision 269-D Schedule 2F ITAA36. And this one finally tells us how this test works.
s269-60: A trust passes the pattern of distributions test for an income year if… (a) the trust distributed …to the same individuals… a greater than 50% share of all test year distributions of income …. and (b) …to the same individuals (who may be different from those in…(a))…a greater than 50% share of all test year distributions of capital.
There is a lot in here. …to the same individuals… so we always need to trace distributions back to individuals.
…distributions of income …. and … distributions of capital – so we need to look at income distributions separate from capital distributions.
…to the same individuals (who may be different from those in…(a)) – so income and capital can go to different beneficiaries.
…all test year distributions of income …. and …capital – so we need to find the test years.
You only look at the pattern over a specific time period, from the 1st test year to the end of the income year. You don’t have to go back indefinitely.
You start with the trigger year. The trigger year is the year in which the trust incurred the loss.
s269-65 (2):…the trigger year is the loss year….
The trigger year is like the line in the sand. You compare what happened before and after that line.
The income year marks the end of your test period. It is the year you want to claim the tax loss in.
The actual period goes beyond the income year by two months. It goes from the start of the income year – so usually 1 July – until 2 months after its end – so usually 31 August the following year.
s269-65 (1) (a):…the period from the beginning of the income year until 2 months after its end…
1st Test Year
You got the end of the test period. Now you need to determine the start of the test period – the 1st test year.
The time span you look at is the six years preceding the income year. The test can’t stretch further back than that.
Before the Trigger Year
You start with the years before the trigger year, aka loss year, but don’t go further back than 6 years since the income year.
s269-65 (b):…the income year, before the trigger year, that is closest to the trigger year…
If there are distributions, take the year closest to the trigger year. That is your 1st test year and you can move on to the actual test.
If there is no distribution before the trigger year, you look at the trigger year itself.
s269-65 (c):…if ….the trust distributed income in the trigger year – the trigger year…
Any distribution in that year? Probably not – the trust made a loss in that year after all. But if there was a distribution, then the trigger year would be your 1st test year.
After the Trigger Year
If there is no distribution before or during the trigger year, then you look at the time after the trigger year. You take the year closest to the trigger year as your 1st test year.
No Distributions = No Test
If there is no distribution in any of the years preceding the income year, then the pattern of distribution test doesn’t apply.
Your test period starts with the 1st test year and ends 2 months after the income year. You look at the distributions over that time span.
s269-65 (e): …each intervening income year…between the [income year] and [the 1st test year]…
Once you have determined the 1st test year and have all distributions on the table, it is a simple numbers game.
You look at the distribution percentage for each beneficiary in the 1st test year, the income year and every year in between.
Circle the lowest percentage of all test years for each beneficiary.
And then add up the percentages you circled.
Et voila you have your pattern of distributions. If the total is greater than 50%, the trust passed the pattern of distribution test. If it is 50% or lower it failed.
Bob received 30%,70% and 50% of distributions in test year 1, 2 and 3 respectively. And 10% in the income year. So you circle 10%.
Sally received the rest of each distribution. So she received 70%, 30% and 50% in test year 1, 2 and 3 respectively. And 90% in the income year. So you circle 30%.
The total is 40% and hence the trust failed the pattern of distribution.
If Bob and Sally on the other hand had equally shared the distributions each year. So 50% for each in test year 1, 2 and 3 as well as 50% in the income year, then the total would have been 100% and they would have passed the test with flying colours.
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 31 January 2019