Should SMSFs fear Labor's trust plans?

Anthony Fensom | 12 Sep 2017

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Labor's plan to tax discretionary trust distributions has sparked fears that self-managed super funds (SMSFs) could be hit in the process.

 

In a 30 July media release, Opposition Leader Bill Shorten pledged to end Australia's "two-class tax system" by tackling the use of income splitting to minimise tax. The measure is aimed at "making the tax system fairer" and "improving the budget bottom line" to the tune of $4.1 billion through to fiscal 2022.

Under the policy, a standard minimum 30 per cent tax rate would be imposed on discretionary trust distributions to adult beneficiaries. According to Labor, individuals and businesses would still be able to use discretionary trusts, but the new impost would prevent such trusts being used as vehicles for "aggressive tax minimisation".

"Labor's changes are about making sure trusts serve their true purpose--not as a tax minimisation tool. This policy is well targeted to address tax minimisation and artificial income splitting. These reforms will not affect 98 per cent of taxpayers in Australia," the announcement said.

Non-discretionary trusts such as special disability trusts, deceased estates, and fixed trusts would not be affected and nor would charitable and farm trusts, Labor said. It said the measure built upon John Howard's reforms as treasurer in the 1980s, when he "cracked down on artificial income splitting to minors by taxing distributions at the top marginal tax rate".

The measure is seen affecting 315,000 trusts, with some 200,000 of these related to small businesses. Council of Small Business Australia's Peter Strong said the policy was a blunt instrument, which would negatively affect trusts used by "tradies, farmers, shopkeepers, professionals, and retirees," while Treasurer Scott Morrison described it as a "direct assault" on small businesses.

SMSFs could also be caught in the net, according to DBA Lawyers director Daniel Butler.

According to Butler, under the current law, unit trusts wholly owned by SMSFs pay zero tax as the unit trust distributes its net income to the SMSF as the unitholder, which pays a minimum of 15 per cent tax on the distributions.

"An SMSF would only pay 10 per cent tax on a distribution of a net capital gain from a unit trust after allowing for the one-third CGT discount where the asset was held for greater than 12 months," he told SMSF Adviser.

"An SMSF in pension phase does not pay any tax from such trust distributions subject to each member's transfer balance cap limit."

Depending on how Labor interpreted the tax law, SMSFs could be taxed at a minimum 30 per cent on trust distributions received from discretionary or non-fixed unit trusts. This would have a "significant impact" on the net after-tax returns of the trusts after June 2019, should the policy become law.

"Labor's policy is still very uncertain on how it will apply if this proposal is successful in its introduction. For example, will the general CGT discount apply, will any tax offset apply like a franking offset in respect of a dividend from a company, and what types of trusts will be considered fixed and non-fixed?" Butler said.

"Labor's policy has created considerable uncertainty for investors seeking to undertake investments or enter into new business structures given the broad-brush policy announcement."

However, this interpretation has been challenged, with other experts suggesting that SMSFs would be treated as fixed trusts not subject to the change.

Under the current policy, should an SMSF receive a distribution from a non-fixed trust, "it would invariably be taxed as non-arm's-length income [NALI] at the top marginal rate, which is significantly higher than the minimum 30 per cent rate proposed by Labor," DMAW Lawyers' Matthew Andruchowycz told The Australian Financial Review.

Taxing trusts "would not raise significant revenue unless Labor also abolished the refundability of dividend imputation credits. That would be a profound change that would substantially limit the ability to income split within families," Gadens partner Peter Poulos told the financial daily.

"Difficult nut"

Tax Commissioner Chris Jordan has described the plan to tax discretionary trusts as "a real difficult nut".

"We are really the only country that operates businesses actively through trusts," he was quoted saying by The Sydney Morning Herald.

"There's a whole lot of reasons, to pass through capital gains discounts and to be able to have a discretion as to income and to protect assets. It's a hard one. It is a real difficult nut that one. I think there have been a few goes at it over the decades."

Alternative measures could include reducing the number of beneficiaries able to be nominated by each trust, banning "bucket" companies, or forcing trusts to distribute non-business income.

In the meantime, though, SMSFs and small businesses can only await the details of any policy change, with the tax debate set to continue up until the next election.

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

This report appeared on www.morningstar.com.au 2017 Morningstar Australasia Pty Limited

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.