Federal Labor leader Bill Shorten recently announced his plans to crack down on high net worth individuals who utilise discretionary trusts for tax minimisation purposes. Previously, conventional wisdom has dictated that the discretionary trust is a legal structure immune from reform.
Nonetheless, Bill Shorten has vowed to implement a thirty percent (30%) floor on the taxation that applies to distributions made by discretionary trusts. Exclusions to the proposed taxation include discretionary trusts utilised for farming purposes, charities or deceased estates.
The rationale for the proposal is that discretionary trusts have allowed high income earners to avoid paying their fair share of tax while lower income earners are forced to subsidise the difference. The move comes after a report by the Australia Institute in July 2017 estimated that the use of discretionary trusts currently costs Australia approximately $3.5 billion.
Use of discretionary trusts
Discretionary trusts have long been utilised as a method of avoiding higher taxation implications for large-income families. Discretionary trusts work by allowing the person that controls the trust (‘trustee’) to distribute the funds of the trust to a select class of individuals called beneficiaries (typically family members).
The appeal of a discretionary trust for a high income earner is that if his or her personal tax rate is higher than that of the beneficiaries, tax can be minimised by making distributions to beneficiaries subject to a lower personal tax rate rather than receiving income personally. Because the beneficiaries are family members, the high income earner can effectively retain control of the income earned while simultaneously avoiding paying additional taxation (i.e. income-splitting).
If Labor’s new announcement were to take effect, it would require discretionary trust users to undertake a comprehensive re-examination of their discretionary trusts to ensure they are not disadvantaged by the changes.
Risks of proposed changes
Introducing a minimum thirty percent (30%) taxation on discretionary trust distributions may disadvantage small business owners (particularly for family run businesses). Discretionary trusts are an alternative to company structures that currently offer important advantages that allow small business owners to mitigate the risks inherent in starting and continuing a business.
If Labor’s proposal is to succeed, it must first answer how it intends to protect small business owners who may now be forced out of discretionary trust structures.
Currently, discretionary trusts have several additional advantages including without limitation:
(a) access to the fifty percent (50%) capital gains tax (‘CGT’) discount for assets held for at least twelve (12) months;
(b) increased privacy and reduced disclosure obligations;
(c) risk minimisation through:
- allowing beneficiaries (who do not ‘own’ the assets of the trust) to avoid being pursued by aggrieved creditors of the business, who are instead limited to pursuing the trust itself; and
- preventing creditors who pursue a beneficiary for any unrelated dealings from accessing the assets owned by the trust.
If you have questions or concerns about discretionary trusts or income-splitting, feel free to contact our Business Law team by submitting an online inquiry or calling us on (07) 5592 1921.