Trusts a likely issue if Labor wins next election
INVESTORS planning for the prospect of a change of government have no doubt considered the ALP's plans for shares and property, but a crucial issue that has flown under the radar is the planned changes to trusts.
The increase in popularity of family trusts or discretionary trusts has placed this wealth management tool at the centre of many family businesses.
According to the most recent Australian Taxation Office research, there is now more than $590 billion of assets sitting in discretionary trusts, nearly double the amount a decade ago. In fact, it is estimated that more than one
On July 30 last year Bill Shorten announced, as part of the ALP's tax reform plan, proposed changes for discretionary trusts if it wins government. The ALP's proposal stops short of taxing trusts as companies. Instead, it suggests the introduction of a minimum 30 per cent tax on trust distributions to beneficiaries aged over 18 and would apply from July, 2019 - immediately after the election.
The ALP proposal is not to tax the trust - the income tax liability falls upon the individual beneficiaries of the trust in the form of supplementary personal income tax.
At present a trustee must lodge a tax return each year reporting the net income or loss: trusts are treated as "pass through vehicles" for tax purposes, so tax only applies when the income is in the hands of beneficiaries.
Income distributions from trusts are generally taxed at the individual income tax rate of the beneficiary. Trusts (unlike companies) can also pass through the benefit of the capital gains tax discount, making trusts attractive vehicles for tax purposes. For people receiving trust money who do not work - or are on low incomes - the change of rules will almost certainly mean a lift in tax costs.
In common with many advisers, I believe discretionary trusts are a legitimate and positive structure adopted by many in small business, individuals and families to help support effective planning.
Trusts provide flexibility in allowing small businesses to manage cash flow with additional benefits in asset protection as well as succession planning and estate planning. In the case of taxing discretionary trusts, I contend those that will be affected will be those that can least afford it.
The ALP has acknowledged that individuals and businesses use trusts for a range of legitimate reasons, but it has also claimed that "in some cases, trusts are used solely for tax minimisation". This seems an extraordinary claim.
The policy has excluded both charitable trusts and farm trusts. In the case of farm trusts, KPMG argues in an August 2017 paper that this decision will raise "difficult questions of 'equity' from the perspective of tax policy design".
Other trusts that are excluded from this policy are special disability trusts, deceased estates and fixed trusts.
It's also worth noting some other relevant KPMG points:
- Without strong anti-avoidance provisions to accompany the change, the policy will incentivise taxpayers to "re-characterise" discretionary trust distributions into another type of income in the hands of a beneficiary (such as interest/employment income or private company dividends).
- To the extent that the ALP policy is targeted at ''income splitting'', it should be noted that a range of statutory provisions, anti-avoidance laws, and tax office rulings already address this issue comprehensively.
With the uncertainty in Canberra it is looking likely that we may soon have a new government via an early federal election.
The government has demonstrated its inability to articulate to voters that a change of government will mean a significant change - that means an increase in taxation. The ALP has flagged negative impacts in signalling likely policy changes in the areas of capital gains tax, negative gearing and personal taxation. Indeed, if you are in the top marginal taxation bracket, there will also be detrimental changes in family trusts and franking credits.
In April, I wrote about the implications for retirees resulting from the ALP's plans to scrap cash rebates for franked dividends.
For those investors with self-managed super fund in retirement phase, franking credits represent a valuable part of their income strategy. Yet this stream would be affected were the ALP to win government and its franking credits plan become a reality.
Already we are witnessing a spike in demand for clarity among the many obtaining financial advice on how the mooted changes might play out.
My view is that the proposed changes discriminate against those in retirement: they are clearly targeted at those with an SMSF, those in retirement, and those that are not members of an industry-based fund. In the case of the franking credit rebate abolition, 96 per cent of the individuals affected have taxable income of less than $87,000.
The ALP's proposed policies are going to hurt small business and will have broad ramifications across wealth management.
This story was first published in The Australian.
Will Hamilton is the managing partner of Hamilton Wealth Management, a Melbourne-based wealth manager.