Time to review family company and trust structures

The 2018/19 Federal Budget contains a number of announcements aimed at further curtailing the use of family companies and trusts. Frequently, family companies and trusts are set up for reasons such as protecting family assets, managing business succession, passing family wealth between generations and so forth. However, these structures also can have income tax implications and this is the subject of the Budget announcements.

Unintended Consequences

To date, these measures – that are presented in the Budget as anti-tax avoidance measures – have not attracted much commentary in the media. But, like most such tax integrity provisions, they will probably have some unintended consequences when introduced. At the least, those families that have family company and trust structures should have them reviewed by a tax professional to determine whether they will be affected and, if so, to decide on any steps to be taken.

Given both the Tax Office’s past announcements and now also the Budget announcements, existing company and trust structures – that were set up when the tax law and its administration were differed in important respects – are not so efficient as a means of accumulating wealth. Particularly where trust structures are being used to accumulate significant wealth, now is the time to review their effectiveness. It may be that a move to another structure could prove to be more effective.

Background to the more relevant Budget announcements and the announcements themselves can be summarised quite briefly:

 

Unpaid Trust Distributions : Tax Office Announcement, 2009 / Budget Announcement, 2018

In late 2009 the Tax Office announced that a family trust distribution to a private company that remained unpaid but owing to the company would be treated as a loan from the company to the trust. Under a tax law provision known as Division 7A, if the loan was not fully repaid by the trust to the company, the trust would be treated as having received the amount as a dividend from the company. To prevent this outcome, the trust would have to repay the amount to the company and could do so under a loan agreement usually over seven years.

The Budget announcement states that unpaid present entitlements will come within the scope of Division 7A from 1 July 2019, thus apparently giving the force of statute law to the Tax Office’s 2009 announcement.

‘Circular’ Trust Distributions : Tax Office Announcement, 2014 / Budget Announcement, 2018

In some structures the trust would own all of the shares in the company. In this case, the company could pay a dividend to the trust that would enable the trust to repay the loan to the company, and the process could then be repeated each year. In mid-2014 the Tax Office announced that this ‘circular’ arrangement would be subject to an existing anti-tax avoidance provision with the effect that the trust would be taxed – at the maximum marginal personal tax rate – on the amount distributed to the company.

Another Budget announcement states that, from 1 July 2019, the anti-avoidance rule that applies to some trusts engaging in ‘circular’ trust distributions will be extended to family trusts with the effect that such a trust would be taxed on the amount at the maximum marginal personal tax rate. This would also apparently give the force of law to the Tax Office’s approach to trusts that make ‘circular’ distributions of their income.

Everett Assignments : High Court Decision, 1980 / Budget Announcement, 2018

Since the Full High Court decision in Everett’s Case (in 1980) it has been accepted that, for asset protection purposes, a partner in a business – usually professional – partnership can transfer or ‘assign’ part of his/her partnership interest to a family trust. Until early this year, the Tax Office also approved of Everett assignments in a couple of public rulings.

Effects of such an Everett assignment are that the family trust then owns a share of the partnership and derives a share of the partnership’s income. The transfer of a partnership interest would be subject to the capital gains tax provisions, but partners, even in large professional firms, are usually entitled to reduce the taxable amount of the gain under the small business capital gains tax concessions. With the removal of State stamp duty on transfer of business assets, Everett assignments have, in recent years, become more popular.

From Budget night, 8 May 2018, the Government has announced, partners entering into Everett assignments will not be entitled to apply the small business capital gains tax concessions to reduce the taxable amount of their gains.