Debating Labor’s trusts policy

By Leith van Onselen

Former Labor minister, Craig Emerson, has penned an article in The AFR today talking up Labor’s plan to tax discretionary trusts and chastising the Coalition for balking at reform when it was in office:

…two of the Coalition’s last three treasurers agreed that such action needed to be taken, only to shirk it.

As a young backbencher, I sat with Simon Crean across the parliamentary table from treasurer Peter Costello in November 2000, negotiating an agreement on business tax reform. Labor would support a cut in the company tax rate from 36 per cent to 30 per cent, together with a 50 per cent discount on the capital gains tax rate, if the government agreed to crack down on trusts and sham contracting. By reaching this agreement, the two major parties were adopting a broadly self-financing reform package based on a review of business taxation chaired by former president of the Business Council of Australia, John Ralph. Costello followed up by signing a letter to Crean.

Costello quickly reneged on the written agreement, leaving reform of the tax treatment of trusts in the too-hard basket. There it remained until April 6, 2011, when shadow treasurer Joe Hockey flagged a crackdown in an evening speech to the Institute of Chartered Accountants. Under pressure from the National Party and conservative Liberals, Hockey abandoned the idea the next morning. Borrowing the words of Peter Costello, used when describing a Mark Latham thought bubble years earlier, Hockey “couldn’t hold a policy from Lateline to lunchtime.”

Ironically, it was Liberal icon John Howard who had first acted on trusts, not as prime minister but as Malcolm Fraser’s treasurer. He legislated that distributions from trusts to children under the age of 18 would be taxed on a non-concessionary basis.

But the Howard amendment left unchanged the tax treatment of distributions from trusts to adult children, stay-at-home spouses, retired parents and other relatives. Smart accountants typically can find four or five adult members of an extended family in the lowest tax brackets for signing up as trust beneficiaries.

An ordinary wage or salary earner, who has tax automatically taken out of his or her pay packet each fortnight, has only one tax-free threshold, whereas a professional can gain access to four or five tax-free thresholds through the concessionary tax treatment of trusts. The result is that these two people, each earning the same income, pay vastly different amounts of tax.

Meanwhile, ABC’s The Business last night featured an interesting debate between the chief of the Council of Small Business, Peter Strong (arguing against Labor’s policy) and the chief executive of the Grattan Institute, John Daley (arguing for Labor’s policy):

John Daley made the far more persuasive case, in my opinion.

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Comments

  1. DodgydamoMEMBER

    Seeing as Mr Strong started the interview not answering the initial question and banging on about some other distracting bullshit (at which point I cursed at him and switched channel, last night) Mr Daley would not have had to do much to be more persuasive!!

    • The only time The Terminator sounded convincing this morning on AM was when he shifted the conversation and rattled off the scripted “Labor bad; Liberal good” line. When pressed for detail, sounded very shaky and unconvincing. Even Fran Kelly sounded a bit pissed off with The Terminator’s constant non-answers.

  2. More Tax, just more. Everyone knows that will fix EVERYTHING.
    Politicians will stop acting against the national interest
    Politicians will stop whoring themselves to rent seekers
    GDP per capita will sky rocket
    Living standards will sky rocket
    Every man, woman and child will begin farting rainbows

    If only we would pay MORE tax. More I tell you, MORE !!!

    • Troll.

      You need to explain why it should be acceptable for some people to dodge tax while others pay the full amount. Otherwise, get on board for reform.

      • He has a point.

        The fake left wing put in a carbon tax (which is fine) but did not even give me a $5 cheque to help pay the electricity bill. (I knew all along that gold plating is the issue, but the average voter did not). Anyway, they lost the 2013 election…

        Even Alaska gives out anti-poverty cheques!

        You can raise taxes – but what is in it for the poor voters?

      • “You need to explain why it should be acceptable for some people to dodge tax while others pay the full amount. Otherwise, get on board for reform.”

        The people they are mostly trying to target have already paid tax on the money in their discretionary trusts!! This is about taxing the earnings once again at 30%. It is theft, especially when they are such unrepresentative swill!!

