Labor acknowledged that trusts can be legitimately used by individuals and businesses for several reasons, including asset protection and business succession. However, it says discretionary trusts also have attractive tax advantages "and are used by high-wealth individuals to minimise their tax obligations".
Labor says distributional analysis from the Parliamentary Budget Office (PBO) based on ATO data "shows that a disproportionate amount of discretionary trust distributions are allocated to people in the lowest marginal tax bracket with little or no work income (ie those earning $0 - $18,200). These are likely to be non-working members of the family such as spouses and adult children in tertiary education."
Farm trusts and non-discretionary trusts excluded
Mr Shorten said Labor's proposal will only apply to discretionary trusts.
It will not apply to non-discretionary trusts, such as:
- special disability trusts;
- testamentary trusts (deceased estates);
- fixed trusts;
- cash management unit trusts;
- fixed unit trusts; or
- public unit trusts (listed and unlisted).
Likewise, it will not apply to:
- farm trusts; and
- charitable and philanthropic trusts.
Individuals and businesses will still be able to use trusts — and trusts will not be taxed liked companies, Mr Shorten said. He said the Commissioner of Taxation will be given discretionary powers to manage the exemptions.
The measure is expected to impact around half of the 642,000 discretionary trusts in Australia today that hold over $590bn of assets. Further details are set out in Labor's policy document, A fairer tax system — Discretionary trusts reform .
Example — income splitting
Labor's policy document sets out the following example of how the proposed trust distribution tax would target income splitting.
John is a partner in a top law firm. John has a spouse who doesn't work and 2 children who attend university and don't work. He earns $500,000 each year from his membership of his partnership which he pays PAYG tax on at the top marginal rate. John has a discretionary trust. In addition to his partnership distribution John's discretionary trust receives a percentage of the profits from his law firm at the end of each financial year. This year the discretionary trust receives an additional $210,000.
Because John is on the top marginal tax rate his accountant advises him that he distribute the $210,000 equally amongst the 3 non-working members of the family, where $70,000 is given to each. Under the current tax arrangements, this would give the family members a tax bill of $47,100, a $51,600 tax saving compared to the income tax John would have paid at the top marginal tax rate.
Under Labor's proposed trust distributions tax, if John distributed the $210,000 in the same quantities to his family, each $70,000 trust distribution would be taxed at the new minimum rate of 30%, which would result in a tax bill of $63,000, an increase of $15,900 compared with the current tax rules.
Date of effect
The proposed measure would apply to trust distributions from 1 July 2019 (subject to final legislation being enacted).
Labor said it intends to consult with the ATO, Treasury and tax experts on the implementation of the policy. It will also provide the ATO with an additional $55 million per year to implement these reforms, to ensure that the policy intent is achieved, and also to bolster the ATO's current trust anti-avoidance activities.
Other Labor policy measures
Labor says it has previously announced:
- "Policies to rein in unfair and unsustainable superannuation concessions which are skewed towards high income earners".
- Reforms to negative gearing and CGT concessions.
- Reforms to close debt-deduction loopholes for multinational companies.
- Plans to cap at $3,000 the amount people can claim as a tax deduction for costs incurred in managing their tax affairs.
Maddocks comment: where to from here?
Whether or not the above changes ultimately become law, discretionary trusts remain a useful tool for reasons other than having attractive tax consequences. These include: succession and estate planning, asset protection, access to CGT discounts and flexibility as to distribution of income and assets.
For those reasons, discretionary trusts provide useful business structures and will continue to be widely used should Labor's proposals be implemented.
Additionally, there is obviously a lot of finer detail to come, which one would expect to emerge from the consultation process referred to above. The change could not be enacted simply, and would need to navigate a range of potential implications (and prevent potential work-arounds). For instance, how would the rules treat a distribution made from the trust not to a spouse, but to a corporate beneficiary (which pays 30%). The spouse then receives a fully franked dividend from the corporate beneficiary equal to the net distribution, but is then eligible for franking credits in respect of the tax paid by the corporate beneficiary (meaning the overall tax impact may be less than 30%).
More Cleardocs information on related topics
You can read earlier ClearLaw articles on a range of trust topics.