What is the proposed change?

From 1 July 2028 the Government will impose a 30% minimum tax on distributions of taxable income from a discretionary trust. The tax will be creditable against an individual’s tax payable. Unlike franking credits, this tax will not be refundable where it exceeds the tax payable by the individual. Importantly, the tax will not be creditable to a corporate recipient of discretionary trust income – meaning that a bucket company that receives a trust distribution will have both 30% tax withheld from the distribution at the trustee level and then suffer further corporate tax itself.

Under the proposal, there will be a carve out for primary production income and it is stated that an opportunity will be given for discretionary trusts to rollover to a new corporate or fixed trust structure.

Why is this being done?

The 5-page release issued by the Government on budget night states that this reform is being implemented to better align the tax paid on discretionary trust distributions to the tax that would be paid by an individual deriving a similar level of income to the trust in their own right. The Government is concerned that the, “Growing use of discretionary trusts is increasingly unsustainable” and that, “The majority of trust income flows to the top earning 10 per cent of families and approximately 90% of total private trust wealth is held by the wealthiest 10 per cent of households”.

Has this proposal been properly thought through?

Many of the issues identified with discretionary trusts by the Government in its 5-page Release are in fact already dealt with by provisions of the Tax Act. For example:

• It is said that, “Since the financial benefit of income splitting goes to the primary earner in most cases…” this measure will align the tax paid by that primary earner with the tax paid by a salary and wage earner on a similar income. Section 100A of the Income Tax Assessment Act 1936 is a provision that has been well enforced by the ATO in recent years. It provides that where the benefit of a trust distribution goes to a party other than the one made presently entitled to the distribution then the trustee is subject to tax at the top marginal rate. In particular, section 100A has been used to attack distributions where adult children on low marginal tax rates have been made presently entitled to income yet the money finds its way back to mum and dad.  There is no need to tax discretionary trust income at 30% to address this mischief – that problem is currently addressed by a provision that has been in the Tax Act since 1979.

• The Release also says that “Small businesses will be able to reduce the impact of the minimum tax by employing beneficiaries working in the business, rather than paying them a trust distribution. Payments of salary or wages to employees will not attract the minimum tax.” Section 26-35 by the Income Tax Assessment Act 1997 limits the deduction of amounts paid to related entities to, “So much of the amount as the Commissioner (of Taxation) considers reasonable.” I doubt that provision will be amended to allow the planning opportunity highlighted in the Government’s Release. Quite simply, the purported employment of a relative at a disproportionate salary is rendered ineffective by the Tax Act.  Further, the employment of erstwhile beneficiaries carries with it payroll tax, other oncosts and compulsory superannuation contributions that are not payable on trust distributions.

• The proposed bucket company double taxation is overreaching and unwarranted.  The double taxation is said to be required to prevent bucket companies turning non refundable trust credits into refundable franking credits.  However it would have been just as simple and less punitive to create a second class of credits in a company of non refundable trust credits which flowed through to shareholders in the bucket company when a dividend was paid consisting of trust profits.  Often bucket companies are used as legitimate financing vehicles for the rest of a family group. To the extent that profits of bucket companies are used for personal consumption expenditure then those loans or payments are dealt with by Division 7A. 

But won’t everything be OK because I can rollover?

The details of the proposed rollover are scant in the Government’s Release. In particular, there are no details as to who will be required to be owner of the shares or units in the transferee entity.

Of critical concern from a tax perspective is the fact that whilst a rollover might be free of Commonwealth income tax, the Commonwealth has no ability to compel the States to make the rollover free from stamp duty. Accordingly, where you have a discretionary trust holding real property, then it would be expected that duty would be imposed on a transfer of the property out of the trust into a new structure.

From a trust law perspective, before undertaking the rollover the trustee of the discretionary trust needs to consider whether doing so is in the interests of the beneficiaries as a whole.  Where the owners of the transferee entity are restricted to a small segment of the trust’s beneficiaries then undertaking the rollover may be in breach of the trustee’s obligations.

At this stage, there are still more questions than answers. If you would like to discuss how these proposed changes may affect your business, investment or family structures, please contact Philip Diviny, Tax Principal, philip.diviny@madgwicks.com.au

The information provided in this article is general in nature and cannot be relied on as legal advice, nor does it create an engagement. Please contact one our lawyers listed above for advice about your specific situation.