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Three family trust ploys the ATO is targeting in $1b crackdown
Under fire are deals to disguise profits as losses, overseas tax scams and trustees playing fast and loose with the rules.
The Australian Taxation Office is targeting “aggressive, egregious” family trust arrangements believed to be costing the nation’s coffers up to $1 billion a year in lost receipts.
Tax officials have identified three arrangements used by trustees to inappropriately use tax losses, access withholding tax concessions and aggressively reduce taxable income.
Facing increased scrutiny: family trusts that bend the rules to avoid tax. Simon Letch
The ATO Tax Avoidance Taskforce is targeting family trusts where family members typically have more than $50 million of assets, excluding their family home. Carlo Moretti, a tax partner with BDO, says: “This year the gloves are off. The ATO is telling advisers and scheme members it is coming after them. These schemes have moved away from being an ordinary year-end tax strategy to something aggressive, egregious and unacceptable.”
A family trust is a popular legal structure used to hold and manage family member assets, including small businesses. It can be set up for as little as $10 for a family, where mum and dad are usually the trustees, to hold assets for children and other descendants.
The trustee typically pays zero tax on income that flows through the trust, including capital gains and franked dividends. The income is distributed to the beneficiaries, who are taxed at their personal tax rates.
The trusts are called discretionary because the trustee decides which beneficiaries get what from the trust each year, and when they get it. Subject to the terms of the trust deed, all capital and income is distributed at the discretion of the trustee.
These are three arrangements being targeted.
Washing profits
A company or trust with tax losses is made a beneficiary of a profitable family trust. The new beneficiary needs to have some connection to the original trust, such as a family member having an interest in the company or trust with a loss.
Let’s say the profitable trust has $1 million in business income and transfers this as an end-of-financial-year distribution to the loss entity, which has tax losses of $1 million.
The loss trust’s assessable income is $1 million but, after allowable deductions for tax losses, taxable income is zero. While the distribution may be made “on paper” by the profitable trust to the loss trust, the profitable trust may retain the $1 million and use it to make a loan to another beneficiary, or put the money back into the trust’s business.
The trust’s assessable income is $1 million, minus any allowable deductions. But its taxable income is zero. This means the profitable trust can use the $1 million as a loan to another beneficiary or put the money back into the trust’s business.
The trustee of the profitable trust has no responsibility for the new beneficiary’s losses.
There’s no hiding for certain family trusts, says BDO’s Carlo Moretti. Dominic Lorrimer
“The profitable trust has washed the money through the loss beneficiary so that it is no longer taxable,” says Moretti.
“The trust can distribute to whomever it likes so long as the person is a named beneficiary or a member of a designated class of beneficiary. “If the beneficiaries don’t need the money, it can be left in the trust.”
Moretti says there needs to be evidence the arrangement is aggressive and has become “pervasive, prevalent and a nasty issue” for the ATO taskforce to investigate.
Withholding tax scheme
This structure is popular with non-resident beneficiaries. Take, for example, a family discretionary trust which includes in its potential beneficiaries a non-Australian tax resident and which earns $1 million of business income.
Normally, any profit from an Australian resident trust may attract taxes on income and profits of up to 47 per cent. But some interest withholding tax agreements, particularly with the US and Britain, reduce tax payable to between zero and 10 per cent.
The arrangement is set up by the trust’s beneficiary borrowing, say, $10 million from a bank and using it to purchase a top-rated bank or Treasury bond.
The trust pays an annual interest rate on the loan of $1 million, and receives a coupon payment from the bond of $900,000. The trust offsets the interest payments against the income, which means a loss of $100,000.
The trust’s business profits dip $100,000, but the foreign beneficiary pays no tax on $900,000.
“These are being packaged and sold to clients by tax scheme advisers and promoters. They’ve becoming pervasive and a really nasty issue,” says Moretti.
Aggressive income cuts
Aggressive use of trust deeds where a trustee manipulates a discretionary power to determine what receipts are income or capital – and who gets what – are also under fire.
A trust deed is an arrangement where a trustee, or company, holds assets in trust for its beneficiaries.
Take as an example a family trust that receives $1 million of business income and, based on the terms of the trust deed, determines that $300,000 is income and $700,000 is capital.
The trustee then determines a corporate beneficiary gets the $300,000 of income (which caps the tax rate to 30 per cent or less) and the trust capital of $700,000 goes to a resident individual tax-free.
“While the law recognises the terms of the trust deed are king, the trustee still has a fiduciary duty which includes governance and adopting a sensible application of the tax laws – substance over form,” says Moretti.
Frank Hinoporos, partner and head of tax at Hall & Wilcox Lawyers, says: “The legal complexity of administering a trust is underestimated, and not following the trust deed strictly can mean expensive mistakes are often made.”
New focus
The specialist tax avoidance taskforce has been beefed up after the government committed more than $1 billion in funding and boosted staff by more than 1200.
The taskforce liaises with about 10 regulatory and enforcement bodies including the Australian Federal Police, Australian Crime Commission, director of public prosecutions, and securities, prudential and anti-money laundering regulators. The ATO has held 19 seminars in the past six months addressing tax advisers and agents.
“The ATO will continue to target higher-risk trust arrangements in privately owned and wealthy groups. These are not ordinary arrangements or tax planning associated with genuine business or family dealings,” says an ATO spokesperson.
Hinoporos says: “The ATO has been actively engaging with the market and clearly telegraphing what it considers to be high-risk arrangements and behaviours, and testing trust anti-avoidance provisions in court – taxpayers and advisers operating in the ATO ‘danger zone’ should expect ATO attention.”
But Peter Bobbin, a lawyer and tax specialist, says family trusts with “vanilla” tax strategies have nothing to fear from the ATO because it is not including “ordinary family dealings” in this crackdown on reimbursement schemes.
“The vast majority of Australian family trusts have ordinary family dealings, don’t engage in tax evasion illegalities or tax avoidance, they just embrace common Australian flow through trust tax law to share the tax and secure the increased wealth among the family.”
Trusts are coming under increasing scrutiny from courts and tax authorities as their popularity pushes numbers to about 928,000 and assets of nearly $2.2 trillion, according to the ATO.
This includes almost 745,000 discretionary trusts, with about 558,000 reporting assets totalling $836 billion in the 2019-2020 financial year, it says.
The ATO has been trying to tighten the screwson family trusts for years and has recently issued tax rulings, practical compliance guidelines and alerts to raise awareness of potential pitfalls and stop abuse.
In addition, the expectation the federal government will introduce measures designed to tax unrealised capital gains for superannuation balances of more than $3 million from 2025 has motivated wealthy investors to invest in alternative investment structures.
“Trusts are commonly used by the public to carry on business and manage passive investments and family wealth. While most taxpayers do comply with their obligations, some enter into arrangements using trust structures to gain a tax benefit,” says an ATO spokesperson.
The ATO says the purpose of the trust taskforce is to address arrangements that:
Other key errors
Common mistakes made by family trusts that will attract the ATO’s attention include: