When the trust pay-or-notify rule applies

When does the pay-or-notify rule apply?

The pay-or-notify rule applies only when a tax-exempt beneficiary is presently entitled to trust income, is not an exempt Australian Government agency, and the trust is not a managed investment trust or treated as one under Division 275. It also depends on the trustee neither paying nor giving written notification in the two-month period.

For practices, the first point is scope. The ATO says the pay or notify rule applies only where an exempt beneficiary is presently entitled to an amount of trust income, the beneficiary is not an exempt Australian Government agency, the trust is not a managed investment trust or treated like one for Division 275 purposes, and the trustee has not paid or notified within the required period.

When must the trustee pay or notify?

The trustee must pay the entitlement or notify the exempt beneficiary in writing of its present entitlement within 2 months after the end of the relevant income year. For an affected tax-exempt beneficiary, either action within that period meets the ATO's stated timing condition; the rule concerns notification or payment, not a general rule for all trust distributions.

The timing requirement is explicit in the ATO material. On the ATO pay or notify rule page, last updated 22 April 2016, the trustee must notify the exempt beneficiary in writing of their present entitlement or pay the entitlement within 2 months of the end of the relevant income year.

Another practical detail is that written notice does not need a final dollar amount. The ATO states that the written notice does not have to specify the dollar amount. It is sufficient if the notice sets out how the entitlement is calculated, for example as a percentage of trust income.

That matters where accounts are still being finalised after 30 June. The source does not say every trust distribution must be physically paid by year-end; it says this rule turns on payment or written notice within the 2-month period for the affected tax-exempt beneficiary scenario.

What happens if the rule applies?

If the pay-or-notify rule applies, the tax-exempt beneficiary is treated as not being, and never having been, presently entitled to the affected trust income for tax purposes. The trustee is instead taxed on a corresponding share of the trust's net income, generally under section 99A of the ITAA 1936, unless the ATO exercises its discretion.

The ATO summarises the consequence as follows: "If a tax-exempt beneficiary is not made aware of their present entitlement to trust income within two months of the end of the income year, the trustee will generally be taxed on a corresponding share of the trust's net income."

The ATO example gives a second set of concrete figures. In 2014–15, Daley Trust generated $100,000 of rental income and had no other revenue or expenses, so its income and net income were $100,000, as measured in the ATO example. The trustee made Philips Trust, a charity, presently entitled to all of the trust income.

However, before 31 August 2015, the trustee gave no written notice and paid only $30,000 to Philips Trust. The facts illustrate that partial payment did not satisfy the rule for the full entitlement.

The ATO says specific anti-avoidance rules prevent trustees from using tax-exempt entities to avoid tax and identifies those rules as sections 100AA and 100AB of the Income Tax Assessment Act 1936. The same page says, broadly, the anti-avoidance rules apply if a tax-exempt beneficiary is presently entitled and either the trustee does not notify or pay within 2 months of year-end, or the beneficiary's entitlement exceeds a benchmark percentage.

That second limb matters because the pay-or-notify rule is not the only rule in this area. On the ATO benchmark percentage rule page, the ATO says the rule is to prevent manipulation of differences between the trust's income and net income. It also says the same amount will not attract the operation of both rules.

What should a practice check first?

A practice should identify tax-exempt beneficiaries who are presently entitled to trust income, test the ATO exclusions, and retain evidence of payment or written notice where the facts fit the rule. DeskMate supports repetitive practice work by running fixed workflows: it takes gathering, chasing, matching, formatting and filing off an accountant's desk, while treatment, exceptions, advice and approvals stay with people. For repeatable workflow design, the skill library shows what each fixed workflow reads, writes and sends for approval, while the Knowledge centre provides dated, regulator-sourced articles on obligations.

1. Identify whether any beneficiary is tax-exempt and presently entitled to trust income for the year.
2. Check the exclusions the ATO lists, including exempt Australian Government agencies and managed investment trusts, or trusts treated like them for Division 275 purposes.
3. If the fact pattern fits, decide whether payment, written notice or both will be used, and retain dated evidence.

It is also worth keeping deed administration in view. The ATO's trust vesting guidance says a trust deed usually specifies a vesting date or event, and on vesting the beneficial interests in the property of the trust become fixed. That page is not a pay-or-notify manual, but it is a reminder that entitlement questions sit inside the deed terms and should not be separated from deed review.