      • Arrow2. Whats the tax dodge here buddy? I’m keen for you to articulate it.
        If I was a betting man I’d wager that you’ve got clue about how things really work and that you’re easily influenced by this hyperbolic, class- based debate given your disdain for those with bigger bank balances?

      • I could earn $200k PA as a contractor and my wife earns nada. A trust lets her and me draw $100k each, hers being for “book keeping”. Now our family tax bill is much lower.

        But as others have said, this isnt an issue specific to trusts but to income splitting in general

    • It isn’t MORE tax, its making sure those who have been avoiding paying their fair share do so. Nothing more, nothing less.

  3. casewithscience

    Trusts involve the ancient practice of splitting legal and equitable title. This was all very useful when you didn’t want your negligent second child to spend all their inheritance and therefore appointed the sensible uncle to act as trustee for the estate. They were also quite useful if you didn’t want to give your cash to the kiddies but rather wanted it handed out for some beneficial purpose to the community. That they are now used for business purposes (unit trusts) and as arrangements to avoid taxation is yet another example of why the human race can’t be trusted with nice things.

  4. So is Mr Emerson saying as per his last para above that a professional can earn say $300K & instead of putting that in their own tax return they put it into 6 tax returns, so each 6 pays tax on $50K?

    • Which is bullshit Sool. IF the argument is based upon what can be reasonably split into a Trust I see the issue as being above that of how a Trust operates. It is other tax law that allows certain businesses and professionals to split income.

      Targeting Trusts for an issue ‘higher up the chain’ is redherring.

      • Yes agree Rich. Pretty sure that scenario is caught by a number of laws in existence already. Much (if not all) of the commentary is quite misleading & I would suggest deliberately ignoring existing tax law. Emerson saying any accountant can find 4 or 5 adult people to sign up as beneficiaries to share the professionals income is laughable.

      • casewithscience

        Trusts aren’t distinct legal entities, they are formed by the trustee and the beneficiary. They don’t get taxed on income the same way as natural individuals (or companies).

      • Exactly Stool. The arguments presented are bullshit. Exactly, so what happens in this case that 4 or 5 random people stake their claim to the distribution they are presently entitled? It doesn’t work out if you give all you’re money to strangers!….

        @casewithscience
        Trusts are not formed by the beneficiary. They are formed by the settlor. If the Trust doesn’t distribute the income/gains they get taxed punitively! Trust income is either taxed punitively (the trustees) or ultimately distributed to an individual or a company – in either case it is taxed as it would otherwise be had it gone directly to the individual or the company. You don’t have a clue what you’re talking about.

      • casewithscience

        @rich

        I wasn’t talking about who makes the trust, I am talking about the characters who are in the trust (once formed). Sorry if you didn’t understand my phrasing.

    • casewithscience

      @Sool

      If you run your own business, then ppl do use that method to minimise taxable income coming directly to the owner, particularly where the business is taking revenue from a fixed asset or other rent (ie assignment of the property into a trust property with the beneficial distributions amongst the family to non-incoming earning persons). That is the point. These schemes are available to non-“worker” segments, but not to workers – hence:

      “An ordinary wage or salary earner, who has tax automatically taken out of his or her pay packet each fortnight, has only one tax-free threshold, whereas a professional can gain access to four or five tax-free thresholds through the concessionary tax treatment of trusts. The result is that these two people, each earning the same income, pay vastly different amounts of tax.”

      • So @casewithscience, a business runs via a Trust. Okay they can split some of the business income elsewhere, as should be expected. Again this is regulated by personal services income rule. This is a non argument.
        I guess you’d be against someone running their business in a company for the same reasons? Say, someone has a bunch of special share classes with no voting rights owned by their children.. pays out franked dividends effectively with discretion, they then get the franking refunded. From an income distribution perspective where is the difference?

      • casewithscience

        @Rich

        I don’t think you are seeing how this works, so I will explain it as simply as possible.

        Say there is a trust with income of $200k per year.

