Overwhelmingly, trusts are used to minimise tax

Cross-posted from The Conversation:

There is very little, if anything, to commend discretionary trusts. The benefits they bring, and it’s hard to see many, are dwarfed by their destructive and damaging features.

Trusts are usually used to allocate money to members of a group, usually a family. Under a discretionary trust, the only way a beneficiary will get income or capital from the trust, is if the trustee chooses to give them something. Family companies are often included as beneficiaries to minimise tax.

The Labor party’s current focus on trusts is warranted because overwhelmingly, trusts are used to minimise tax, avoid paying creditors and to avoid the fair division of property after a relationship breakdown.

Due to a lack of data, it’s hard to estimate the amount of lost tax revenue from the current regime. However, on conservative assumptions, I estimate we are easily losing A$2 billion per year in income tax through discretionary trusts.

If a discretionary trust elects to be a “family trust” under the tax law, it can also access a number of other concessional tax rules. These tax concessions aren’t available to any other entities or taxpayers.

How trusts are used

There are a few other ways discretionary trusts are used. They are also used to frustrate creditors, people who are owed money by the beneficiaries of trusts.

Someone who is owed money by a beneficiary of a trust can’t go to the trust to settle their debt. This is the case even if the beneficiary has received money from the trust in the past and is likely to receive money in the future, after release from bankruptcy (having not paid their debts).

Unsecured creditors, such as suppliers of businesses dealing with a trustee, also cannot settle their debts with a trust if the trustee doesn’t have sufficient assets. Often the trustee will be a company paid to manage the trust, with only a few dollars of share capital.

According to data used in my research from the Australian Taxation Office, a lot of family wealth (aside from the family home) is held in discretionary trusts. On relationship breakdown, one spouse will often argue that because the assets are in a discretionary trust, they are not owned by anyone, and therefore won’t be divided with the rest of the couple’s assets.

The Family Court has wide powers to decide what can be divided, and generally the court included assets in the discretionary trust to be divided, where a spouse is a trustee, or has the means to appoint or remove a trustee. However, if the spouse is “removed” or “distanced” from the discretionary trust, it becomes harder and harder for the court to include these assets to be divided.

Discretionary trusts are also used in succession planning. Where a person has property to give away and wants the flexibility to do it over time. It also allows the payments to change with needs and circumstances. For example, if a trust beneficiary landed a high-paying job, they could be given less. Conversely, they could be given more if they lost their job.

There may be a case for these arrangements when a person has died. By putting assets into a discretionary trust, a deceased person may be able to “tie up assets” for around 80 years (the maximum period permitted). But this sort of flexibility is available to anyone when they are alive; there is no need for a discretionary trust.

So can we just get rid of trusts? Legally, it could be done. But outright abolition is not practically achievable, at least in the short-term.

What to do with trusts

There are broadly two options for tax reform when it comes to trusts. These measures can be implemented while leaving users of discretionary trusts free to enjoy all other legitimate features and benefits.

The first option, which many still seem to favour, is to impose the company taxation system on the discretionary trust (that is, tax them as companies). Due to the presence of the refundable franking credit tax offset rule, taxing trusts as companies would not really address the central issue of tax minimisation.

Trusts would still be able to manipulate allocations of money across low-rate beneficiaries and change allocations from year-to-year to avoid tax. However, it would remove the availability of the capital gains tax discount to discretionary trusts.

Another option is to use an attribution approach to trusts, just as the social security system does and as family law effectively does. Under the attribution model, the person who contributed the assets to the discretionary trust and/or the person who controls the assets in the trust are deemed to own the income and the assets. This would largely reflect general law entitlements of each spouse and very often reflect the economic contributions to building up those assets.

Of course, this model has challenges in design and in enforcement. However, given the complexity of rules in Australia’s income tax and the enforcement issues that confront the Australian Taxation Office in numerous areas, any difficulties with the attribution model are easily overcome. And of course, it’s already part of the social security regime for assets and income tests.

Article by Dale Boccabella, Associate Professor of Taxation Law, UNSW

Comments

  1. “overwhelmingly-trusts-used-minimise-tax”

    Yup, but you say it like its a bad thing…..I find it interesting you spend significant time pointing out the perverse self interested behaviour of politicians of all persuasions, whom frequently act against the national interest – and then jump up and down about thicken taxation revenue as if it will cure everything..!

    It doesn’t matter how much tax we pay……they will squander ALL OF IT ON THEMSELVES!

    • Yep, it’s legal tax minimisation. But as it stands it’s not fair, so the case for change is strong. These sort of reforms (spreading the tax burden more widely and fairly) need to happen in concert with removing self-interested politicians (or in concert with developing better frameworks to minimise abuse of power).

    • BubbleyMEMBER

      @Lisinoperil – You’re suggesting that we throw our hands in the air and give up? Thats not an option either.

  2. Serious, how many so-called wealthy people, have kids that don’t work and can allocate money to?
    Most successful people have kids who are at least 1/2 successful, hence the benefits are bugger all.
    It’s largely ALL about protecting assets for most rich people,

    • Torchwood1979

      My experience of them as well. Know a few people who had rich grandparents/parents who just used the trusts to dodge tax and pay the grandkid’s/kid’s HECS, buy them a car, living allowance through uni so they didn’t have work etc.

      Very nice to have, but considering those of us with normal families have to pay higher HECS debts and take a cut in Youth Allowance while studying full time to give these guys the good life, it’s hard to see the fairness to society overall.

