On 30 July 2017, the Labor party announced it would (in Government) introduce a standard minimum 30 per cent tax rate for discretionary trust distributions to mature beneficiaries (people over the age of 18).
Individuals and businesses use trusts for a range of legitimate reasons, such as asset protection (for which ‘discretionary’ trusts are particularly useful) and business succession. But discretionary trusts can also be used for tax minimisation. In particular, discretionary trusts allow for trust income to be distributed on an entirely discretionary basis to beneficiaries in lower tax brackets so that the tax paid on the overall amount is much less than it would otherwise be if earned by the person controlling the trust. This is commonly called ‘income splitting’. Whilst income splitting is completely legal, the Labor Party is going to attack it on the basis that it is not ‘fair’.
Under Labor’s policy, individuals and businesses will still be able to use discretionary trusts. However, the new minimum 30 per cent tax rate on distributions will make sure discretionary trusts cannot be used as a vehicle for aggressive tax minimisation. It does this without taxing trusts like companies (a thing widely criticised of recent).
Labor’s policy builds on the reforms of former Treasurer John Howard in the early 1980s. Mr Howard cracked down on income splitting to minors by taxing distributions at the top marginal tax rate. Labor’s policy extends this principle to adult beneficiaries, but at a less punitive rate of 30 per cent.
Labor’s policy only applies to discretionary trusts. Non-discretionary trusts – such as special disability trusts, deceased states and fixed trusts – will not be affected by this change. Nor will it apply to farm trusts and charitable trusts.
Similar to John Howard’s reforms, exemptions will apply under the new arrangements, such as for people with disability, to ensure people suffering genuine hardship are not affected. The ATO Commissioner will be given discretionary powers to manage this.
This policy has been costed by the independent Parliamentary Budget Office. It is estimated to raise $4.1 billion over the forward estimates to 2021-22 and $17.2 billion over the medium term.
Further details are set out in Labor’s policy document, A fairer tax system – Discretionary trusts reform.
Subsequent to this announcement, commentators have noted that this measure can be defeated, albeit by yet more expense and complication. The same beneficiaries, who would be denied sub-30% rates of tax, could still enjoy those lower rates of tax, if the trust distributed the relevant amount of its income to a company. The company could then pay franked dividends to the same persons. The critical thing is that ‘franking credits’ are ‘refundable’ to recipients, to the extent that their tax rate does not absorb all of the 30% franking credit. Post refund, therefore, those individuals have still been effectively taxed at the same sub-30% rates of tax. And, dividends could be paid to different shareholders at amounts in the directors’ discretion. This would maintain the flexibility of a discretionary trust.
[FJM; Labor announcement; LTN 143, 31/7/17]