Dale Boccabella

At the October Tax forum, to be held on October 4^th and 5^th 2011 in Canberra, experts and academics are to sit down and discuss taxation in Australia. Alas, with all the noise ahead of the Tax Forum, little attention has been focused on trusts.

I want to see them resolving the treatment of discretionary trusts.

Discretionary trusts (DTs) have become pervasive and they will grow in number. In addition to DTs being set up by living persons (principals), it has become common practice for many assets passing on death to be housed within a DT (testamentary trusts/discretionary will trusts). And, wealth that will pass to future generations in Australia over the next 20-years or so will be unprecedented.

So what makes DTs popular? To answer this we need some understanding of this “entity”. It is a trust. But unlike many other trusts (e.g. listed property trusts, listed share trusts), the [potential] beneficiaries do not have fixed entitlements to capital or income. Whether a beneficiary gets a distribution of capital or income is at the discretion of the trustee (legal owner of trust property) and/or those behind the trust. Accordingly, a beneficiary does not legally own anything until the trustee decides to make them a distribution.

The trustee is the legal owner of trust property, but trust property does not belong [beneficially] to the trustee. The trustee is often a “$2 company”. Often, trust property will have been transferred to the trust for no money by the people behind the trust (usually Mum and Dad). These people are likely to be potential beneficiaries along with the children, and a family company.

As well as being the only shareholders in the $2 trustee company, Mum and Dad may also be the appointers of the trust. Appointers have power to remove a trustee if they are not satisfied with the way the trustee is exercising his/her/its discretion.

What flows from all this? First, assets held within a DT are generally beyond the reach of creditors of the beneficiaries, and creditors of the principals who set up and transferred assets to the DT. This also means the trustee in bankruptcy of a beneficiary or the principals usually cannot access those DT assets. Further, the principle that creditors of a trust (e.g. suppliers of goods to trust) can, in certain circumstances, access the assets of beneficiaries of the trust, does not apply to a DT.

In terms of “divisible property” for the purpose of a family law proceeding (relationship breakdown), the Family Court can take into account assets held in a DT, but this is less likely where the DT’s assets existed before the failed relationship commenced.

Secondly, the DT allows the trustee flexibility to make income (and capital) allocations to beneficiaries based on their differing needs and capacities. For example, one of the children might currently be unemployed or sick and therefore a greater income allocation can be made to him/her for the current year. The DT also allows the trustee to defer or stagger a particular child’s entitlement because there is concern about the child’s big spending habits (spendthrift). It should be said though that it is rare that the flexibility of the DT is sought to deal with the differing capacities and needs of beneficiaries. Other less sophisticated legal arrangements can more than adequately deal with the differing needs and capacities scenario.

Thirdly, and this is usually the most important advantage sought, the DT allows for tax minimisation; substantial minimisation. The flexibility that has a genuine non-tax basis to it (see above) also provides the means to minimise tax by, for example, allocating a given taxable income across a number of taxpaying units (simple income splitting). In addition, the DT allows income allocations across tax years to take account of beneficiaries’ other tax profile that can change over years. There is also the advantage of streaming different income types to beneficiaries who can make best use of certain items of income, a technique the government has recently re-endorsed.

There are many other tax advantages from a DT including allowing income allocations to children under 18-years of age to be taxed at the adult tax rate schedule where the DT arose under a will (testamentary trust). Normally, under-18s are taxed at a penalty rate of tax on their unearned income.

The advantages of DTs are quite substantial. No other entity comes close to offering all the advantages of the DT; some offer one or two advantages of the DT. And of course, one person’s advantage is another person’s disadvantage. For example, suppliers to DTs may have trouble getting payment for debts, and minimized tax through DTs must be made up by other taxpayers or government services must be reduced.

Are there any disadvantages to those using a DT? The main one is the danger of a “rogue trustee”. That is, the trustee might exercise their discretion in a way contrary to the wishes of the principals who set up the DT. With careful legal drafting, including wise selection of appointers, safeguards against this can be provided.

It is one of life’s twists that DTs can also breed suspicion and “distrust” amongst “beneficiaries” who would otherwise (fixed trust) expect an entitlement. The reason is that entitlements under a DT are contingent on the trustee’s discretion so that a beneficiary may be at the whim of the trustee, and those controlling the trustee.

