On Friday12 October 2018, the Government released draft legislation to give effect to its 2018-19 Budget measure to extend a specific anti-avoidance rule for closely held trusts engaging in circular trust distributions to ‘family trusts’ (but note, these are discretionary trusts that have made the ‘family trust’ election under (under s272-80 of Sch 2F to the ITAA36).
There is currently a regime designed to impose tax on circular distributions of assessable amounts in Div 6D of Part III of the ITAA36. Otherwise, no tax might be paid, as each trustee passes on the assessable income to the next.
The problem, which this measure is designed to remedy, is that the regime doesn’t currently apply to trusts that make a ‘family trust’ election – as the regime only applies to ‘Closely Held Trusts’, and ‘family trusts’ (and derivative entities) are excluded (as ‘excluded trusts’ – see definition in s102UC(4)), paras (c), (d) & (e)).
The ‘circular assessable distributions’ regime works this way.
- The purpose of this part of the regime is to recover tax, where there has been a circular distribution of assessable amounts.
- The regime focusses on the so called ‘untaxed part’ of Closely Held Trusts’ s95(1) ‘net [tax law] income’ (s102UE). This is, in essence, amounts distributed from other trusts, where no tax has yet been paid (typically because s97 gives the assessable income to the beneficiary).
- The regime applies when a Closely Held Trust distributes to a beneficiary, in its capacity as a trustee (Trustee Beneficiary under s102UD).
- There is a tax incentive for Closely Held Trusts to give the Commissioner a ‘Correct TB Statement’ within the TB Statement Period.
- Under s102UM, a Closely Held Trust, that does correctly report, in time, will only be taxed on so much of the Untaxed Amount (distributed to the Trustee Beneficiary) as returns to it as a circular distribution (assuming that there has not been non-disclosure tax earlier in the loop). This ‘Circular Distribution Tax‘ is imposed by the Taxation (Trustee Beneficiary Non- Disclosure) (No. 2) Act 2007.
- The situation is worse, however for a Closely Held Trust that does NOT correctly report on time. Under s102UK, it would be subject to ‘Non-Disclosure Tax‘ equal to the whole of the Untaxed Amount (not just the amount that comes back to it as a circular distribution). This Non-Disclosure Tax is imposed under the Taxation (Trustee Beneficiary Non- Disclosure) (No. 1) Act 2007.
- A ‘Correct TB Statement’ is defined in s102UG(3) and requires the Closely Held Trust to advise the Commissioner of the name and tax file number, of the Trustee Beneficiary, and the amount of the Untaxed Amount (included in that Beneficiary’s s95(1) tax law ‘net income’).
There is also a ‘Tax-Preferred’ distributions regime. It’s purpose os to track non-assessable ‘Tax-Preferred Amounts (s102UI) by obliging Closely Held Trusts to make similarly correct and timely disclosure of those Amounts (s102UT), breach of which is an offence (s8C of the TAA53).
The draft amendments would, in this context, do the following.
- amends the definition of ‘excluded trust’ to remove ‘Family Trusts’ and other relevant entities (that is remove paras (c), (d) & (e) from the definition in s102UC(4)) – so that these Family Trust type entities become subject to the Circular Distributions Regime.
- amends s102UK(1), so as to relieve these Family Trust type entities, from having to make Disclosure Statements, whenever they distribute an Untaxed Amount (which they received from another Trust). This also relieves them from having to pay the Non-Disclosure Tax (on the whole of the Untaxed Amount, it got from another trust). The draft does this by inserting a new para (ca) into s102UK(1).
- The EM says that the Family Trust type entities are spared this obligation because “it is considered that such reporting would impose unnecessary compliance costs on family trusts” [para 1.14].
- The EM hastens to add that these Family Trust type entities will still be subject to the ‘Circular Distributions Tax’ under s102UM – because they have not lodged the Disclosure Statement [para 1.15 of the EM].
- Quite how the Commissioner is to find out that a distribution has been circular (in the absence of TB [Disclosure] Statements, is not clear to me. This appears (to me) to be a ‘limp’ attempt at this reform.
- In any event (undeterred by these problems) the draft Act would also amend s102UT(1) to relieve these same Family Trust type entities from the legal obligation to lodge Disclosure Statements advising of their distribution of Tax Preferred Amounts (by inserting a new s102UT(1)(c)). The EM simply says this is to avoid failure to lodge a Disclosure Statement is not an offence [para 1.16].
- It appears, however, that the other ‘collateral damage’ from this ‘compliance cost’ relief from lodging Disclosure Statements, is the Commissioner’s capacity to track ‘Tax-Preferred Amounts, distributed by these Family Trust type entities. It seems that the other purpose of these statements (tracking Tax-Preferred Amounts) has also been lost in the name of reducing ‘compliance costs’.
- The draft legislation also makes a consequential change to s12-175(1)(c)(ii) of the TAA (following the amendment to the definition of ‘excluded trust’). This is a section imposing a withholding obligation, on certain trustees, if they distribute to a beneficiary, who hasn’t first advised their Tax File Number (TFN). The obligation applies to trustees of trusts that are Closely Held Trusts, or would be if paras (c), (d) & (e) of the current the definition of ‘excluded trust’ were disregarded. As those provisions are to be repealed, it would have been meaningless to go on referring to them. The EM seem to make more of this by saying: “clarify that trustees of family trusts continue to face a withholding obligation where the beneficiary does not quote a tax file number to the trustee before the time of the distribution” [para 1.17].
DATE OF EFFECT: The changes will apply from 1 July 2019.
SUBMISSIONS are due by 31 October 2018.
[Treasury website: Media Release, Consultation Page, Draft Bill, Draft EM; LTN 198, 15/10/18; Tax Month – October 2018]
FJM 21.10.18
CPD questions (answers available)
- Is this measure aimed at imposing tax on circular trust distributions?
- Is the existing regime for doing this in Div 6D of Part III of the ITAA36?
- Is it ‘family trusts’ as generally understood that were exempted from this regime?
- Does the existing regime impose larger ‘Non-disclosure Tax’ on the Closely Held Trust, if it doesn’t lodge correct disclosure with its tax return, and only a Circular Distributions Tax, if that disclosure statement is correct and lodged on time?
- Do the newly included ‘family trusts’ still have to lodge the Disclosure Statements on time and pay the Non-Disclosure Tax, if they fail to do so?
- Is there a clear mechanism for the Commissioner to know when to apply the Circular Distributions Tax?
- Whilst exempted from having to lodge disclosure statements for ‘Untaxed Amounts’ do family trusts still the obligation, that other Closely Held Trusts have, to report ‘Tax-Preferred Amounts’ under s102UT?
- Do ‘family trusts’ still have a TFN withholding obligation under s12-175 of the TAA?
