This article aims to promote a comprehensive understanding of the taxation of trusts in Malaysia among candidates preparing for Paper P6 (MYS), Advanced Taxation. The explanations in this article go further than would be expected for a candidate in the Paper P6 (MYS) exam - however, they serve to promote understanding.
This article will focus on trusts generally and will not deal with unit trusts and REITs (Real Estate Investment Trusts). Also, the aspect of 'further source income of a trust beneficiary' will not be discussed as this is excluded in the syllabus for Paper P6 (MYS).
This article is organised as follows:
A Trusts – the basics
B Aspects of tax treatment of trusts and trust beneficiaries
C Tax computation of trusts – some common items
D An illustrative computation
A. Trusts – the basics
Before delving into the specifics of taxation, let us first establish common ground by considering the basics.
What is a trust?
A trust is a relationship (not a legal entity by itself) where property, be it real, personal, tangible or intangible, is transferred by one party (the settlor) to be held by another party (the trustee/s) for the benefit of a third party (the beneficiaries).
Thereafter, the two parties involved in a trust are:
- Trustees - who may be an individual or a company appointed by the trust instrument or, where necessary, appointed by the court. A trustee may be a professional or a non-professional. The trustees are the legal owners of the trust property and they are responsible for administering the affairs of the trust such as investing the trust assets, accounting for transactions related to trust assets and reporting to the beneficiaries, and filing tax returns on behalf of the trust. Trustees therefore owe a fiduciary duty to the beneficiaries. In the tax context, trustees are representatives of the trust.
- Beneficiaries – are the beneficial or equitable owners of the trust property. Any legal persons may be a beneficiary: living individuals, another trust such as a charity, or legal businesses. A trustee may himself be a beneficiary. Depending on the terms of the trust, beneficiaries will receive the income and/or the property itself at the appointed time.
How and when does a trust arise?
A trust arises when a trust deed or a will is executed to create respectively an express trust or a testamentary trust.
In an express trust, the trust deed would stipulate the terms of the trust as follows:
- What property is to be transferred to the trust
- Who the beneficiaries are
- What the powers and duties of the trustees are: power of investment, power to vary the interests of the beneficiaries, powers to appoint new trustees etc.
Madam Wealthy (the settlor) transferred a rent-producing property to a trust she created for her two nephews, Lucki and Luckee. The trustee holds the property for the benefit of Lucki and Luckee. The trust deed provides that:
- The trustee is empowered to invest the trust monies according to his best judgment
- The trustee will be paid a trustee remuneration of RM9,000 per annum
- Lucki and Luckee are to receive an annuity of RM12,000 when they attain the age of 18
- The trustee may disburse money to the beneficiaries for their education
- The remaining monies are to be accumulated, and
- The rental property and the cumulative monies of the trust are to be distributed to Lucki and Luckee when the younger of them attains the age of 35.
In a testamentary trust, the trust arises when there is an interim period between:
- the date of completion of the administration of the deceased estate – ie the residuary estate is ascertained (or ascertainable), and
- the date the estate property and moneys are distributed to the beneficiaries and the legatees.
Mr Well Thee died testate (ie with a will) on 1 February 2012. The executor (appointed in the will) duly gathered all assets of the deceased estate, paid off all debts owing, thereby ascertaining the residue of the deceased estate and effectively completing the administration of the deceased estate on 31 October 2012.
Mr Well Thee’s will stipulated that the properties and cumulative monies of his estate are to be distributed to his three children only after the demise of his widow. In the meantime, the widow will receive an annuity of RM15,000 per year during her lifetime. 60% of the distributable income from the assets of the deceased estate would be distributed to the three children in equal shares while the remaining 40% will be accumulated until the widow’s demise.
In the above scenario, a testamentary trust has effectively arisen on 1 November 2012.The executor of the will then assumes the role of the trustee and the trust beneficiaries are the widow and her three children.