The cost of financial planners, tax advisors, lawyers, etc, in setting up a DT and properly maintaining it can also become expensive as an effective DT must be kept-up-to date with changes in the circumstances of relevant parties. Indeed, these professionals are doing, and will continue to do, a solid trade in DTs.

By and large though, the disadvantages to those who can avail themselves of a DT are not significant and are overwhelmed by the advantages. And, no other entity (e.g. fixed trust, company) comes close to offering the same or similar tax and non-tax advantages.

As far as tax goes, various government inquiries have endorsed the current tax treatment of DTs. Indeed, the Assistant Treasurer, the Hon Bill Shorten MP told a Tax Institute conference recently: “We don’t believe trusts are any form of tax avoidance. We see trusts as a legitimate feature of how Australians conduct their financial affairs.” The tax advisors listening must have had a quiet chuckle; they need to be quiet because a loud chuckle may prompt the Assistant Treasurer to actually check the basis for that ridiculous statement.

Equally important are the non-tax advantages. To my knowledge, there has not been a systematic and comprehensive inquiry on the asset protection aspects (code for not paying debts), property division aspects, etc, of DTs. However, there has been isolated reform in various areas that has reduced the abusive use of the DT (e.g. pensioners cannot house assets in a DT and avoid having those assets counted for asset and income testing purposes).

The pervasive use of the DT has snuck up on society. The time for a comprehensive review of the advantages and disadvantages of DTs has come. At the moment, many Australians are gorging themselves on the advantages of DTs, and similar advantages are not available to others.

Dale Boccabella is an Associate Professor at the Australian School of Taxation and Business Law.

Fariborz Moshirian

The IMF has downgraded the economic outlook for 2012 much more than expected, including the forecasts for Australia, as global financial turmoil in the US and Europe is starting to impact on the Asian economies.
The recent World Economic Outlook report released by the IMF states that ‘The global economy is in a dangerous new phase. Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing’.

However the International Monetary Fund (IMF) may be too pessimistic in downgrading its growth forecasts for the Australian and global economy.

During the Global Financial Crisis, the G20 leaders’ summits were used to coordinate economic and financial issues amongst all member countries. However, despite some progress being made within the G20 framework, the progress has been disappointing. The current global financial turmoil requires a more coordinated effort between all G20 member countries, particularly the G2 – the US and China. However, the progress has been disappointing and the next leaders’ summit in November may be too late to muster the desperately needed coordinated approach for the current global financial turmoil.
The IMF has cut its Australian growth forecasts from 2% to 1.8% for 2011 and trimmed the growth forecast to 3.3% for 2012.

Every time we get the forecast from the IMF we need to be cautious. This is simply because the Reserve Bank and the Australian Treasury have more resources, and more insight about the Australian economy. We also need to look at the forecasts in a dynamic process rather than in a static environment, where for instance, in the next two to three years, we do not know the massive amount of demand which might come to Australia from China, India and other parts of Asia.
The IMF’s forecast for 2011 is now roughly in line with the Reserve Bank of Australia’s own forecast of 2%, however the IMF is now much more pessimistic about next year than the RBA, which has forecast above-trend growth of 4.5%, compared to the IMF at 3.3%.

We can trust IMF to the extent that their data and information that they are providing is reliable. Against that, I would probably say that the IMF forecast was probably a little bit too pessimistic. So my feeling would be that it’s likely to be somewhere in between. I think that at the end of the day all of this highlights that sooner or later the Government will have to announce a tougher stance in terms of the Budget, both in terms of either raising taxes or cutting spending.

The whole policy of IMF prior to the global financial crisis was to liberalise the market, particularly in emerging economies. Now they are still playing catch up, particularly with all the contagion in Europe. While we should be concerned about the position in Greece and Portugal, our investment banks are in a better position, and we have far less debt. It is unlikely that the contagion will have much impact, other than giving our share prices a rollercoaster ride. The IMF would like to see the US and Europe implement both a short term stimulus and have a plan for the long term budget balance. However, given the size of public debt, such a policy may not be easy to implement.

Fariborz Moshirian is a Professor of Finance at the Australian School of Business.

Larry Dwyer

Confidence in the domestic and international tourism sectors has taken a nosedive according to the latest survey, and this is likely to be due to the high dollar. However tourism operators in Australia may also be losing touch with their market, and should be continually reinventing their game.

