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.
Purpose
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 one who deducts it … 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.
Division 267
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 you 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 income (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.
Division 269
So now we are in Subdivision 269-D Schedule 2F ITAA36. And this one finally tells you 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.
Test Period
You only look at the pattern over a specific time period – the so called test period consisting of the income year and the six years before that. So you don’t have to go back indefinitely.
To get to the test period in five steps: 1 – Income Year, 2 – Six-Year Timeframe, 3 – Trigger Year, 4 – 1st Test Year, 5 – Test Period.
1 – Income year
You start with your income year. It is the year you want to claim the tax loss in. It is the year you want to offset the year’s income with a previous loss.
The income year marks the end of your test period. There is no looking into the future.
But when we talk of income year, it is actually 14 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…
2 – Six Year Timeframe
Now you count out your six year timeframe. Take your income year and count back six years. That is your six-year timeframe.
Your actual test year will sit within this six year timeframe. No going back further than that.
3 – Trigger Year
Now you look for your trigger year. The trigger year is the year in which the trust incurred the loss. So you could also call it your ‘loss year’.
s269-65 (2):…the trigger year is the loss year….
Your trigger year might sit within the six years or before.
4 – 1st Test Year
Now you need to find the 1st test year. For a year to qualify as your 1st test year, it must sit within the six-year timeframe and it must have had a distribution of profit.
Start with the year before the trigger year. Is it still within the six-year timeframe and had a distribution? If yes, that is your 1st Test Year.
s269-65 (b):…the income year, before the trigger year, that is closest to the trigger year…
If not, look at the trigger year. Is it within the six-year timeframe and had a distribution?
s269-65 (c):…if ….the trust distributed income in the trigger year – the trigger year…
If not, move up. Go to the first year after the trigger year. And then the next. You slowly move your way through the six-year period until you struck gold and find your 1st test year.
If there is no distribution in any of the years preceding the income year, then the pattern of distribution test doesn’t apply.
5 – Test Period
So now you can determine your test period. 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]…
Pattern of Distributions Test
Now 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, so you have one circle per 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.
Example 1
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.
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