The effective start date for the proposed reforms to the trust income tax provisions in Division 6 is still expected to be 1 July 2014. The proposed reforms will have significant implications for all taxpayers operating through trust structures, and we urge members to keep abreast of developments in this area of trust law. Once the review has been completed, it is highly likely that trust deeds will need to be updated to reflect new operative provisions.
The options paper contains further detail on two proposed models being considered in the reform of trust taxation. The two models being looked at are the economic benefits model (EBM) and the proportionate assessment model (PAM).
The options paper does not comment further on the patch model raised in the 2011 discussion paper. Under the patch model, the government proposed to retain the current structure of Division 6 but introduce refinements, such as a new definition of the term ‘income of the trust estate’, to be based on tax concepts. The patch model’s absence from the options paper does not mean that it has been abandoned, but it does suggest that the government favours more substantial reforms at this stage of the consultation process.
The EBM uses a quantum-based approach to trust taxation and relies not on the concept of present entitlement but rather on what beneficiaries actually receive. It represents a more radical departure from present trust tax rules than the PAM.
The assessment process for the EBM would work as follows:
- Calculate the trust’s taxable income as if the trust were a resident taxpayer
- Identify the components of the trust’s taxable income
- Distribute and allocate amounts representing taxable income
- Assess the beneficiaries on the amounts distributed/allocated to them
- Assess the trustee on the remaining taxable income at the highest marginal tax rate.
The PAM is similar to the existing proportionate system, whereby beneficiaries are taxable on their proportionate share of ‘trust profit’ of a relevant class.
Under the PAM, the assessment process would work as follows:
- Calculate the trust profit
- Determine the different classes of trust profit and calculate the class amounts
- Determine the proportions of the class amounts to which beneficiaries are presently entitled
- Calculate the taxable income of the trust as if the trust were a resident taxpayer
- Allocate the trust’s taxable income to the classes maintained by the trustee (if applicable)
- Assess the beneficiaries on the trust’s taxable income based on the proportionate share of the class amounts to which they are entitled
- Assess the trustee on the remaining taxable income at the highest marginal tax rate.
Both the EBM and PAM have flaws that make the final choice problematic. For that reason, the patch model may need to be re-visited if these shortcomings cannot be resolved in a way that reduces uncertainty and complexity. Alternatively, we may see hybrid versions of the EBM and PAM to overcome inherent flaws.
Regardless of which model is chosen, income character retention and streaming different categories of income through to beneficiaries will be core features. At present there are complex interim provisions that allow for fully franked dividend and capital gains streaming only. These interim arrangements were hastily put together as a result of the decision in the landmark Bamford case (Commissioner of Taxation v Bamford HCA 2010), which arguably put an end to streaming.
The options paper also looks at the possibility of introducing rules to specify how deductions are to be allocated against different types of income. The basis of allocation of expenses will be important under full streaming as it will affect the amount of income of different classes, thereby impacting tax outcomes for beneficiaries. The IPA supports a ‘fair and reasonable basis’, as opposed to a prescriptive approach, to allocation of expenses.
On the issue of a lower trustee tax rate, the options paper does not consider the arguments compelling for aligning the default trustee rate (currently 46.5 per cent) to the company tax rate. Not only are trustees subject to the highest marginal tax rate but they also do not qualify for CGT discounts or the refunding of excess imputation credits on fully franked dividends.
The IPA has stressed in its previous submission that many small businesses use trust structures, and the broader issue of allowing a trust to accumulate trust income for working capital purposes should form part of the review.
Since the ATO changed its view on unpaid present entitlements in favour of corporate beneficiaries, retaining funds in a trust for legitimate business purposes has been a primary concern for our members. We acknowledge that a lower trustee tax rate will require integrity rules similar to those in Division 7A to ensure that such income is not later accessed tax-free by beneficiaries. The government needs to acknowledge the commercial reality that there are many small businesses using trust structures, and that their ability to grow requires access to working capital.
The options paper has also acknowledged the administrative difficulty of determining beneficiary entitlements by 30 June, and an extension beyond this date will be considered. The IPA will be advocating that the due date for lodgement of trust returns should be the default date for making trust resolutions for discretionary family trusts. A 31 August deadline will be insufficient to allow many accountants to draw up trust accounts properly. The EBM, for example, will require beneficiary entitlements to be determined at the latest point possible (ie accounts preparation) to avoid trustee assessments, as it is based on the quantum approach, with no margin for error.
With the latest submissions from stakeholders now being considered by the government, the IPA will stay closely tuned to developments on the new trust tax laws and will keep members fully informed.
