Determining residence of a trust body

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The trust body is distinct from its beneficiaries, and the residence position of each is determined independently. The taxability of a beneficiary will usually be affected by their residence position and, to some extent, by the residence position of the trust body. Apart from determining the tax rate applicable to it, the residence position of the trust body does not affect its own taxability. A non-resident trust is taxed at the normal non-resident rate (28%), but the rate for a resident trust may be different (for example, 27% for the year of assessment 2007).

There is a special rule to ascertain the residence position of a trust body. In general, a trust body is resident for a basis year for a year of assessment if any one or more of the trustees is resident for that year. However, the trust body will not be resident for that year if any of the following occur:

The trust was created outside Malaysia by a non-citizen;

The trust income for the basis year was wholly derived outside Malaysia;

The trust was administered for the whole of the basis year outside Malaysia; or

At least half the trustees were not resident in that basis year.

The tax residence of an individual beneficiary is determined under Section 7 of the Act in the usual way, as is the residence of any individual trustee. The residence of a corporate trustee is determined in accordance with Section 8.

Source of income

It is important for a trust body to consider the rules that apply to sources of income. Income that accrues in (or is derived from) Malaysia, or is deemed to be derived from Malaysia, is income of the trust for tax purposes. Foreign source income is not within the scope of charge. Even if it is received in Malaysia, it is exempt by Paragraph 28 of Schedule 6 of the Act.

Example 6

A non-resident trust had the following income for the year of assessment 2007 (the basis period being the year to 31 December – see table below):

The Malaysian dividends constitute the total income of the trust body, deemed to be derived from Malaysia in accordance with Section 14 of the Act. The tax position of the trust is as follows:

In the case of a beneficiary, their share of the total income of a trust, determined in accordance with their fractional entitlement to the distributable income of the trust, is deemed to be a source of income and derived from Malaysia. This applies whether the beneficiary is resident or not, and whether the trust body is resident or not.

Example 7

Sam and Nick were entitled to a third of the income of the trust for the year of assessment 2007. The other third was accumulated under the terms of the trust. Nick resided in Malaysia for that year, Sam did not.

Sam and Nick both have deemed income from the trust of RM10,000 (two-thirds of RM30,000 and halved). Sam, as a non-resident, is liable to tax at 28% on his share of income. Nick is taxable as a resident according to his personal circumstances. Each is entitled to a Section 110 set off for a proportion of the tax chargeable on the trustees in respect of the distributable income (RM8,400 minus a third equals RM5,600. RM5,600 divided by two equals RM2,800).

Discretionary trusts

A discretionary trust is one in which the trustees are given power to allocate income between members of a class of beneficiaries in varying proportions (or not at all). This requires a different method of calculating the beneficiary's share of income.

The starting point is the total income of the trust body for a year of assessment. This amount is compared with the total of all sums classified as income received in Malaysia by the beneficiary from the trust in the basis year for that year of assessment. The lower of the two sums becomes the beneficiary's ordinary source income from the trust. Where two or more beneficiaries have received income distributions during a basis year, the amounts are added together in order to make the comparisons. The lower figure is then divided in proportion to the respective income distributions.

Example 8

The following applies to the RST Trust for the years of assessment stated:

Income distributed to beneficiaries in the basis year.

Ordinary source income divided in proportion to distributions.

The beneficiaries' ordinary source income for the year of assessment 2007 would be based on the lower figures for total income.

Where a trust is partly discretionary and partly for beneficiaries in fixed shares, the income is divided and the two parts are dealt with separately.

Anti-avoidance and settlements

The use of trusts for tax-planning purposes has become widespread in some jurisdictions to counter the effects of high tax rates, inheritance taxes and capital gains tax. In Malaysia, little use has been made of trusts for tax planning, particularly since the repeal of estate duty in 1991 and the virtual halving of tax rates on income. Any attempt to use a trust for tax mitigation must pay regard to the general anti-avoidance provisions contained in Section 140 of the Act, which empower the director general to disregard transactions that avoid tax.

Section 65 contains specific anti-avoidance provisions regarding trusts or settlements. It works by deeming the income of a settlement to be the income of the settlor, where certain conditions apply. The obvious intention is to prevent wealthy individuals from passing over their assets or income to family members who have zero or low tax rates.

Where, as the result of a settlement, income will (or may) become payable or applicable in the basis period for a year of assessment to (or for the benefit of) a relative of the settlor who at the beginning of that year is under the age of 21 and unmarried, the income of a settlement is deemed to be the income of the settlor instead of the income of the trustees or of the legal beneficiary.

Exceptions are as follows:

• The settlor is no longer alive at the time when the income arises;
• The relative is married at the beginning of the year of assessment;
• The relative reached the age of 21 at the beginning of the year of assessment;
• The person is not a relative of the settlor; or
• There are no circumstances under which income will or may be paid to, or for the benefit of, the relative during the basis period for the year of assessment concerned.

The term 'relative' includes all of the following:

• A child or stepchild of the settlor;
• A child of whom the settlor has custody or maintains at their own expense;
• A child adopted by the settlor or by the settlor's spouse; and
• A spouse, grandchild, brother, sister, uncle, aunt, nephew, niece or cousin of the settlor.

Deeming income to be that of the settlor also applies where the purported gift is incomplete so that under the terms of the settlement there is a possibility of the settled property (or the income from it) passing back to the settlor, or to the spouse of the settlor.

Exceptions are as follows:

• The settlement no longer contains the offending terms; in other words, they have lapsed or have been removed; or
• The settlor is no longer living.

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