The trust will subsist from 1 November 2012 until such time the trust properties and moneys are distributed to the three children after the death of the widow.
B. Aspects of tax treatment of trusts and trust beneficiaries
Trusts are, as for other chargeable persons, subject to the prevailing tax principles and provisions of the Income Tax Act. There are also specific provisions relating to income from trusts and income of trusts, and these are:
- Section 2 – Definition of 'trust body”
- Section 21A – Basis period of a trust
- Section 61 – Trusts generally
- Section 62 – Discretionary trusts
- Section 63 – Trust annuities
- Section 73 – Trustees as chargeable persons
- Section 77A – Return of income
- Section 107C – Estimate of tax payable and payment of instalments
- Section 110(8) and (9) – Set-off for tax deducted
Schedule 1, paragraph 2(c) – Rate of tax
Candidates are not required to know section numbers for the exam, however they are provided here for information.
The trustees make up the trust body and the trust body is a chargeable person for income tax purposes. All the trustees of a trust are jointly and severally responsible for doing all acts and things as are required by the Income Tax Act.
For tax purposes, the relationship between the trust and the trustees is that of principal and representatives – ie keeping records, submission of tax returns and payment of tax or debt due to the Government. It should, however, be noted that the trustees of a trust are responsible for payment of tax, debt or penalty only up to the accessible moneys from the trust. This significantly means that the trustees cannot be compelled to pay out of their own pockets to settle the tax debts of the trust!
Residence status of a trust
A trust is considered a resident trust if any of the trustee members of a trust body is resident in Malaysia in the relevant year.
However, a trust is considered a non-resident trust for the relevant basis year if the following conditions prevail:
- the trust was created outside Malaysia by a person or persons who were not citizens of Malaysia
- the trust income is wholly derived from outside Malaysia
- the trust is administered wholly outside Malaysia; and
- at least half the trustees are non-resident in Malaysia.
For tax purposes, the significance of the residence status of a trust is as follows:
- A resident trust may deduct from its total income the share of trust income due to a beneficiary
- A resident trust may deduct any annuity payable to a beneficiary, and
- Any annuity paid by a resident trust to its beneficiary is deemed derived from Malaysia, regardless of whether the trust itself has any total income in the relevant year of assessment.
Scope of charge
As is generally the case with other chargeable persons, a trust is subject to tax in Malaysia only in respect of income derived from Malaysia. All income derived from outside Malaysia is exempted from tax when remitted to Malaysia.
For its accounting period, a trust may adopt the Gregorian calendar year, or a financial year ending on a day other than 31 December, just like a company, limited liability partnership and co-operative society.
Sources of income
A trust body is treated as deriving income from sources of income such as business, rents, interest, dividends, other income. It can also be a partner of a partnership and is assessable to tax in respect of its share of partnership income. The same tax principles and provisions apply to trusts as they do to other chargeable persons.
Pursuant to Schedule 1, a trust is subject to tax at the prevailing fixed rate of 25% of its chargeable income, just like a company. Unlike a company though, the preferential rate of 20% for small companies, is not available to a trust, however small the value of the trust property may be.
From this perspective, a trust is subject to tax at a higher effective rate than the resident individual who is eligible for personal tax reliefs and the scaled rates of 0% to 26%.
This term is not defined in the Income Tax Act. The ordinary meaning is used – ie the actual amount of money available for distribution by the trust which means the net income after deducting all expenses where money has actually gone out. Some of the expenses thus paid out may not qualify for tax deduction. It is therefore likely that the distributable income in a given year is less than the total income of the trust. By the same token, the distributable income may be more than the trust total income for the year: some items of income may be tax exempt, or some tax deductions (for instance capital allowance) do not involve cash outgoings.
It is pertinent to bear in mind that the amount of distributable income is not relevant in the computation of total income. Nevertheless it is an important figure: the share of the distributable income pertaining to a particular beneficiary is used to arrive at the fraction in quantifying the beneficiary’s share of the total income of the trust.
