Trusts must generally distribute all available profits or income to beneficiaries. Otherwise the trustee will be taxed at the top marginal rate on any undistributed income.

If the beneficiary of a trust is a company, and the trust does not pay the income amount the company is presently entitled to, Division 7A of the Income Tax Assessment Act 1936 can apply.

This means that the trust retains the benefit. The ATO will consider the benefit to be an unfranked deemed dividend. Essentially, it is treated as an untaxed payment from the company to the trustee.

The whole dividend without any franking credit will be reported in the trust tax return. Tax will be paid at the top marginal rate.

Trusts and Division 7A rules can become very complex depending on the circumstances. If you think these rules might apply to you it’s recommended that you speak to a tax professional or contact the ATO for more information.

Usually when the ATO comes across problems with amounts taken from a trust, it will have been going on for a period of time and amounts owing will have been increasing and may have interest accruing and owing as well. It is usually a very costly mistake to rectify.