A mat­ter of trust

Business First - - CONTENTS - by An­dreas Costi

Few struc­tures are as widely used but as lit­tle un­der­stood as trusts, es­pe­cially when it comes to the po­ten­tial tax con­se­quences which can arise where they are mis­used.

A trust is ba­si­cally a struc­ture which al­lows a per­son or com­pany to hold an as­set for the ben­e­fit of oth­ers. The per­son who con­trols the as­set is the ‘trustee’ and those who ben­e­fit are the ‘ben­e­fi­cia­ries’. The as­sets held in a trust can vary – property, shares, businesses and busi­ness premises are all com­monly held in trust struc­tures. The cre­ator of the trust (the ‘set­t­lor’) sets out the spe­cific rules as to how these as­sets should be man­aged in a doc­u­ment called the trust deed.

By putting as­sets in a trust, you don’t own the as­sets in your name. The as­sets are legally con­trolled by the trustee. How­ever, you can po­ten­tially con­trol ex­actly how those as­sets are man­aged now and in the fu­ture. You have the power to set out who re­ceives the in­come aris­ing from the as­sets and when they re­ceive it, as well as who re­ceives the un­der­ly­ing cap­i­tal rep­re­sented by the as­sets them­selves and when.

Dis­cre­tionary Trusts (some­times known as Fam­ily Trusts) are the most com­mon type of trust used by busi­ness own­ers in Aus­tralia. They are gen­er­ally cre­ated to hold a fam­ily’s as­sets and/ or busi­ness so as to pro­tect those as­sets and to fa­cil­i­tate tax plan­ning for fam­ily mem­bers.

From a tax per­spec­tive, the main ad­van­tage is that any in­come gen­er­ated by the trust from busi­ness ac­tiv­i­ties and in­vest­ments, in­clud­ing cap­i­tal gains can be dis­trib­uted to ben­e­fi­cia­ries in lower tax brack­ets (of­ten spouses or chil­dren). Be­cause the trustees of the trust have the ‘dis­cre­tion’ to dis­trib­ute in­come and cap­i­tal as they see fit – and no ben­e­fi­ciary has a fixed en­ti­tle­ment to re­ceive any­thing – the trustees are able to ‘stream’ in­come in a tax ef­fec­tive way on a year to year ba­sis. The downside is that to the ex­tent that they don’t dis­trib­ute the in­come of the trust, the trustees them­selves are li­able to tax

on the undis­tributed in­come – and a rate of tax usu­ally higher than the ben­e­fi­cia­ries them­selves would have to pay. Note also that there are limited cir­cum­stances when the trustee has to pay tax on be­half of cer­tain ben­e­fi­cia­ries, the most com­mon ones be­ing where ben­e­fi­cia­ries are chil­dren un­der the age of 18 or people with cer­tain dis­abil­i­ties.

In most cases, from an as­set pro­tec­tion per­spec­tive, as­sets held in a fam­ily trust can­not be at­tacked by cred­i­tors or law­suits so they are ideal for pro­tect­ing as­sets from busi­ness or per­sonal dis­putes and they can also fa­cil­i­tate the trans­fer of as­sets from gen­er­a­tion to gen­er­a­tion tax free.

The prob­lem with trusts is that they have be­come – in the minds of the ATO at least – syn­ony­mous with tax avoid­ance, par­tic­u­larly where they are used by the highly wealthy. The per­cep­tion has grown that trusts are in­creas­ingly be­ing used to hide in­come al­to­gether, to con­ceal the un­der­ly­ing own­er­ship of as­sets and to fa­cil­i­tate trans­fers of funds tax free be­tween fam­ily and busi­ness groups through mech­a­nisms such as in­ter­est free loans.

To com­bat this per­ceived tax risk, last year, the ATO an­nounced the cre­ation of a spe­cial Trusts Task­force, given the job of look­ing into non-com­pli­ance amongst the mil­lions of trust struc­tures in place. Amongst the ar­eas the task­force will be look­ing at are the fol­low­ing:

• trusts or their ben­e­fi­cia­ries who have re­ceived sub­stan­tial in­come and are not reg­is­tered, or have not lodged tax re­turns or ac­tiv­ity state­ments (mean­ing that in many cases, dis­tri­bu­tions of in­come from trusts have never been dis­closed on a tax re­turn)

• trusts in­volv­ing off­shore deal­ings

through tax havens

• agree­ments with no commercial ba­sis which di­rect in­come en­ti­tle­ments to a low-tax ben­e­fi­ciary (a spouse or child for ex­am­ple) while the ben­e­fits are en­joyed by oth­ers (a busi­ness owner or part­ner, for in­stance)

• where there is an ar­ti­fi­cial char­ac­ter­i­sa­tion of amounts, such that tax out­comes do not re­flect the eco­nomic sub­stance of what ac­tu­ally took place, with the re­sult that some par­ties have re­ceived sub­stan­tial ben­e­fits from a trust while the tax li­a­bil­i­ties cor­re­spond­ing to that ben­e­fit have gone else­where – for ex­am­ple, by mak­ing trust res­o­lu­tions that ar­ti­fi­cially re­duce trust in­come in an at­tempt to di­rect min­i­mal en­ti­tle­ments but full tax li­a­bil­ity to en­ti­ties with no ca­pac­ity or in­ten­tion of pay­ing the tax

• where there has been mis­char­ac­ter­i­sa­tion of rev­enue ac­tiv­i­ties to achieve con­ces­sional CGT treat­ment – for ex­am­ple, by us­ing spe­cial pur­pose trusts to at­tempt to re-char­ac­terise min­ing or property de­vel­op­ment as dis­count­able cap­i­tal gains (a very com­mon sit­u­a­tion arises where prof­itable property dis­pos­als are claimed as cap­i­tal to en­joy the 50% dis­count whilst loss mak­ing dis­pos­als are claimed as in­come to en­joy full ben­e­fit of the tax losses)

• where changes have been made to trust deeds or other con­sti­tu­tional documents to achieve a tax plan­ning ben­e­fit, and are not cred­i­bly ex­plain­able for any other rea­son

• where trans­ac­tions have ex­ces­sively com­plex fea­tures or sham char­ac­ter­is­tics, such as round robin circulation of in­come among trusts (which ba­si­cally means that in­come flows through a con­vo­luted and hard to fol­low trail of en­ti­ties be­fore end­ing up back where it started, with­out a cor­re­spond­ing tax li­a­bil­ity aris­ing any­where)

• where new trust ar­range­ments have ma­te­ri­alised that in­volve tax­pay­ers and/or tax scheme pro­mot­ers who have his­to­ries of or con­nec­tion to pre­vi­ous non-com­pli­ance – for ex­am­ple, people con­nected to liq­ui­dated en­ti­ties that had un­paid tax debts. So, where does this leave you? Well, if you have sub­stan­tial per­sonal and/ or busi­ness as­sets and have never con­sid­ered set­ting up a trust for the ben­e­fit of your fam­ily, there is plenty to be gained by talk­ing to your tax ad­viser or lawyer about the pros and cons. If you al­ready have a trust struc­ture in place, now is prob­a­bly the time to do some due dili­gence – look at what you’ve got, how you’ve used that struc­ture and con­sider the mo­tives be­hind your plan­ning, talk to your ad­vis­ers and get their sign-off that noth­ing you’ve done is likely to fall foul of the ATO.

An­dreas is re­spon­si­ble for the de­vel­op­ment and sales of Goal Group Ltd suite of prod­ucts and ser­vices and the re­la­tion­ship man­age­ment in Aus­tralia and New Zealand. www.goal­group.com.au

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