On 21 November 2011, the Assistant Treasurer released a consultation paper Modernising the taxation of trust income – options for reform. The paper explores the current issues impeding the effective operation of Div 6 of ITAA 1936 as well as those hampering the effective taxation of trusts more broadly. The paper also outlines a number of options for reform, ranging from minor changes to the current operation of Div 6 to the introduction of a new model for the taxation of trust income.
Time to update trust rules
The IPA welcomes the release of the paper, which begins the process of modernising antiquated trust rules which have created unnecessary complexity and uncertainty. Updating the taxation of trust has always been a top priority among tax professionals and is long overdue, and the Institute has been advocating for reform in this area of tax law for many years.
Background to the reform
Recent Court decisions have highlighted the need to address compliance difficulties faced by the 600,000 trusts in Australia, many of which are used by small- to medium-sized businesses to house their trading businesses. The Henry review also recommended that Division 6 requires legislative clarification and should be rewritten to reduce complexity and uncertainty around its application.
The Government has indicated in the consultative paper that the review is not a crack down on the use of trusts. It considers that, where used appropriately, trusts are a legitimate structure through which taxpayers should be able to conduct their personal and business affairs.
The Government proposes that any options for reform would be developed within the broad policy framework currently applying to the taxation of trust income. That is, the taxable income of a trust will continue to be assessed primarily to beneficiaries, with trustees being assessed to the extent that amounts of taxable income are not otherwise assessable to beneficiaries.
The policy framework
The Government has outlined five principles for its policy framework concerning trusts:
- Tax liabilities in respect of the income and gains of a trust should “follow the money” in that they should attach to the entities that receive the economic benefits from the trust.
- The provisions governing the taxation of trust income should be conceptually robust, so as to minimise both anomalous results and opportunities to manipulate tax liabilities.
- The provisions governing the taxation of trust income should provide certainty and minimise compliance costs and complexity.
- It should be clear whether amounts obtained by trustees retain their character and source when they flow through, or are assessed, to beneficiaries.
- Trust losses should generally be trapped in trusts subject to limited special rules for their use.
The Government said it has determined that the key issues impeding the effective taxation of trusts that require immediate reform include:
- the interaction between the distributable income and taxable income of a trust
- the method by which the taxable income of a trust is allocated to either the beneficiaries or trustee of the trust
- whether the amounts received by a beneficiary retain their character and source (and when “streaming” of those amounts is effective for tax purposes), and
- the scope of Div 6 and other taxing provisions applying to trusts.
The paper discusses a number of important issues such as:
- problems with the operation of Div 6, for example, anomalous outcomes (through differences in a trust’s distributable and taxable income), present entitlement issues, “nil” assessments, the application of s 99B, creating present entitlement to income by 30 June, the allocation of trust expenses among classes of income, streaming and character flow-through
- the interaction between Div 6 and other parts of the tax law eg, Capital Gains Tax (CGT) provisions, franked distribution rules, consolidation provisions, withholding tax rules, Division 7A, the managed investment trust regime, the trustee beneficiary reporting rules
- fixed trusts
- the trust loss rules
- the family trust rules
- key features of trust regimes in other countries eg, the US, Canada, UK, NZ, Ireland, South Africa.
