Trusts under spotlight for anti-avoidance rules
Trusts under spotlight for anti-avoidance rules
Two new anti-avoidance rules announced in the federal budget put the kibosh on some aggressive tax-planning techniques.
Both relate to distributions from trusts, which is something the ATO is also keeping a close eye on through its trusts taskforce.
What are the new measures:
The first measure is an anti-avoidance rule applying to circular (or round-robin) distributions by family trusts.
Some trustees seek to make distributions through a chain of trusts. So that the identify of the ultimate beneficiary is disguised and no tax is ever paid.
The government expects to increase revenue by $20 million over two years, by making it clear that family trusts CANNOT engage in such behaviour.
William Buck national tax leader Greg Travers says the change will affect a small number of taxpayers, mainly larger private groups with wealth accumulated over generations.
“A standard family trust distributing to family members should not be affected,” he says.
“But some families will have multiple layers of trusts to deal with different parts of the family and often each part of the family will manage their own affairs independent of other parts”
“This measure will necessitate a review of the trust distributions made across the entire family group, which will be quite an exercise.”
How it works:
So what’s the mischief occurring?
Suppose there are two trusts, trust A and trust B.
“If in a particular year trust A chooses to distribute all of its income to trust B, and then trust B chooses to distribute all of its income to trust A, you have this perpetual motion where income allegedly never comes into the hands of any beneficiary who is going to be taxed,” BDO tax partner Mark Molesworth explains.
Legislation was previously enacted to impose a top rate of tax on circular distributions but at the time family trusts were excluded. The government will close that loophole.
“This measure will better enable the ATO to pursue family trusts that engage in these arrangements by extending the specific anti-avoidance rule, imposing tax on such distributions at a rate equal to the top personal tax rate plus the Medicare levy,” the budget
A family trust for tax purposes is one whose trustee has made a “family trust election”. This election is a choice to specify an individual around whom the family group is formed. A
maximum number of beneficiaries is then nominated.
“Presumably some people were thinking, well, if I have two trusts with the family trust election I can go round and round in circles and nobody ever pays tax,” Molesworth says.
“Again, it’s not a strategy I would ever have recommended to any of my clients because I think it runs the risk of falling foul of the quite wide anti-avoidance provisions that already exist in the law. But it would appear the government wants to make it absolutely clear this is not allowed.”
William Buck’s Travers hopes there will be exclusions for taxpayers doing the right thing. Trusts that lodge electronic returns and quote valid tax file numbers for all beneficiaries, for
example, should be exempted, he says.
“The compliance burden needs to be placed on those taxpayers who are causing the issues, not those who are complying with the laws.”
The second measure involves testamentary trusts, which come into play after someone’s death.
They have tax advantages in that income distributed to minors is taxed at full adult marginal rates. Each beneficiary is therefore eligible for the $18,200 tax-free threshold and whatever
relief is normally afforded by the lower tax scales.
The income distributed is known as “excepted trust income”.
But beneficiaries aged under 18 who receive income from other types of trusts only receive $416 tax-free before penalty tax rates apply.
“This measure will clarify that minors will be taxed at adult marginal rates only in respect of income a testamentary trust generates from assets of the deceased estate, or the proceeds of
the disposal or investment of these assets,” the budget papers say. It will apply from July 1, 2019.
The government wants to stop what might be colloquially called “testamentary trust stuffing”, Molesworth says.
“If I set up a testamentary trust and then people who are still alive transfer assets into the trust to increase its level of income, that extra income will not be treated as ‘excepted trust income’,” he says.
Suppose Bob passes away and his will establishes a testamentary trust containing an asset that produces $10,000 a year for a child beneficiary, Dale.
Relatives then add new assets to the trust which bring Dale’s income up to $20,000.
The budget measure makes it clear that only the first $10,000 will be treated as tax-advantaged “excepted trust income”.
“You’re still allowed to turn over the assets and move from BHP to Rio shares, for example,” Molesworth says. “But ultimately it’s all got to be traceable back to the original bundle of assets.”
The government must be sufficiently concerned that mischief is occurring to warrant a budget measure.
“But it’s something that I would in fact recommend against because you’re really not complying with the spirit of the law and the tax commissioner could take the view that you were only doing it for the purposes of avoiding tax,” Molesworth says.
Family tax planning:
Golnar Nekoee, an associate with Bradley Allen Love lawyers, says the measure clarifies what most experts already believe to be the case, and testamentary trusts will continue to be an important feature of family tax planning.
“It does not mean that assets which have not derived from the deceased estate cannot, or should not, be injected into a testamentary trust that has already been established,” she says.
“Assets held within a testamentary trust structure, provided it is drafted carefully and correctly, can be significantly safeguarded when it comes for family law separation for bankruptcy.”
William Buck director of tax services Todd Want agrees the only people affected will be those deriving inappropriate tax outcomes.
“It’s a measure that is targeting those who should be targeted, not the everyday families who are setting up testamentary trusts for the right reasons,” he says.
“However, the devil will be in the detail. It’s important that the government drafts the laws in a way that only captures the parties who are achieving inappropriate tax outcomes and doesn’t increase red tape for everyone else.”
For more information you can read the full AFR report here.Â or contact us if you would like more information aboutÂ anti-avoidance rules and trust structures.