Crackdown on family trusts becomes law
The Labor proposal aims to limit the ability of families to minimise tax by splitting income
WHAT’S ON THE TABLE?
Labor is planning to tax distributions from trusts at a minimum rate of 30%. Currently distributions are taxed in the hands of the individuals who receive them at their marginal tax rate, which theoretically means they could be taxed at anything up to the top marginal rate of 47% plus the Medicare levy.
In reality, however, many people use trusts to minimise tax by directing trust income to non-earning or low-earning beneficiaries. This is why Labor argues that trusts give the wealthy (who presumably can pay accountants to set them up and run them) an unfair advantage over pay-as-you-earn workers who don’t have the option of directing their income to someone else.
HOW TRUSTS WORK
A trust is a legal entity set up to hold assets, usually within a family or extended family. So instead of buying a business or an investment portfolio in his own name, Fred Nerk might choose to set up a trust to own those assets.
A trust can be either fixed, which means the beneficiaries have a specific entitlement to trust assets and income, or discretionary, which means the trustee decides who benefits from trust assets. Because of their flexibility, most family trusts are structured as discretionary trusts.
There are several advantages to this. First, if the trust is properly structured, Fred doesn’t own or control the assets, so they should be protected from his creditors if Fred should be bankrupted at some time in the future. They should also be protected from legal claims against Fred if he is sued for negligence.
But that’s not what has them in Labor’s sights. The trustee of a discretionary trust also has the ability to decide from year to year which beneficiaries will receive any income or capital distributed by the trust. So if Fred is on a big salary, he may receive no distributions from the trust. Instead, they may be distributed to lower tax paying family members such as Fred’s non-working wife, his retired father and his daughter, who is studying full time at university. All will pay much lower rates of tax than Fred would have if he had received the trust income.
If, later on, Fred retires but his daughter takes on the family business and earns more income, the trustee may decide to distribute the income to Fred and his wife to minimise the tax payable.
Note, however, that penalty tax rates