Well Thee Trust
Statement of income for the year ended 31 December 2012
|Trust income: rent||120,000|
|Interest from bank fixed deposits||24,000|
|Dividend income (single-tier)||10,000|
|Expenditure: trustee's remuneration||9,000|
|Repairs and maintenance of rental property||28,000|
|Depreciation of rental assets||4,800|
|Annuity to beneficiary (widow)||15,000|
Based on the above information, the computations of the trust’s distributable income and total income are juxtaposed below to illustrate the differences:
|Distributable income (RM)||Total income (RM)|
|Dividend||10,000||nil||Single-tier dividend is tax-exempt|
|Trustee's remuneration||9,000||nil||Non-qualifying for tax deduction|
|Repairs and maintenance||28,000||28,000||Incurred in producing rental income|
|Accounting fees||6,000||nil||Non-qualifying for tax deduction|
|Depreciation||nil||nil||No cash outgoing / Not incurred and non-tax deductible|
|Annuity||15,000||nil||Non-qualifying for tax deduction|
|Tax deductible expenses||(28,000)|
Assume that one of the beneficiaries, Beneficiary A, received a distribution of RM27,000 from the trust in the year 2012.
His fraction (expressed as a percentage here) of the distributable income for the year of assessment 2012 is 28% (ie 27,000/96,000).
This fraction of 28% is then applied to the trust total income to determine Beneficiary A’s share of the trust total income: 28% of RM116,000 = RM32,480.
These refer to the part of the trust income over which the trustee has discretion as to when and how much to distribute to which beneficiary or which class of beneficiaries. A discretionary trust is treated in exactly the same manner as other trusts. The significance and impact of being a discretionary trust is on the determination of the statutory income of the beneficiaries as prescribed under section 62.
A trust is created for Beneficiaries B, C and D. Pursuant to the trust deed, the trustee is empowered to release moneys in amounts deemed appropriate by him to the beneficiaries for their living expenses.
|Year of |
|Distribution to beneficiaries (RM) ||Total income
of trust (RM)
The statutory income of the beneficiaries is computed as follows:
|YA||Statutory income from trust ||Notes|
|1||15,000||nil||nil||s62(2)(a) – lower of total income or the amount distributed
|2||nil||5,000||8,000||s62(2)(a) – lower of total income or the amount distributed|
x 25,000 =
x 25,000 =
|s62(2)(a) – total amount distributed exceeds total income, apportion accordingly
Trust for accumulation
This refers to the part of the income of the trust which is to be accumulated until such time the conditions are fulfilled for its eventual distribution to the beneficiaries. That part of the trust income which is subject to accumulation should therefore be excluded in calculating the distributable income.
The amounts so accumulated are effectively taxed as part of the total income of the trust in their respective years.
When the accumulated amounts are finally distributed, they would have assumed the character of capital rather than revenue and would therefore NOT be sums of an income nature. As such, the amount finally distributed after accumulation is NOT taxable income in the hands of the recipients.
It is possible and usual that trusts exhibit mixed elements of annuities (fixed amounts), discretionary payments and amounts or fractions subject to accumulation. These are mixed trusts. The tax treatment of such trusts will generally be the same as for trusts generally, but will incorporate the points discussed in the preceding paragraphs.
These requirements include the advance estimation of tax (CP204 and CP204A), payment of tax instalments, the timely submission of annual tax returns (within seven months after the close of annual accounts), the settlement of final tax (by due date) etc. These are the acts and things that trustees are responsible for.
The entitlement of a beneficiary to a fixed annuity or any income from the trust is a source of his in relation to the trust and is referred to as his 'ordinary source'. Such trust income is the beneficiary’s statutory income from the trust and is assessable to tax on the beneficiary.
Where the stipulated conditions are satisfied, the proviso to section 61(2) and section 63 provide that the amounts deemed as a beneficiary’s trust income or annuity from trust are deductible from the total income of the trust.