With the Australian dollar hovering just above parity with the US dollar there are plenty of deterrents to tourists coming to Australia from overseas. If you add in the long distance, it’s no surprise that numbers are dropping, and so is confidence.
Six out of ten tourism operators are reporting forward sales to be worse or much worse than they were, according to the Mastercard Tourism Industry Sentiment Survey, with 80 percent of respondents saying the exchange rate is the number one impediment that dampens overseas visitor arrivals.
Certainly the Australian dollar is very high and that deters tourism to Australia. Even though figures show that the number of international passengers through Sydney and Melbourne airports is rising, Americans have always regarded Australia as a dream destination, but they regard the cost and the distance to come here as daunting.
Many more people are now finding that Australia is just too expensive for them – particularly holiday makers from Western Europe, who also have the tyranny of distance to cope with.
I feel we’ve been locked into the traditional ways of marketing for too long. Increasingly, marketers are recognising the extremely important impact of the internet and word-of-mouth marketing. Australians are net savvy, and will look up resorts, and read reviews. Why should they stay in a tired resort in Queensland – when they can travel to Bali and get something much more modern for half the price?
Australian holidaymakers may need reminding of the allure of the attractions that are right under their noses. And with domestic travellers representing three quarters of Australia’s tourism market, it’s an area that resorts need to capitalise on.

The impact of strikes at Qantas may further dent Australia’s attractiveness. Now with the added complication of industrial relations problems at Qantas causing flight disruption, many more holiday makers from overseas might become even more reluctant to make the trip.

Professor Larry Dwyer is an expert in tourism and tourism marketing at the Australian School of Business

Anne Junor

Jerry Parwada

While the big equity markets of Europe, the US and even Australia have struggled since the global financial crisis, investors have increasingly found that there are profits to be made in emerging and also the new frontier markets.

The story of Brazil is now well known, but new mutual funds and also hedge funds have been investing in countries as diverse as Romania, Kenya, Kazakhstan and Nigeria.

The economic forecasts for some of these markets are certainly bullish. By 2015 the BRICS group of Brazil, Russia, India and South Africa is expected to account for almost one quarter of global GDP, up from 8 percent in 2000.

Sub-Saharan Africa has not featured strongly on many investment radars but over the next five years seven of the region’s economies are expected to be among the top ten economies measured by growth.

This year the Zambian and Nigerian economies are both expected to grow by 6.8 percent, Mozambique by 7.5 percent, Ethiopia by 8.5 percent, and Ghana by 13.7 percent.

These are encouraging forecasts, but if the emerging and frontier markets are to remain a beacon of light for global markets some structural issues need to be addressed if the phenomena is to be sustainable.

The boom in many of these markets is being accompanied by strong inflationary pressures which, if left unchecked, will undermine the markets and create havoc in the individual domestic economies.

Already, we are seeing very high food price inflation in many of these countries, driven in part by the substitution of staple food for the production of biofuels. The moment food production is substituted for fuel production food will rise in price and inflation is the result.

These are the kinds of investments which deliver returns to investors while creating difficulties for the local population. These are transient money flows which may be damaging to the very growth potential that make the emerging markets so attractive.

If the inflows are too unbalanced, the phenomena will become more speculative than sustainable and beyond that will also foment political instability. More prudent Governments might deliberately slow down growth to curtail inflationary pressures.

The hedge funds, mutual funds and private equity groups investing in these markets and also local industries such as biofuels are stateless entities driven entirely by profits and are difficult to regulate in terms of how they invest. If a nation tries to protect itself from speculative investment through regulation, the funds will simply go elsewhere.

There is, however, a solution and it is in the hands of multi-lateral agencies such as the World Bank and its finance arm, the International Finance Corporation, and regional development banks such as the Asian Development Bank and the African Development Bank. These agencies have the ability to balance the growth story with intelligent investing and counter-balance the more speculative inflows from the likes of the hedge funds.

Portfolio and inflows of Foreign Direct Investment are much better directed to projects that genuinely improve productivity. This is the only kind of money flow which is permanent in any way.

Zimbabwe, for example, has a crying need for import substitution after the political turmoil of the last decade has decimated its agricultural sector. Zimbabwe, once the farm of southern Africa, is now importing food from neighbouring countries.

The IFC could increase its partnerships with local organizations in such an economy and successfully contribute to the production of food. Partly due to the flow of hard currency remittances from expatriates, many of these countries are dollarized in one way or another so food can be sold at competitive prices, removing the need for massive subsidisation.

