Trusts – ATO Attempting to Reduce Their Effectiveness

Trusts, and more specifically family or discretionary trusts are a key strategy for many Australian taxpayers wanting to legitimately minimize their tax positions, and also to protect their wealth against attack. However, they are under the microscope again of the Tax Office again as they try to reduce their effectiveness.

Governments over the years have attempted to reduce the tax advantages provided by trusts (can you remember when the previous Howard Government considered having trusts pay tax like companies).  But thanks to common sense, the lack of political will by the governments and vocal groups such as Australian farmers, trusts have continued to allow taxpayers to distribute income amongst family members and/or corporate beneficiaries to achieve the lowest level of tax applicable to that trust income.

The Australian Taxation Office doesn’t like trusts and have said so for many years.  The ATO believe trusts are used to avoid tax, and conveniently overlook the fact that trusts have existed for hundreds of years, long before Australia even had a tax system.

But there are some winds of change blowing now, with a recent High Court case called Bamford V FC of T, and the Commissioner of Taxation issuing several publications that outline his views of certain aspects of trusts, that will in fact try to reduce some of the advantages trusts have provided up to now.

One of the main issues arising from this case was the basis of how income can and should be distributed by a trust to the beneficiaries. The High Court in its decision has reminded us all that it is important all decisions with respect to the distribution of income out of a trust is in line with that trust’s deed, and that the trustee(s)’ resolutions with regards to distributions must take into account what the trust deed requires and permits for distributions.

What the court did not address (it didn’t get asked to) is the ability for trusts to “stream” income.  Streaming generally refers to the practice of trustees allocating different types of income to the beneficiaries, such as one beneficiary receiving all interest income derived by the trust, whereas another beneficiary may receive all the capital gains.  This is likely to be another matter that the ATO will give attention to in the future, but for the time being, remains unaddressed.

The practice of using corporate beneficiaries to cap the tax payable on income derived by trusts has also come under attention of the Commissioner. It has been common practice over many years for trusts to reflect the distribution to the company as an “unpaid present entitlement”, and rather than distribute monies to the company for that distribution, the trust retain the monies and look to reinvest the monies in other investments and/or business interests of the trust.  Until recently, the Commissioner has neither attached this practice nor stated there was any mischief in such strategies being adopted.

However, it appears the Commissioner has changed his mind about this practice.  The Commissioner has determined that if the distribution is not paid to the company within a reasonable time frame, it would treat the unpaid present entitlement as a loan caught under the private company loan provisions.  As a form of concession, the Commissioner has stated that the ATO will not take any direct action on such unpaid present entitlements that exist up to 30 June 2010. However after this date, the Commissioner will look to apply his new views to those unpaid present entitlements that are created after 30 June 2010.

Given this is such a significant departure by the Commissioner to previous practice, expect at some stage, a test case will be brought before the courts to challenge the Commissioner’s views on this strategy.

So, the question for all of those that have a family or discretionary trust – do you hold or know where you can find a copy of the trust deed?

If not, we would strongly suggest you get onto locating a copy of the trust deed, as everything the trust does going forward must take into account what that trust deed allows it to do.

Over coming months, we will be discussing with those clients that have trusts, the impact of the above changes, and to review the trust deeds of those trusts to ensure they do allow for the sorts off discretions to distribute income in the most appropriate tax efficient way.


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