      • Torch,

        Fact is most well off probably have better access to advisers who can educate them on the best way to do things. That’s not a reason to hate.
        Imagine this. Your son is married to an unstable lady and you believe the relationship is on the rocks, or your daughter is knee deep in debt and her business is struggling. You are on your death bed completing your will. You’d be bloody crazy if you didn’t
        use a trust to pass assets on As the alternative is a min of half is gone in divorce court, or chewed up by bankruptcy. .
        Or you have a drug addicted son, you want him to receive income from your estate but don’t want him to have access to the capital – lest he put it up his veins.
        Primarily Trusts are about making wealth last and keeping it away from risk. Not pissing it away.

    • 8mill. That is exactly why I use a trust. Asset Protection. And I am not rich nor really a high earner.

      No tax MB doesn’t love!

    • BubbleyMEMBER

      Nup, I know a bloke with 2 kids and a family trust. Its all about tax avoidence.

  3. so a trust allocates resources, like a salary…but for the average desk jocky working joe, for this to happen wouldnt their employer need to pay their wage into the trust … and to do that the trust would need to invoice the employer?

    no wonder the average joe cant set this up

    • Bennoz. Mate you have no understanding at all. Like most people. They hear the word Trust and think of Skase or Bond burying cash from the ATO…..

      Any body can most certainly invest via a trust, fact is most ‘everyday’ people don’t because they wouldn’t get the negative gearing benefits…..

    • They are generally used to distribute the income from *assets* acquired with accumulated (taxed) earnings. So no you cannot dodge your PAYG taxation obligations by using a discretionary trust, but you can minimise the tax paid on income from assets.

      Another point worth noting, is if the trust asset generated income splitting was somehow able to be stopped, you can achieve the same thing buy simply transferring or acquiring assets in the first place in other family member names. This is more hassle, less flexible, and does not provide the asset protection benefits of the trust – but for people primarily interested in the tax minimisation, they could just do this instead – so I feel very little “lost” revenues would be gained by fundamentally changing the taxation arrangement of trusts.

      • There is a fuckload of difference between distributing the yield on $1m of assets to your 19yo kid and actually giving the kid $1m of assets so he can earn that yield directly.

        The first happens all the time. The second doesn’t and would continue not to if trusts became unavailable/taxed like companies.

        So bollocks to “little lost revenues”.

  4. “These tax concessions aren’t available to any other entities or taxpayers.”

    What concessions are not available??? Keep to hear.

  5. Hey Dale you Muppet!
    Of course creditors can’t demand trust assets at will! They are not assets of the person. They can’t take your wives house either or your superannuation (provided rules are followed) or your best mate’s car. What is your bloody point?
    This is so bleeding obvious I can’t understand why you bring it up.

    Pieces like this are written so that people with no real understanding are influenced.
    Surprised to see that this bloke is a an associate professor!

    These arguments are so poorly thought out

    • MichaelMEMBER

      Remember Rich, “Associate” in front of any important sounding title actually means “not a”.

    • MB is just tending more and more to be an irrational propaganda machine and this is a classic example. We dealt with it yesterday in detail. It was shown, very clearly by those who have half a clue, that other than for asset protection Trusts are stuffed. Then we get this crap the next day.
      What a load of codswallop!!!

  6. Trusts are great. Why give money additional money to the govt.? They only know how to scandalously waste it!!! NBN fiaso is a prime example. No thanks!!

  7. Meh, the idea of taxing trusts like companies is not new. It was visited in the Ralph Review and it all came to naught.

  8. This Professors article is almost a joke. The obfuscation re how bad Trusts are is so overdone. Target superannuation which is Australia Caymen Islands & you would recover so much more tax. Actually why don’t we target trusts & every other structure such as companies, super funds, partnerships, individuals & make them near on impossible to administer & use in small business development & wealth creation? Oh, actually we already do except for superannuation. Oh? And while we’re at it what was the professors point about if you make a Family Trust Election you can receive more rorts? Like what? Using franking credits like everyone can in Australia (note super funds can over rort franking credits if you want to get specific!). The article is very big on bad but not so flash on specifics & facts. Yet another classic “Conversation” article. Even the professors point re creditors was pretty loose on the actual facts. What he says is not quite that simple & I’d suggest that 90% of Family Trusts would fall foul of creditor action in some form or another because his basis of what is Trust Capital is mostly not how it happens. I’ve jumbled my rant so sorry. But basically the professor is a noisy gong like the “Conversation” & I’d again say I concur with Flawse & a couple of others tonight. The trust attack is over blown & existing laws if administered correctly by ATO would mostly eliminate every bodies over blown concerns.

  9. RubiconMEMBER

    Most seriously rich people I know use a trust for asset protection firstly, and a company for tax minimisation.

    The trust income is streamed to the company that only pays tax @30% instead of at marginal rates. Of course the company also gets the benefit of franking streamed from the trust.

    That is where the real rort is. Companies should not be allowed to be private investment vehicles. Unlike trusts they can retain earnings indefinitely …. and stream income too (a bit more difficult) but possible…never heard of children being employed for ‘managerial’ roles etc?

    Trusts have to distribute income yearly or pay the top tax rate, companies pay tax at 30%!! So why would you change that? If you ‘force’ trusts to now pay [email protected] 30% then the seriously rich would not have to use a company anymore!!

    FWIW I believe that this is an orchestrated effort to give trusts the benefit of the companies tax rate while at the same time trying to drop the company tax rate. They are hoping for a win somewhere.

    • The company beneficiary can always distribute the income to a second discretionary trust and then that can distribute to individual beneficiaries with the franking attached. The company beneficiary basically holds money at 30% until the individual beneficiaries of said trust can pull it out without paying a lot of tax – i.e. once they have retired and have no employment income.