Such initiatives would not only help feed the local population, but they would also lessen the pressure for inflation which is the biggest economic danger.

The boom in emerging and frontier markets will only be a positive for the countries themselves if it is balanced and sustainable. And if it is sustainable it will be a positive for the global economy over a long period and prove to be more than an investment fad.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.

Professor John Piggott

By anyone’s count, 7 billion is a lot of people. But it’s worth bearing in mind that the number could have been much higher. In 1965, the total fertility rate (an estimate of the number of live births in a woman’s lifetime) across the world stood at 4.9. If that rate had been maintained, the global population would be growing towards 15 billion by 2050, instead of 9 billion plus.

What’s changed is how many children each woman has, on average. The UN estimates that currently, the total fertility rate is about 2.5 globally. That same organisation projects fertility falling to 2.03, somewhat below replacement, by the end of the century.

At the other end of the life span, life expectancy at birth has increased from 56 in 1965 to 68 today. This increases population, of course, but not by as much as the reduction in fertility reduces it.

But these two trends imply a third, not much discussed when attention is focused on just the total, and that is population structure. The ageing of the population is a happening phenomenon in countries such as Japan, the world’s oldest. In these countries, low fertility has led to a range of economic and social challenges. These are well rehearsed at the level of a single economy – fiscal stress because so much support for the aged is provided by government; an older and generally less flexible labour force; a decline in entrepreneurship and innovation; challenges in caring for the aged; and so on.

Policies directed towards increasing fertility are therefore frequently encountered, because age dependency ratios are projected to move so rapidly, as the working population peaks and then declines, and the baby boomers retire and live longer.  The UN lists 47 countries who believe their fertility is too low, and 43 of these have policies aimed at raising the fertility rate. Australia is among the 43.

But the best policies for higher fertility are indirect. The decline in fertility in the 60s and 70s stemmed in large part from the increase in women’s labour force participation, perhaps the largest change in labour markets in the last century. Countries with superior childcare facilities, and attitudes of acceptance towards mothers of young children in the labour force, tend to have higher fertility rates than those where this level of social support does not exist.

From a global perspective, the age dependency ratio, which may be thought of as the ratio of the retired population to the working-age population, has moved from 9% in 1965 to 12% today, and is projected to more than double, to 26%, by 2050. And while countries whose population are already shrinking, such as Japan’s, find this challenging, this dynamic at a global level is much more dramatic. For centuries, a gradually expanding population has kept economies growing and societies dynamic. We don’t yet know what will happen when we can no longer rely on that future.

John Piggott is a Scientia Professor of Economics and Director of the ARC Centre of Excellence in Population Ageing Research (CEPAR) at the University of New South Wales.

Laurel Hixon

In its boldest recommendation on the future financing of aged care, the Productivity Commission proposes that housing and related living expenses be “unbundled” from the care costs and become the responsibility of the individual.

That makes economic and social sense, but also comes with a set or risks both for public sector funding and also for the individual which need to be navigated carefully.

Among the extensive recommendations included in its recent report “Caring for Older Australians,” the Productivity Commission has attracted attention for recommending that relatively sophisticated financial instruments—equity release schemes or reverse mortgages—can help people pay those reasonably predictable living expenses while the government continues its commitment to the more health-related costs of care. This explicitly acknowledges the need for combining private responsibility and public risk-sharing in the most sensible way.

Tapping into the equity in the family home presents a practical and viable solution to at least part of the aged care dilemma for some Australians. Housing wealth in Australia represents about half of total private assets, and using part of that wealth to fund care is a solution to two issues: the very real desire of people to stay in their homes and the wider public policy issue of transferring some of the cost of care to the private sector. Nearly 78 percent of older Australians own their homes outright, without mortgages.

Economic theory supports this approach as well. In health care, it has been well demonstrated that, if a person does not know when or whether they will need care, and the cost of that care is expensive, then insurance is needed to spread the risk over people. The private market does not work well in these situations. On the other hand, the housing and living costs, which are more predictable, are efficiently and equitable distributed in the private market and with greater consumer choice.

The Productivity Commission is especially committed to making greater choice available to aged care consumers in terms of the mix of services they receive, where they receive services (at home, in “age-friendly housing” or in a residential care facility), and from whom they receive those services. They have put forth a number of recommendations related to this goal.

