Chapter 3
Family trusts
3.1
Schedule 2 of the bill amends Schedule 2F of the Income
Tax Assessment Act 1936 (ITAA) to narrow the definition of 'family'
and limit variations in the 'test individual' in the election rules for family
trusts.[1]
3.2
The Government's intent is to reduce the scope for family trusts
to use tax losses to lower income tax. Minister Bowen described the measures in
terms of improving the integrity of the tax system and achieving cost savings
to 'help fund more urgent priorities'.[2]
3.3
The bill essentially reverses some (but not all) changes to
family trust arrangements introduced last year in the Tax Laws Amendment
(2007 Measures No. 4) Act 2007. Treasury explained the changes in the bill
as follows:
The trust loss rules in schedule 2F of the Income Tax
Assessment Act 1936 are primarily there to prevent the tax benefits arising
from the recruitment of trust losses being passed to beneficiaries that did not
bear the economic loss or the bad debt when it was incurred. It does this
basically by tracing through the underlying ownership. Many family trusts are
discretionary trusts, which means that the beneficiaries may not have a fixed
interest, so it will be difficult to trace through their economic ownership in
the trust. Therefore, in many cases, they would not be able to meet the
standard rules for determining whether they can carry forward and utilise a
loss to reduce income tax in later years.
As part of that background, in recognition of that, the rules
within schedule 2F provide a special concession to family trusts. That is, if
you make an election and specify a test individual, you may carry forward your
losses and utilise them without meeting the other rules. Provided that you only
distribute to family members or members within the family group, you are not
subject to family trust distribution tax, which is charged at the top marginal
tax rate, plus the Medicare levy, of 46.5 per cent. So, in essence, this is a
concession within the tax law to family trusts. The previous government made
amendments in 2007 that varied the operation of those rules and made them more
concessional...This government has reversed two of those measures, one applying,
in effect, with a transitional rule.
You have asked when it might affect people. The answer is that
the rules currently provide for variations, and they can only be made in two
circumstances. One is where there is a family breakdown and the control of the
trust changes to the spouse; in that case, they can make a variation. The other
rule was, if you met certain conditions, you could change the test individual
once, and only once, going forward. Those conditions were about who you had
distributed to previously. So to meet the conditions you had to only distribute
or confer present entitlement to people who would have been in the family
group, had that person always been the test individual.[3]
Changes to the definition of 'family'
3.4
The bill amends the definition of 'family' in the family trust
election rules to limit lineal descendants to children or grandchildren of the
test individual or the spouse of the test individual (excluding lineal
descendants of nephews, nieces or great-grandchildren of the test individual).
3.5
This change was criticised by the Institute of Chartered
Accountants in Australia. They argued:
The definition of
"family" only extends down two generations. We don’t perceive any
policy rationale for placing a generational limit on the definition of family
especially given that the typical life of a trust is 80 years, which means they
commonly extend into a fourth generation. This means that many family trusts
will eventually have to distribute outside the family group and such
distributions will be subject to FTDT.[4]
3.6
CPA Australia argued that the measures proposed in Schedule 2 of
the 2008 bill effectively amounts to a de facto inheritance tax; and is 'wholly
inconsistent' with trust law and commercial practice.[5]
3.7
On the broader issue of the definition of a family, CPA Australia
gave the example of a family living with (elderly) grandparents, parents and children.
If one of the parents is nominated as the test individual, the lifespan of the
trust is limited to the lifespan of the grandchildren (if Family Trust
Distribution Tax is to be avoided). If one of the children is nominated, the
lifespan of the trust may be longer but the descendants of their siblings will
be disadvantaged since only one generation beyond the sibling can benefit from
the trust without incurring the tax.
3.8
CPA Australia thereby argued:
It is difficult to see a policy
justification for placing a generational limit on trusts that have made a FTE.
Most trusts typically have a life span of 80 years, which will commonly span
four generations. In our view there is no compelling reason why two generations
should be sliced off the normal lifespan of a trust.[6]
Limitations to variations in 'test individual'
3.9
The bill prevents family trusts from making a once-off variation
to the test individual specified in a family trust election (other than for the
2007–08 income year or in the case of marriage breakdown).
3.10
The Institute of Chartered Accountants in Australia argued there
were cases where it was justified to change the test individual. They cited the
Explanatory Memorandum from the 2007 Act which refers to :
the situation where a trust has chosen the wrong test individual
in its family trust election but the trust had acted in the past as if the
proposed new test individual was always the test individual.[7]
3.11
CPA Australia argues the bill would add significant complexity to
tax law, such as in cases where an inappropriate person is selected as the test
individual by family businesses especially from an estate planning and
succession perspective.[8]
The extent of budget savings
3.12
The Government estimates that the measure will save
$1 million in 2008–09 and $6 million each in the following three years.[9]
As the provisions refer to events occurring in future generations, there may be
more substantial savings in distant years.
