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Taxing the nest egg
By Richard Thornton
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Unlike a company or co-operative that is brought into existence and registered under the provisions of a specific law, a trust has no separate existence in law. The Act contains detailed provisions dealing with the taxation of trusts, but it does not define a trust. The concept is recognised under Malaysian law, but we need to refer to English law to gain an understanding of the terminology.
A trust has been defined as 'An equitable obligation, binding a person (trustee) to deal with property over which he has control (trust property) for the benefit of persons (beneficiaries or cestuis que trust) of whom he may himself be one, and anyone of whom may enforce the obligation.' Underhill quoted with approval in Green v Russell (1959) 2 Q.B.226.
Trust provisions can vary, but two basic aspects are important: certainty as to what the trust property is; and certainty as to the intended beneficiaries. Beneficiaries might be named specifically, or as a class of persons.
Method of taxation
The Act, in Sections 61 to 63, sets out specific rules for taxing the income of trusts. These cover the trust body itself and the beneficiaries, who are assessed and charged to tax separately from the trust body.
The trustees are also known as the trust body and regarded as a single and separate person for all tax purposes (except for the penalty provisions).
Trusts, whether carrying on business or not, have to comply with the self-assessment system in the same way as companies do, in particular:
- The basis period is the period covered by any accounts made up by the trust, otherwise the year to 31 December.
- The return of income must be submitted within seven months of the end of the basis period.
- Any tax due must be paid without further demand within seven months of the end of the basis period.
- The trust must provide an estimate of tax payable within one month before the commencement of its basis period and make instalment payments.
The trust body's income
The first step is to ascertain the total income of the trust body computed in accordance with Section 44 of the Act.
Income of the trust body consists of income from any source comprising property of the trust, including a trustee's share of any partnership income, which is also trust income. Deductions can be made from gross income in ascertaining the adjusted income from each source.
EXAMPLE 1
The trust body of ABC Trust is resident in Malaysia. Accounts are made up to 30 June each year. The trust had the following amounts of income for the basis period 1 July 2006 to 30 June 2007. This forms the total income of the trust body for the year of assessment 2007 (see below).
| Statutory income | RM |
| Property | 16,000 |
| Dividends (taxed at source at 27%) |
8,000 |
Subject to any set off for tax paid by instalments, the trust body will have the following liability to tax due for payment no later than 31 January 2008:
| RM | |
| Tax on RM24,000 at 27% (the rate applicable to trusts) |
6,480 |
| Less Section 110 setoff regarding dividends RM8,000 at 27% |
(2,160) |
| 4,320 |
Beneficiary's income tax
A beneficiary is allowed a credit under Section 110 for the amount of tax chargeable on the chargeable income of the trust body, or for a proportion of it if they are entitled to less than the whole of the distributable income. This proportion is calculated by dividing the beneficiary's ordinary source income from the trust for the year of assessment concerned by the total income of the trust for that year.
EXAMPLE 2
continued from Example 1
Beneficiary D, a Malaysian resident, is entitled to half of the distributable income of ABC Trust for the basis year to 31 December 2007. Assuming the beneficiary to be a single man with no other income or deductions to claim, his tax position for the year of assessment 2007 is:
| RM | |
| Statutory income ordinary source 1/2 x RM24,000 |
12,000 |
| Personal relief | 8,000 |
| Chargeable income | 4,000 |
| Tax payable RM4,000 –
RM2,500 = RM1,500 at 1% |
15 |
| Rebate – RM350 limited to | 15 |
| Less Section 110 setoff 12,000/24,000 x RM6,480 |
(3,240) |
| Tax repayable | 3,240 |
There is no need for the ABC Trust to make any tax payment in respect of D's share of the total income. The Director General has a power, which is usually exercised in such cases, to deduct the income entitlement of a resident beneficiary in ascertaining the chargeable income of a trust body.
EXAMPLE 3
continued from Examples 1 and 2
Assuming that D's share of the total income of the trust, but not that of the other beneficiaries, is allowed to be deducted in ascertaining the chargeable income of ABC Trust, the position for the year of assessment 2007 would be:
Trust
| RM | |
| Total income as in Example 1 | 24,000 |
| Less amount deducted regarding D | (12,000) |
| Chargeable income | 12,000 |
| Tax at 27% | 3,240 |
| Less Section 110 set off regarding dividends RM4,000 (1/2 x RM8,000) at 27% | (1,080) |
| Tax due for payment no later than 31 January 2008 | 2,160 |
Beneficiary D
| RM | |
| Chargeable income as in Example 2 | 4,000 |
| Tax on chargeable income | – |
| Less Section 110 set off regarding dividends RM4,000 (1/2 x RM8,000) at 27% |
(1,080) |
| Tax repayable | 1,080 |
When the fractional entitlement of a beneficiary changes during the basis year, the total income is apportioned between the different periods on a time basis. A beneficiary's entitlement is then calculated separately for each time period and their ordinary source income for the year is the aggregate of the fractional entitlements.
EXAMPLE 4
continued from Examples 1 to 3
Beneficiaries E and F were each entitled to a quarter of the distributable income of ABC Trust until 31 March 2007, when E passed away. F then became entitled to a half share.
Apportionment of total income
1 January 2007 to 31 March 2007
3/12 x RM24,000 = RM6,000
1 April 2007 to 31 December 2007
9/12 x RM24,000 = RM18,000
E's ordinary source income 1/4 x RM6,000 = RM1,500
F's ordinary source income 1/4 x RM6,000 + 1/2 x RM18,000 = RM10,500
Trusts intended to benefit minors frequently provide that income is to be accumulated by the trustees for a period of time rather than being distributed year by year. The trust will bear any tax attributable to the income. On subsequent distribution, such income is not treated as income of the recipient.
EXAMPLE 5
continued from Examples 1 to 4
In ABC Trust, a third of the trust income was being accumulated for a minor during the basis year 2007, and only the distributable income is revealed in Examples 1 to 4. The full amount of the trust's total income for the year of assessment 2007 is RM36,000. The full position is in the box on the right.
| All income RM |
Accumulated RM | Distributed RM | |
| Statutory income | |||
| Property | 24,000 | 8,000 | 16,000 |
| Dividends | 12,000 | 4,000 | 8,000 |
| Total income | 36,000 | 12,000 | 24,000 |
| Tax on RM36,000 at 27% | 9,720 | 3,240 | 6,480 |
| Less Section 110 set off regarding dividends RM12,000 at 27% | (3,240) | (1,080) | (2,160) |
| Tax payable by the trust (ignoring any reduction for beneficiary D) | 6,480 | (2,160) | (4,320) |
| Note: Only the amounts in the third column are taken into account in respect of beneficiaries D, E and F | |||
Richard Thornton is a tax examiner. He is also the author of 100 Ways to Save Tax in Malaysia for Individuals, published by Sweet & Maxwell Asia.
* Next month, we bring you Part 2 of this feature on trusts and settlements.