Family trusts could be eligible for ‘mind-boggling’ tax cut
The Australian Tax Office has tweaked its view about whether companies linked to family trusts are eligible for tax relief, but industry veterans say the situation remains “utterly confused” and “mind-boggling”.
A new statement on the ATO website says companies will be eligible for the lower 27.5 per cent rate afforded under the Enterprise Tax Plan even if their activities are “relatively passive”.
The word “relatively” has been added since similar advice was provided in a footnote to a draft ruling earlier this year.
The footnote caused a stir among tax practitioners because it seemed to expand the range of businesses eligible for cuts to include companies holding passive investments, such as so-called bucket companies that receive income from discretionary trusts.
Revenue Minister Kelly O’Dwyer has been eager to quash the idea that wealthy families might be beneficiaries of the government’s small business tax cuts, which were “not meant to apply to passive investment companies”.
Tax Institute senior tax counsel Bob Deutsch said the ATO’s latest statement did nothing to clear up confusion about eligibility.
“The position with all this is, in my view, utterly confused and will lead to countless errors being made by tax practitioners,” he said.
“The bar appears to have been set relatively low in satisfying the requirement for carrying on a business in this context. Concrete examples would be required to give the community a better understanding of what is meant by ‘relatively passive’.”
Arnold Bloch Leibler tax practice chief Mark Leibler said it was obvious the tax cuts were only ever meant to apply to active trading businesses.
“I have never seen a standoff like this before between the Tax Office and Treasury and the responsible ministers,” he said.
“I find this mind-boggling. What the government contemplated was people who are actually engaged in real, active business activities…not bucket companies sitting around and deriving passive income.”
At present, companies with turnover of up to $25 million are eligible for the 27.5 per cent rate. The Coalition plan is for companies of all sizes to progressively qualify for the lower rate, which will then be dropped to 25 per cent.
Australian Council of Social Services senior adviser Peter Davidson said most people had the impression the tax cuts were going to businesses whose owners struggle on low incomes.
“The reality is that most of those businesses don’t use companies or trusts,” he said.
“Those that do are more likely to be professional such as doctors and lawyers than shopkeepers or personal trainers. And now the tax office has raised the prospect that wealthy people using bucket companies to warehouse their investment income could also benefit.”
The ATO footnote said: “Generally where a company is established or maintained to make profit or gain for the shareholders it is likely to be carrying on business…this is so even if the company holds passive investments and its activities consist of receiving rents or returns on its investments and distributing them to shareholders.”
Mr Davidson said the government would probably need to amend its legislation to prevent passive investors from taking advantage of the lower rate.
But the policy presented even bigger opportunities for tax planning by the wealthy and the only way to close the loopholes was to tax trusts at top marginal rates, he added.
“A common tax avoidance structure combines a trust with a private company beneficiary,” he said.
“In 2015, small private companies received $17 billion in distributions from trusts.”
The tax cuts also have consequences for franking credits.
Once a company moves on to the 27.5 per cent rate, dividends will be franked at the lower rate even if tax was paid at 30 per cent.
According to tax advisers BDO, this means dividends paid to shareholders on the top marginal rate will end up being taxed at 51 per cent, with the government to pocket the other 2 per cent.
Mr Leibler said the government had overlooked another element that would ultimately prove detrimental to shareholders.
“Unfortunately, what the government has done through its legislation is to provide that while a company is categorised as carrying on a small business and is being taxed at 27.5 per cent, that company can only frank to 27.5 per cent,” he said.
“And that applies not only to reserves previously taxed in the hands of the company at 27.5 per cent but also distributions of all or any of the company’s reserves that have previously been taxed at 30 per cent.”