Having lost a full frontal battle to totally demolish trusts just over ten years ago by trying to tax trusts as companies, the ATO has resumed the battle in recent years in a sniper approach. The latest sniper attack comes in the form of a consultation paper released late last year that puts forward options that will further limit the tax effectiveness of trusts.
Last year saw trusts tax effectiveness hit by reducing the tax free distributions to minors from $3,300 to $416; reduced flexibility of trust distributions if tax returns need to be amended; and higher taxes if trust distributions to companies are not cash flowed.
This consultation paper headed “Modernising the taxation of trust income” sets out a number of options. One of these options, which seems more favoured by the ATO is one used in New Zealand, Canada & the USA, called the “Trustee assessment and Deduction model” – TAD for short. Under this model whatever taxable income is not physically distributed to the beneficiaries of the trust in cash or property is taxed against the trustee. Under current law the tax rate for taxable income to the trustee is 46.5%.
The problems with this approach are:
- The higher rate of tax. This is due to both the penalty rate of 46.5% and that if the distributions cannot be cash flowed through to lower income individuals and not for profit organisations in the required time frame the tax free or lower tax rate opportunity is lost.
- Difficult to retain cash in a trust: A business needs to retain cash for working capital, debt reduction and purchase of assets.
This approach is pushing businesses to look more closely at operating through company structures. However company structures do not have the range of capital gains benefits that trusts do. If you are over 55 when you sell your business then the company structure will give most business owners the opportunity to receive the capital gains tax free. Alternatively if you sell your business before you are 55 you have the opportunity to roll over the capital gain into another business asset and thus defer the capital gain until you are over 55.
Not all business owners want to wait until they are 55 before they realise the proceeds from the sale of their business. For this reason the more appropriate structure moving forward is more likely to be a combination of a trust and a company working in tandem. The trust structure gives you the capital gains tax benefits and the company enables you to retain profits and keep your tax rate at a maximum of 30%.
While submissions on the draft paper close in two weeks it will be another six months before we see the draft legislation.
If you are setting up a new business or restructuring your existing business it will be important to keep these possible changes in mind. It is also important to keep in mind that the ATO is continually finding ways to minimise the effectiveness of trusts, especially as a business entity.
Peter Ambrosiussen is the principal of Ambrosiussen Accountants & Advisors and accredited Gazelles International Coach www.ambrosiussen.com.au
Published by Toowoomba Chronicle www.thechronicle.com.au on Saturday 28 January 2012.