In particular, they wisely recognize that these choices often change over time and have recommended that the Government remove a major financial disincentive to selling one’s home when the choice is to move to a more supportive care environment.  Rather than have the proceeds from the sale of a home result in the loss of eligibility for the Age Pension, people may invest those proceeds in a government-run savings account.

Taken together, these initiatives work both on a human level and also on a financial level. For Governments, there is a looming financial imperative. According to the latest Intergenerational Report, the share of the budget committed to aged care will increase from 3 percent in 2009/2010 to 6.6 percent of total Government spending, or 1.8 percent of national GDP, by 2049/50.  The central theme of the Productivity Commission report is a discussion of the relative roles that the public and private sectors should play in aged care financing.

With regard to both health care and retirement income, the Australian government has taken the approach of moving greater responsibility “off budget” and on to the individual and private sectors through private health insurance subsidies and mandatory superannuation schemes. As aged care services interface with the health care system and aged care financing is closed linked to aged pensions, it follows then that Government will seriously consider the same strategy for addressing the future growth associated with services needed to care for an ageing population.

Already, Australia has a strong public policy commitment to retirement savings through the compulsory superannuation scheme. Increasingly, superannuation and equity in the family home will become the basis for individual wealth in Australia and the Productivity Commission focuses on these as the source of individual funding to help the increased cost of aged care. But, as we transition to any new system of shared responsibility we need to understand better the parameters around these.

Finally, if there is any weakness in The Productivity Commission’s report it is this: the central assumption that more choice is better is not necessarily backed up by data and up to date research. Recent academic* work has shown that people’s actual choices often do not reflect their true preferences and best interests. Choice reflecting personal preference is a laudable goal but, operationally, this is not easy to implement.

Without making choices easy-to-understand through better information and research, we open up a whole new world of risk we can ill-afford.

Emphasizing the desire for choice has several risks. On the side of the government payer, there is a risk that, by putting choice in the hands of the consumer, public dollars will not be spent in a way that creates the largest public benefit.

On the side of the older person and their family, they may become overwhelmed and frustrated by the responsibility of making meaningful choice out of a large number of options. Or, in the case of rural and remote communities, the consumer may realize that meaningful choice simply isn’t available. Neither of these situations makes anyone better off.

Laurel Hixon is a Senior Lecturer and Research Associate at the Australian Institute for Population Ageing Research at the University of New South Wales.

A version of this opinion piece appeared in the Australian Financial Review on 15th September 2011.

Larry Dwyer

What is the future for tourism in Australia?

Aussies travelling and taking their holidays at home seem to be a “dying breed”, thanks to the high dollar, with most Australian residents having a taste for international travel only cataclysmic world events could change.

I feel Australia should place more emphasis on its urban tourism attractions, rather than the outback. Its cosmopolitan cities, its attractive streetscapes, its fine dining, sophistication and the sheer liveability of its cities are second to none. There are many fine urban tourism precincts that rival any around the world. And remember that Melbourne has vaulted Vancouver to become the best city in the world to live, according to the latest Economist Intelligence Unit’s Global Liveability Survey, with Sydney not far behind.

Domestic tourism products struggling the most are large-scale resorts in remote or outback destinations which are harder and more expensive to reach, and which simply can’t compete for value for money with overseas destinations.

I’ve also seen that consumer values are changing in ways that favour urban tourism, including strong Generation Y attributes such as being money rich and time poor, plus seeking hedonistic, discerning experiences. They are less loyal to brands – something the airlines know well now – and they seek value for money, not necessarily low prices, within authentic tourism experiences.

Australia should give up trying to compete at the mass-market level to attract tourists. A move to putting emphasis onto Australia’s urban areas has a good synergy with meetings, conferences, and events. Business tourism would be an important market in this context. However there is a place for the outback, and tours to more remote areas could piggyback on this.

One of the world’s fastest growing tourism markets is that of business events tourism. It is typically one of the highest yielding inbound tourism segments because of the high per-delegate spend. Worldwide, there is competition among destinations for such business and, with substantial government support for marketing activity and infrastructure development, this trend is expected to continue.

There are substantial opportunities for operators to associate themselves with business event tourism by way of accommodation, catering, tour operations, and organising professional conferences. Herein could be the future of Australian tourism, with business tourism capable of providing increased opportunities for the Australian tourism industry with strong appeal across all key markets.

Larry Dwyer is a Professor in the School of Marketing at the Australian School of Business.