While the Federal Budget didn’t bring much in the way of significant tax announcements, the three year ‘Budget Repair Levy’ on individuals earning more than $180,000 a year from 1 July 2014 places some importance on year-end tax planning opportunities.
Usually in end of year tax planning, individuals are looking to bring forward tax deductions and delay the derivation of income where possible. However, for individuals on the top marginal tax rate, any benefit of delaying the derivation of income to future years may be unwound when taking into account the Budget Repair Levy, the increase in Medicare from 1.5% to 2% and the time value of money. This can be illustrated by the following example:
Jim, an individual on the top marginal tax rate, has the option through tax planning of paying tax this year or next year on $100 of income. If paying tax this year at the existing marginal tax rate, including base Medicare (46.5%), Jim will have $52.50 remaining after tax has been paid. If delaying the derivation of income until next year, although he has delayed paying tax for an additional year and can earn an interest or other return on the full $100, for 12 months, Jim will also need to factor in the higher tax rate on any interest earned during this period. Based on an interest rate of 3%, Jim will be worse off delaying the derivation of income until the following year, with an after tax return of approximately $52.50 if taxation is delayed compared with $54.30 if the income is derived in 2013/2014 and only the after tax amount invested for 12 months.
Plans to accumulate profits in a corporate structure over the coming three years to reduce the impact of the levy should also be met with caution. Due to the reduction in the company tax rate from 1 July 2014 from 30% to 28.5% the benefit of franking credits attached to the additional company tax payable now will most likely be lost when dividends paid in future years may only be franked at 28.5%.
Although intended to prevent high income earners salary packaging benefits to avoid the Budget Repair Levy, the increased FBT rate (to align with the tax rate for the period that the Budget Repair Levy applies), will not commence until 1 April 2015. Pending any adjustments to the announced measure prior to its introduction, this potentially provides an opportunity for high income earners to salary package benefits that will have the effect of bringing them below the $180,000 threshold in the current year. The same opportunities potentially exist when the FBT rate is reduced with effect from 31 March 2017.
Considerations for end of year tax planning for discretionary trusts
As always, as 30 June approaches, it is important for trustees and their advisers to be aware of the key points of the Australian Taxation Office’s (ATO) approach to trustee distribution resolutions including:
- trustee resolutions to distribute the income of the trust must be made by 30 June
- the ATO will not accept resolutions which purport to:
- adjust the entitlements of beneficiaries in the event of a future ATO amendment to the trust's taxable income
- distribute ‘notional’ income (e.g. due to franking credits and non-deductible expenses), or
- stream other types of income (other than capital gains and franked dividends) to different beneficiaries.
Tax advisers and taxpayers need to be aware it is now critical that trustee resolutions are made by 30 June each year. This is a significant change from the historical practice of determining the exact beneficiary entitlements after 30 June, for example, once the trust’s taxable income is known and the tax returns are being prepared. The ATO will accept informal written records of a trustee resolution made by 30 June.
Generally, if the trust deed allows, an oral resolution will be effective to distribute the income of the trust by 30 June, and the resolution can be later recorded in writing. However, the ATO would be likely to challenge the existence of an oral resolution which is not documented by 30 June, on the basis of a lack of evidence. This is particularly so if the details of the resolution were unlikely to have been known as at 30 June (e.g. exact dollar amounts of income of the trust). The ATO Trusts Taskforce will continue in the 2014/15 financial year to target taxpayers who ‘exploit trusts to conceal information, mischaracterise transactions and artificially deal with trust income to avoid or reduce tax’.
Tips for trustees
- make a resolution in writing, and where possible, have every trustee, or every director of the corporate trustee, sign the resolution by 30 June
- be wary of dealing with franking credit gross-up amounts and non-deductible expenses, including under a ‘section 95’ income equalisation clause – see Draft Taxation Ruling TR 2012/D1
- use percentages and ‘balance’ distributions to ensure all of the income and capital gains of the trust are effectively distributed by 30 June
- do not make resolutions which attempt to re-allocate beneficiary entitlements ‘in the event of a future amended assessment by the Commissioner of Taxation...’
- if the trust has a discount capital gain, make sure the total gross amount (i.e. the discount and non-discount parts) of the gain is distributed to the beneficiaries who are intended to be assessed on the capital gain, and
- when distributing to a private company beneficiary, ensure that the distribution is actually paid, or put in place a compliant ‘Investment Deed’ arrangement under PS LA 2010/4.
With the 2% Temporary Budget Repair Levy to be introduced from 1 July 2014, correct and valid trust distributions will become even more important, going forward. Trustees also need to be aware of the continuing ATO focus on unpaid present entitlements, when planning the use of private companies as trust beneficiaries. As noted above, the effect that the 1.5% company tax rate reduction (from 1 July 2015) will have on franked dividends paid after that date should also be taken into consideration.