Where the beneficiaries’ trust statutory income is not deducted from the trust total income, sub-sections (8) and (9) of section 110 provide for proportionate tax credit to be deducted in arriving at the tax payable by the beneficiaries. Thus, there is no double taxation of that part of trust income which is assessable to tax on the beneficiaries.
C. Tax computation: some common items
The determination of the chargeable income of a trust is largely based on the same basic tax principles applicable to other chargeable persons. Below are some of the items which should be noted:
Generally, remuneration payable to a trustee to administer the affairs of a trust is not tax deductible, unless it can be shown that the trustee is involved in the income-producing process of the trust assets. For instance, if the trustee manages the wholesale business activity carried out by the trust in addition to administering and carrying out the stipulations of the trust deed, only the proportion attributable to the direct running of the business activity may be tax deductible in arriving at the adjusted income of the wholesale business.
Annuities to beneficiaries
Where the whole of the trust income is derived from Malaysia, or the trust is a resident trust, any annuity paid to beneficiaries is deemed to be derived from Malaysia. Such amounts paid are then deductible from aggregate income and in arriving at the total income of the trust body.
The beneficiaries who receive such annuities from the trust body are treated as having a source of income from the trust and are duly taxable in Malaysia in respect of such income. It is important to note that the quantum of annuity received by a beneficiary constitutes his statutory income from trust annuity even if the trust itself has no total income (after deducting business losses for instance).
Distributions to resident beneficiaries
Where a beneficiary has a share of the total income of the trust, and the beneficiary is resident in Malaysia in that year, that share may be deducted from the total income of the trust body in arriving at its chargeable income. The beneficiary is directly taxable on such share. This mechanism avoids double taxation of the income from the share.
D. Illustrative tax computation of a trust
Building on the facts in Illustrations 2 and 3, Well Thee Trust derives income from rent, fixed deposit interest from Malaysian banks and single-tier dividends from Malaysian companies. RM9,000 per year is paid as trustee’s remuneration. According to the terms of the trust, Beneficiary A, the widow receives an annuity of RM15,000. The three children, B, C and D, will receive 60% of the distributable income in equal shares while the remaining 40% will be accumulated.
|Expenditure: Trustee's remuneration||nil|
| Repairs and maintenance of |
| Accounting fees||nil|
| Depreciation of rental assets||nil|
| Annuity to beneficiary||nil|
|Interest from bank fixed deposits||24,000|
| Dividend income (single-tier)||nil|
|Less Annuity [s63(3)(b)]||(15,000)|
|Less Share of total income to beneficiaries |
|60% of total income||(60,600)|
|Tax charged at 25%||10,100|
Trust income of beneficiaries
Beneficiaries A, B, C and D should report their trust statutory income for the year of assessment 2012 as follows:
|Beneficiary A (widow) – Statutory income from trust annuity||15,000|
|Beneficiary B – Statutory income from trust (60,600/3)||20,200|
|Beneficiary C – Statutory income from trust (60,600/3)||20,200|
|Beneficiary D – Statutory income from trust (60,600/3)||20,200|
[Note: The normal practice is to deduct the share of total income deemed derived by the resident beneficiaries in arriving at the chargeable income of a resident trust, as this obviates double taxation. Should the DGIR have specific reasons in particular cases not to deduct the beneficiaries’ share of trust total income, the trust beneficiaries will still be responsible for reporting and assessing their share of income from the trust in their individual tax returns. They would then be eligible for the corresponding tax credit under section 110(8).]
A trust is treated much like other chargeable persons. Both the trust and its beneficiaries are subject to tax in respect of trust income. To avoid double taxation of the same trust income, and provided requisite conditions are fulfilled, specific provisions are in place to facilitate deductions in respect of distributions to its beneficiaries.
Written by a member of the Paper P6 examining team