In an audacious move to target income splitting, if elected, the Australian Labor Party (ALP) has announced that it will introduce a minimum standard 30 per cent tax rate on all discretionary trust distributions made to beneficiaries over the age of 18 from 1 July 2019. Touted to tackle income inequality and enforce “fair taxation”, the proposed changes have been described as meddling with “off-limits tax territory”.
How will a discretionary trust distribution tax work?
The policy proposal of the ALP is scant in detail and leaves a number of questions unanswered. What we do know is that the new tax builds on the existing regime which taxes minor beneficiaries on certain income at the highest marginal tax rate. If the new tax is to follow that model, this would mean that the beneficiary will be assessed at a minimum of 30 per cent, with no tax credits provided.
This approach is confirmed in the policy document. To the extent that the income is distributed to a tax payer with a higher marginal tax rate (>30 per cent), the income would be taxed at that higher rate.
There are, of course, carve outs. The proposed changes will only apply to discretionary trusts. This means other non-discretionary trusts will not be impacted by the change. Further, farm trusts (undefined) and charitable institutions will not be subject to the proposed changes. Similarly, exemptions will be provided for distributions to certain mature beneficiaries, including people with disabilities.
At this stage, it is difficult to assess how effective the new policy will be. It is estimated that the policy will only impact 2 per cent of taxpayers and 318,000 discretionary trusts. Yet, the independent Parliamentary Budget Office estimates the policy will raise $4.1 billion over the forward estimates period to 2021-22. Quantitative analysis aside, a number of unanswered policy questions remain, including:
- how will non-cash distributions made from a discretionary trust be treated? Non-cash distributions can occur through the transfer of property, shares, or units. Presumably, the trustee will need to fund the 30 per cent tax on the distributions from other sources.
- how will the policy apply to distributions made to non-resident beneficiaries? Non-resident beneficiaries already face a higher marginal tax rate, and are initially taxed at the trustee level. It is not clear whether a credit for the 30 per cent tax will be available to non-residents as is generally the case at the moment.
- what if adults receive the discretionary trust distributions indirectly via a company? Will a mechanism be introduced to ensure that the franking credits generated at the company level are not refundable in these circumstances?
The ALP has proposed to provide $55 million per year to the ATO to ensure that the intent of the policy is achieved, and also to bolster the ATO’s current trust anti-avoidance activities. The ATO may need to allocate a significant proportion of these funds to managing the administrative complexity that will come with the introduction of this new tax.
It is clear that policy makers are starting to turn their attention to tax minimisation created through trust structures. With high-net wealth individuals being a reoccurring feature in the “fair taxation” debate, we can expect more initiatives that will “make the tax system fairer and improve the budget bottom line”.