3.13
This estimate is consistent with the revenue costs estimated last
year for the 2007 Act, which this bill largely revokes.[10]
The estimated costs for the 2007 bill were $8 million a year but not all its
provisions are being revoked.
3.14
Mr Mark Leibler of Arnold Bloch Leibler questioned the basis
for this estimate:
it is inconceivable to me that the
estimate of $8M per annum could have related to the inclusion of the lineal
descendents of family members. The inclusion of lineal descendents is only
likely to have revenue cost implications - if at all – well into the future.[11]
3.15
Mr Leibler told the committee that he had 'seen some work' from
Pitcher Partners showing that family trust distribution tax on average to the
year 2005-06 was just under $1.5 million. The committee took evidence from the
Director of Pitcher Partners who made no mention of this revenue estimate.
3.16
Mr Leibler argued that the government's costing assumes the
reversal of family trust status for people who were included in a family trust
group under last year's amendments. However, he believed the removal of the 'lineal
descendants of family members' provision would not involve 'a reversal of
family trust status'. Accordingly, Mr Leibler reasoned that there will be a
significantly smaller revenue gain than the Treasury estimates. He claims:
The idea that even $1 million per annum would be saved in
relation to the lineal descendants issue is a complete and total nonsense.[12]
There's no revenue in it. All it will do is create complications
and anomalies.[13]
3.17
In a similar vein, the Institute of Chartered Accountants opined:
We doubt very much if it will save the government any money and,
if it does, it will be very little.[14]
3.18
The Taxation Institute of Australia also argued the lineal
descendants measures in the bill will not result in any significant savings:
in respect of the lineal descendants, I do not see these
measures raising anywhere near the amount of revenue that perhaps our friends
from Treasury [expect] ... it will be many, many, years before trusts will hit a
position where the only surviving beneficiaries that are able to receive
distributions might be great grandchildren. At that point in time, the trust
will restructure and perhaps vest rather than incur a penalty tax.[15]
3.19
However they suggested a capital gains tax event could be
triggered sooner as a result of the measures in the bill.[16]
Similarly, Family Business Australia suggested the measures could convert some
assets currently exempt from capital gains tax due to being purchased before
the tax was introduced into assets that now would be subject to the tax, but
they also did not quantify the impact.[17]
Mr Leibler also referred to capital gains tax implications in the longer
term:
it is likely going forward that capital gains are going to be
brought forward because people are going to want to vest their trusts because,
as you run into grandchildren or great-grandchildren who are no longer
beneficiaries rather than paying penalty tax on distributions you may want to
vest the trust in relation to beneficiaries who are still alive and who comply.[18]
3.20
Treasury's Colin Brown agreed the changes to rules on lineal
descendants did not have large revenue implications in the short-term and there
was a degree of uncertainty around them:
The bulk of the cost saving in this measure comes from the
reversal of the measure to be able to change the test individual over the
forward estimates period. The component that is related to changing the lineal
descendants has a different cost over a different time frame. It has a longer
term cost, which is larger.[19]
My recollection of the costing of this is that the lineal descendants,
over the forward estimates period, is a very small part, probably around $1
million [each year] ... but that that number outside of the forward estimates
period would grow...the costings are very indicative. There is not a lot of data
on which to base an assessment.[20]
Committee view
3.21
The committee does not believe that, because the revenue savings
from the lineal descendents amendment is allegedly only a quarter that of
Treasury's estimate, the amendment should be cut from the bill. The proposed
amendment will achieve the government's stated objective of cost savings
(however large) and fulfil its pre‑election commitment to tighten family
trust arrangements. Beyond the forward estimates period, the lineal descendents
amendment could potentially realise quite significant cost savings. It is,
moreover, in keeping with the broader objective of Schedule 2 of the bill which
is to preserve the integrity of the tax system.
Compliance costs
3.22
The Government stated 'these amendments are expected to have a
small impact on compliance costs'. [21]
3.23
This was contested by some submitters and witnesses. The Taxation
Institute of Australia argues that the 2007 amendments were 'specifically
targeted to overcome a number of acknowledged problems with the operation of
the family trust election rules and reduce the onerous associated compliance
costs'.[22]
This would seem to imply that the 2008 bill would render compliance costs once
again onerous.
3.24
CPA Australia also argue the bill runs counter to the objective
of reducing the compliance burden on taxpayers.[23]
3.25
Senator Joyce suggested it will only be accountants that benefit
as a large number of trusts need to rearrange their affairs. [24]
Senator Annette Hurley
Chair
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