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.

Associate Professor Dale Boccabella

The Federal Government has looked at slashing the tax free threshold for duty free goods, following complaints from retail giants that shoppers now want to buy online overseas. Retailers say they want a tax barrier to drive customers back into their stores, and a report by PwC today says that although Australia lags behind in online shopping, it is catching up fast, with an increase of 13% in sales expected this year.

However this could cost Australia more. The cost of collecting the tax may outweigh what tax revenue could be raised. As the Board of Taxation indicated around a year ago, there are many practical difficulties in collecting GST on goods bought over the web where the online shop is overseas.

The Government has now confirmed that it has examined reducing the threshold to $500, however online retailers such as eBay say that only a very small minority of transactions would be impacted by this, and little additional revenue would go to the government, which puts the cost of implementing the change at $38 million.

There are two alternatives to collecting the tax, both of which would be costly and time consuming, and neither of which would actually raise any significant revenue.

We could get the Australian consumer to collect the GST on the sale made to them and send a remit to the Tax Office. The bottom line here though is that Australian Governments are very reluctant to impose tax collection or reporting obligations on consumers as opposed to businesses. Quite simply, consumers wouldn’t want the hassle, and wouldn’t be thankful for having this burden imposed on them.

The alternative is to ensure that all companies that can trade online with Australian consumers are registered for GST. However, the government is under considerable pressure to keep overseas companies with only a few Australian customers out of our GST system because of the high compliance costs that go with GST registration, which would mean that the compliance costs can outweigh the revenue collected.

Indeed, one could query why the low value threshold was increased so significantly to $1,000 (from $250) in 2005, and why there wasn’t much opposition from retailers at the time. The brick and mortar retailers may have a point that this is placing them at a competitive disadvantage. However Australia’s GST is ‘only’ 10%. Admittedly anecdotal, I have seen price differentials between on-line goods and brick and mortar goods that cannot be explained by the presence or absence of GST, and is more likely to be from the high cost structures of brick and mortar businesses, and possibly from excessive mark-ups.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business, University of New South Wales.