The Taxation of Family Trusts

Article excerpt

The impression is often given that trusts exist merely to evade taxes.They have far more important reasons to exist than that.And their tax advantages are very limited or even non-existent.

THE social welfare lobby and the Commissioner of Taxation are both calling for changes to the income tax treatment of family trusts and their beneficiaries. Trusts are being portrayed as the rich person's tax dodge. Is this correct?

Inter vivos (that is, living) and testamentary trusts have been around in England for hundreds of years and in Australia since colonization. They pre-date income tax and were not, as is sometimes suggested, invented in order to minimize tax.

Family trusts in particular have many non-tax uses-for example, the passing of assets from generation to generation, the making of provision for young children, the pooling of family wealth to enable larger and more efficient investments to be made and the ability to make gifts with strings attached. Such trusts are often used to run small family businesses-this helps to protect personal assets against business creditors and business assets against personal creditors.

Unlike many artificial tax minimization schemes in current use, the employment of a trust structure does not ever reduce the total amount of income which is subject to tax. The most that it can ever do is lower the rate of tax which applies to that income and even that does not always occur.

Furthermore, in most cases a trust structure reflects the real-life position -- namely, that the total income flowing into a family is actually intended to be for the benefit of the whole family and not just for the benefit of a single socalled breadwinner. Thus, spreading family income around for income tax purposes is no more immoral than spreading it around for spending purposes. In the current era, looking after one's family is usually considered a good thing in Australia.

In practice, most family trusts do socially useful things. They invest only in genuine, conventional investments of exactly the same type as those normally selected by highly conservative personal investors for their own portfolios. Some stimulate the economy by financing small businesses. Such trusts should certainly not be discriminated against.

It is, of course, true that-because of the sliding scale of income tax in current use-splitting income among a number of different beneficiaries with low marginal tax rates can produce a smaller total tax bill than if all the income were left to be taxed at a higher rate. The same phenomenon, however, can apply to income channelled through partnerships or companies.

This approach is indeed unfair to ordinary wage earners who lack the ability to split PAYE income in a similar fashion. The remedy for this, however, would be to allow notional splitting of such incomes-not to do away with trusts.

One proposal mooted from time to time is to tax trusts as though they were companies. This would undoubtedly bring in more revenue, at the expense of trust beneficiaries.

The reasoning seems to be that some items which can be distributed tax-free through trusts would attract tax if channelled through companies as unfranked dividends-for example, capital gains within the indexation componet, building allowances or amounts arising from the revaluation of assets. This is indeed an anomaly in the legislation -- but the proper way to correct it is to change the way companies are taxed so that transactions which Parliament intends to be tax-free stay that way. …