$60 billion in trust payments under cloud following ATO court loss
Payments of around $60 billion from family trusts are under renewed legal scrutiny as the Australian Taxation Office (ATO) considers whether to appeal its defeat in a landmark decision about tax avoidance.
A decision on March 8 by the Full Court of the Federal Court upheld that financial strategies involving trusts which merely result in the payment of less tax are not evidence on their own of a dominant purpose of tax avoidance.
The legal principles are applicable to family trusts that annually pay income to around 1.7 million people.
The court, in dismissing the use of trusts as a tax-avoidance scheme, repeatedly referred to their “real economic and financial effect” and warned the ATO cannot dictate to taxpayers how they should arrange their affairs.
The case involved Minerva Financial Group (MFG), a company that provides non-bank financial services. Between 2012 and 2015 the MFG Trust distributed effectively all of its interest income to scheme members not resident in Australia, which means they paid withholding tax of 10 per cent rather than the corporate rate of 30 per cent.
The tax commissioner determined Minerva had obtained a “tax benefit” with a scheme covered by Part IVA of the Tax Act concerning avoidance. Minerva unsuccessfully appealed to the Federal Court after the ATO disallowed Minerva’s objection.
But the Full Federal Court unanimously allowed Minerva’s second appeal. The court set aside the decision of the lower court and remitted the issue to the ATO for redetermination.
“Nothing supports a conclusion that any part of the schemes either entered into or carried out any of the schemes for [the] dominant purpose of enabling a tax benefit,” the court ruled.
The ATO says it is considering the ruling and a possible application for leave to appeal to the High Court, which means scheme trustees could be left in limbo about the treatment of trust structures for possibly up to 12 months.
Why it matters
The case targeted a ‘big end of town’ billion-dollar company and distributions totalling nearly $100 million.
But the broad underlying trust structure and legal principles are applicable to popular family trusts that annually pay income to around 1.7 million people, according to tax specialists.
About 11 per cent of taxpayers lodging a tax return reported trust income in 2020-21, or around 200,000 more than the previous year, according to Treasury.
Tax specialists warn the uncertainty could create potential problems for trustees seeking clarity on how income will be legally distributed through family trusts in the lead up to the June 30 end of tax year.
That the Federal Court’s decision was unanimous against the ATO adds to the uncertainty about whether an appeal application to the High Court will be successful.
Alternatively, trustees might have to wait for the ATO’s “decision impact statement” to provide hints that it could be widening avoidance measures to family discretionary trust distribution decisions. A decision impact statement is a response to significant cases decided by courts or tribunals.
John Jeffreys, a tax consultant says: “The issue remains under a cloud until the High Court decides which way it will go.”
Jeffreys says in many cases the decision about which beneficiaries receive income is determined by the overall tax outcome for the family, or family group.
“Clients know this, accountants know this, the ATO knows this,” he says.
“It is an accepted fact of Australian small business and family investment life. But can the decision of trustee to make distribution to beneficiaries in the most tax effective manner be a ‘scheme’ to which the anti-avoidance provisions of tax law apply?”
Take some comfort
But trust users can take some comfort in that Jeffreys says it is unlikely that tax authorities are planning to “aggressively attack hundreds of thousands of trustee decisions intended by families to save tax”.
Mark Molesworth, a partner with tax consultancy BDO agrees: “The court goes to great pains to point out that taking a course of action that merely results in the payment of less tax is not evidence on its own of a dominant purpose of tax avoidance. This should be of comfort to taxpayers who undertake planning that does, appropriately, take tax into consideration.”
Kaitilin Lowdon, special counsel for Sladen Legal, adds: “Taxpayers are entitled to rely on the decision of the Full Federal Court until there is a contrary decision, either of the Full Federal Court (in another matter) or the High Court. However, if the Commissioner seeks special leave to appeal to the High Court it is representative of the continued attack on trust structures, including family discretionary trusts.”
A family trust is a structure used to hold and manage family assets, including small businesses. They can be set up from $10, 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.
Tax authorities have repeatedly warned about cracking down on individuals using family trusts to make bogus distributions to beneficiaries – often adult children on lower marginal tax rates – and using the cash for themselves.
The Minerva case scrutinised trustees use of their discretion to make distributions.
BDO’s Molesworth says: “Trustees of discretionary trusts may have less to fear from Part IVA than was thought. But there are plenty of other specific tax avoidance rules that they still have to think about.”
Those rules tackle unlawfully reducing taxable income, increasing deductions against income, increasing rebates and obtaining refunds.
Molesworth warns if the decision is upheld it may lead to more taxpayers considering “running matters to trial, rather than settling with the ATO”.
