It’s official – the ATO is coming after trusts and it could send some businesses to the wall
The ATO's final ruling, released yesterday, concerns the contentious issue of unpaid present entitlements flowing between discretionary trusts and their corporate beneficiaries.
Under a tax planning arrangement used by thousands of entrepreneurs, a trust distributes income to a corporate beneficiary, which then pays tax on that distribution at the corporate tax rate of 30%. But no cash actually moves between the trust and the corporate beneficiary – instead, the funds remain in the trust, where they can be used by the business owner as working capital to fund further growth. This is known as an unpaid present entitlement.
But the ATO wants to crack down on instances where the funds retained in the trust are used to purchase personal assets, such as cars or property.
It will do this by treating unpaid present entitlements as a deemed dividend paid by the corporate beneficiary, taxed at the highest marginal tax rate.
Yasser El-Ansary, tax counsel at the Institute of Chartered Accountants, says the structure has been popular among SMEs as it provides them with a source of working capital at times when such finance may be difficult to obtain from lenders.
While some taxpayers may have been flouting the rules, he says most taxpayers using trusts have done the right thing.
"It certainly using the sledgehammer to crack the nut – the vast majority of people have used the funds in the trust to grow their business and eventually pay more tax."
Robert Jeremenko, senior tax counsel at the Taxation Institute of Australia, describes the final ruling as "flawed" and argues the ruling could end up costing SMEs and family trust owners "hundreds of millions of dollars".
"Many family trusts and SMEs which run their business using a trust structure will either have to restructure their affairs or they will be taxable on deemed dividends," he says.
"Restructuring itself may have adverse affects as businesses or individuals may not have access to the cash required to restructure their affairs."
"Some small businesses may go to the wall as a result – especially as some aspects of the ruling are retrospective."
He gives the example of a small family business operating a trust and finds itself with a large tax liability under the new rules.
"First of all they need to work out how they pay that liability, which is not going to be easy at a time when cashflow is tight."
After that, he says, the company will need to pay for advice on how to restructure its affairs and then actually execute that restructure – a costly process for a small business.
For those entrepreneurs using these structures, El-Ansary says it is crucial to get in touch with your tax advisor.
"The priority for anyone who is involved in family trusts is to connect with your tax adviser as soon as possible. You need to have a discussions about how this ruling may change the way you structure your business.
And while every individual's circumstances will be different, there may be some solutions to the problem.
"For some taxpayers, the impact of this ruling may simply be to put in place commercial agreements in order to reclassify the unpaid present entitlement as an arms-length loan agreement," El-Anary says, although tax agents say this can be a complex and paperwork-heavy process.
What has particularly angered tax experts like Jeremenko and El-Ansary is that those entrepreneurs using these trust structures were doing so under a previous ruling from the ATO approving their use.
El-Ansary says the Government must now legislate on the issue of unpaid present entitlements to clear up any confusion and should also launch a wider review of the increasingly complex trusts regime.
"What really needs to happen in this area, given the complexities that keep arising every year, is a holistic review of the way trusts are taxed."
"It's become so complex for the average business to manage that the likelihood is compliance may suffer in the future."
Jeremenko says his organisation will continue to lobby Government about the implications of the change, particularly on small business.