        The trustee is the real owner of the asset but they have an otherwise personal income and don’t want to pay full income tax at the top rate.

        The trust is set up with four beneficiaries, who have no other income, except for the trust receipts. All those beneficiaries are wards of the trustee (ie his/her kids).

        So, if the trustee took the income directly, rather than through trust, they would pay the top marginal tax rate on the 200k income – being a sum of $63, 232.00 in tax.

        If each beneficiary is paid $50,000 from the trust and have no other income then each of them pay the effective lower rate, being 4 x $3994.50, or $15,978.00.

        So, as a matter of maths, the use of the trust has reduced the amount payable to the ATO from $63,232.00 down to $15,978.00. That is, a loss for Australia of $47, 254.00.

        This is the method of tax reduction that is being criticised here.

        You see, the trick is that the trust is not an entity, but rather a legal relationship. The trust does not pay tax on actual income, just the net. With a full distribution to the beneficiaries (ie sending out the 200k in the year) there is no income tax payable by the trustee for the trust. Rather, the only assessment is on the income derived from by the beneficiaries.

        (Apologies if this is still complex, I am a solicitor so I can sometimes set things out in an overly complex fashion).

      • @casewithscience,

        I understand what you are saying clearly. My point a similar outcome is achievable anyway through the creative use of different share classes.
        I see no issue with the use of Trusts as an asset holding vehicle. I believe they are integral to long term family planning and asset protection, and that attacks like this have potential unintended consequences.
        From an income distribution point of view it is only cheaper up to $37K of Income, as the incremental dollar is taxed at 32.5% above this. Above this it may as well be received into a Corporate Entity.
        Something that hasn’t been mentioned is that a Trustee distributing to other parties (by book entry only) is exposing themselves to calls on these amounts as the beneficiaries are presently entitled to. This rules out using many potential beneficiaries.
        The analysis on how big this tax ‘loss’ is to the government is flawed and doesn’t consider other arrangements or benefits forgone by those beneficiaries showing a higher than otherwise taxable income.
        Honestly, what dollar value of tax is ‘lost’ as a result of distributions made to persons over the age of 18 (yet earning less than $37K), that would otherwise have been received by an individual on the highest MTR? Net of any benefits they may forego. Also, excluding farms and testamentary trusts.
        Much of the commentary I have seen attacking trusts has been fundamentally an income-splitting/PSI problem (ie: something that occurs above the trust structure). I have even seen comments attacking Trusts as they shield assets from creditors… which is something so fundamental to Trust law that it’s sad to even see it mentioned as an argument against. Lest the poor banks not understand how to read a balance sheet!

        They may as well be cracking down on insurance bonds, or depreciation write offs…As they both continue to ignore any real reform.

        PS: Dealing with those in the legal profession is great. Generally concise communicators and pleasant people.

  5. As much as I hate to say it (because I use a discretionary trust as my investment entity) this makes sense. It’s really not cool that I can get refunded the franking credits because I’ve distributed them to someone below the tax-free thresh-hold.

    That said, I’ll likely just pay out the franked dividends to a holding company, which will then pay a franked dividend to the same person, so net benefit is 0…

  6. PlanetraderMEMBER

    What an absolute crock this is – there are rules in place to stop income splitting through trusts for personal exertion income (i.e. thus equating with PAYG). How many people have 4 or 5 adults around to distribute to? If you distribute to an older parent you may affect their age pension (income test), the penalty of which is 50% of income so higher than the top MTR. If you own investments anyone can use a trust so i don;t see what the problem is there. The only argument i see is if you use a business owned by a trust to divert income that would otherwise be PAYG to other beneficiaries, but again the personal service income rule comes in. So given that, where is the tax dodge? I would like to see how they expect to save so much money. The fact is they won’t.
    Enforce the current rules that are in place if people are rorting the system – but in Australia there seems to be a lack of desire to do so hence why we need political smoke and mirror tricks to make the punters think they are doing something.

