Let us not muck around especially with the controversy about the budget changes and the High Court\u2019s adverse decision for the ATO\u2019s legislative action to address the tax advantages of reinvesting distributions within the trust structure. Instead of pussyfooting around, tax reform requires addressing the tax advantages that trust structures open for businesses and investors compared to ordinary taxpayers and investors in company structures.<\/p>\n\n\n\n
Consider first the capital gains tax differences. Users of company structures face capital gains tax at the full company tax rate (maximum of 30%) with no allowance for inflation. The capital gains tax legislation assesses trusts in the same way as individuals. For trusts realising large capital gains, the resulting benefits can be considerable depending on the trust structure and the circumstances of the potential beneficiaries.<\/p>\n\n\n\n
Trustees have no (or extremely limited) in the case of unit or fixed trust structures about the distribution of the gains. But discretionary and family trusts have wide scope to distribute the gains to minimise the potential tax liability on the recipients. In many cases allocations of these distributions can be finalised after the trust has realised the gain.<\/p>\n\n\n\n
Furthermore, unlike companies forced to pay all distributions to shareholders, trusts are under no requirement to pay all distributions to the nominated recipients, Formal notification of the distributions for accounting and tax assessments satisfies the requirements. <\/p>\n\n\n\n
Without delving deeply into tax theory, discretionary trust distributions offer all the advantages of tax splitting that are not available to wage earners and many other investors. Imagine how wonderful life for wage earners and other investors would be if they could share their income with partners and adult children in dealing with the ATO. <\/p>\n\n\n\n
No such luck, running businesses or investing assets through family or discretionary tax structures offers have much greater flexibility in reducing tax liabilities by splitting their income with other family members especially when one partner already receives directly taxed wage and salary income. The hostile reception to the budget proposal setting a minimum 30% tax rate on trust distributions highlights the tax advantages currently attached to distributions to lower income beneficiaries.<\/p>\n\n\n\n
Administering the legislation adds to the complexity of administration for the ATO. Way back in the late1980s, a successful moneylender approached me for confirmation of the benefits of his family trust operating structure. Established on an accountant\u2019s advice, he distributed the substantial annual income in a three-way split with the bulk going to his brother and sister in the UK.<\/p>\n\n\n\n
Not remarkably close to his relatives, I suggested he check the benefits of this strategy compared with operating as a company with his accountant. It turned out the big \u201cadvantage\u201d of this structure was the low withholding tax on distributions overseas. The strategy set out to maximise funds for reinvestment in the business by not having to pay the distributions. On paper at least his relatives owned a large part of the trust assets.<\/p>\n\n\n\n
There are similar overtones in the recent adverse Court decision on the ATO\u2019s attempt to address the benefits of not paying out annual trust distributions. Trying to decipher the Court\u2019s rationale, it appears that at least in law some recipients of trust distributions do not have the beneficial ownership of the money reinvested in the trust.<\/p>\n\n\n\n
If my understanding is correct, it is time for a drastic change in the legislation, in the same way as unrestricted share lending wreaks havoc with the definition of beneficial owners of assets. Ordinary Australians have paid a huge price in increased pressure on personal income taxpayers from the 1970\u2019s ATO advice to Bill Hayden. They saw no need to legislate to reverse another Court decision allowing family trusts to distribute to companies set up within the trust structure.<\/p>\n\n\n\n
Excuse me. What part of your family is your company? Great advantage much less painful and costly (less than $1,000) to produce. The ATO argued no point because dividends were double taxed and ignored the substantial advantages of tax deferral by not paying dividends and even profiting from the sale of an asset rich company. Ignoring history, the 1987 decision to end double taxation of companies owned by residents provided a huge incentive to insert company beneficiaries into the trust structures. Lower tax rates and tax deferral advantages as before.<\/p>\n\n\n\n
This time round the government may be starting to appreciate just how trust taxation rules unfairly help a significant percentage of higher income taxpayers. They may even want to consider two widely used ways in other countries to level up the playing field.<\/p>\n\n\n\n
The first deals effectively with the recent adverse Court decision. One simple legislative change would suffice. Simply level tax at the top personal marginal tax rate on any trust distribution that does not transfer beneficial ownership to the recipient.<\/p>\n\n\n\n
Second, essential in countries when there are gift taxes, change the legislation to require that the trust\/borrower pays a taxable interest rate (e.g. cash rate plus 2% margin) on all distributions automatically reinvested (retained) in the trust. This is not a book on tax effective investing, but any expert can advise about the tax-effectiveness of income splitting using interest free secured loans.<\/p>\n\n\n\n
In the family aid loan\/gift area, interest-free secured loans are an excellent way of ensuring the money stay and are used tax-effectively in the family structure. <\/p>\n\n\n\n