    • Absolutely
      MB have been promoting this BS for about a week. Each day, particularly the first day, somebody with knowledge has torn the thing to shreds. Why is MB still promoting this as some great step forward about which nothing has been previously done?
      What a load of baloney. Under the current rules most would abandon the Trust if they could. It’s pointless as far as saving tax goes and has become very tricky for compliance.
      Wouldn’t it be more down a macrobusiness line to do an estimate of HOW MUCH extra tax this would glean given that there is almost no advantage to it? The 17 Billion figure is just complete and utter tripe. How about a bit of integrity?
      MB would be better dealing with facts but all we are getting is pro-Labor (other than UE’s migration posts) political tripe. Again this is supposed to be a business site not a pro-Labor political spin site.

      • Agreed Flawse. The reasoning is flawed, and the tax saving argument is primary school grade maths.

    • Say you’re a partner in an accounting firm. You’ve bought in to the partnership. Your profit share is paid not to you but to your family trust. You then distribute to family members. It’s not personal service income because it’s a return on the capital that you’ve put in to the firm.

      • Joseph, as you’d be aware there are limits to what can be split away from the partner. Service Trusts that provide the office services, etc, are heavily regulated and typically take 10-15%. More recently the ATO has approved many Everett Assignments where a partner may sell a stake in their partnership to their trust, company or other person. PWC has advised on many of these arrangements. This generally means that 50% of compensation can go via a trust, the argument for allowing this is that each partner is effectively a business, so some of the income should be treated as such. There are tests to determine what is allowable, and these are approved by the ATO. Some are generous, some are more conservative. However, even if one disagrees with these rulings or specific cases IT NOT A TRUST PROBLEM. They could assign their interest anywhere.

        My problem with the commentary regarding trusts is that trusts serve a legitimate purpose, and the arguments against so far are poorly made, or in the case I’ve highlighted above, wrongly directed. Shoten’s argument is pure dishonesty, and people eat it up for tall poppy reasons; believing it must be those damn rich folk who all perpetually avoid tax (yet write tax cheques each quarter that are multiples of what most pay in years) not knowing that nearly everybody could better structure their investment/family affairs for $250 with an online Trust deed…..

    • “there are rules in place to stop income splitting through trusts for personal exertion income (i.e. thus equating with PAYG)”

      Thank you. It is yet more tightening of what you can and can’t do in this nanny country. The really rich will see this as another incentive to domicile in another country where tax is optional and the Commonwealth will go from getting somehting to nothing.

      • Cost IndexMEMBER

        Bingo JC.

        The French did the exactly the same thing recently. Everyone just left taking their knowledge with them. The French being the socialists they are, shot themselves and hence everyone else in the foot. As socialists always do.

    • Nobody (except a couple of commenters here) is raising the issue of personal exertion income.
      The issue is around discretionary trusts being used as investment holding structures. Allowing the trust income to be distributed by the trustee to obtain tax benefit either by distributing in a way to take advantage of lower marginal rates or beneficiary brought forward tax losses, and the CGT discount where the beneficiary is an individual. Although the CGT thing is also a rort in fixed trusts.

      • Sweeper all the examples I have seen on TV, in the Press relate to income splitting. Ie: Mr Accountant earns $700K – takes $500K personally splits $200K to a trust ‘saves’ XXX dollar of tax.

        If the big issue is holding assets in the trust I think it’s a false argument really especially when considering the nature of trusts historically. The income is taxed in the hands of whoever receives the distribution. This is absolutely fair.

  7. Cost IndexMEMBER

    Trusts are required to make up for a distorted system. Worked all my life to save for my children, but have had my hard-earned continually confiscated and wasted by bureaucrats on pet projects. Now I understand why taxation is theft.

  8. Labor would support .. a 50 per cent discount on the capital gains tax rate

    Instead of whining about what previous Liberal governments didn’t do, Labor should be apologising for the stupid mistakes that they actually agreed to and let pass through parliament, in this case allowing the change in CGT from fully taxing real gains to half taxing nominal gains.

    This was one of the stupidest changes to tax law of all time and the Labor Party went along with it. It certainly went downhill after losing Keating.