When I first arrived in Australia I could not believe such an entity could exist with the flexibility to reduce taxes. I was fascinated and realised the potential for reduced taxes as great asset protection. You could not really go wrong.
The ATO does not like the way trusts can be used to reduce taxes. And I have to say half the reason the ATO is getting mad is because accountants have not just crossed the line but basically ran over the field, stole the lemonade and returned looking smug and innocent at the same time. it’s wonder the ATO is getting pissed off.
So, over the years they have made life harder for accountants and business owners. First, they was a major discussion about what is trust income and what is taxable income. Then came requirement that trust resolution had to be done before they year end when very few would have any idea about what the actual profits are.
There is now talk about how loans are treated (known as Div 7A loans) but the one that is scaring accountants out of their wits is one of their own making.
For years accountants have been allocating income to children or other family members (which lowers taxes) but did not give too hoots if the money was ever given to them by the trust. In most cases, money was still taken out the business owner.
So lets take an example. Dr A is a GP and runs a medical practice. As a GP he has a personal income of $450,000 and the practice makes a further $200,000 profit from service fees.
The practice is operated through a trust so the accountants have advised Dr A that in order to reduce taxes he should distribute the $200,000 to his 4 children all of whom at are various stages of education at the University.
So far, all is good and legitimate. The problem?
Well, the $50,000 due to each child is not paid to the child. It is taken out by Dr A for him to spend on his luxury trip to the Serengeti in Africa and a new Mercedes Benz.
In other words, Dr A gets money on which he has not paid any tax. And for the ATO that’s a bit of a problem.
We accountants have hit back by saying that Dr A assists his children financially while they are studying but unless the ATO can specifically see the money flow of assistance they will assume no assistance has been given. This would be true if Dr A tells the ATO he is assisting in tuition fees only to find out that the Children have taken out HECs debt to cover fees.
In simple terms the ATO is trying to stop trust distribution arrangements where one member of the family is made entitled to a trust distribution, but the actual economic benefit (payment of cash) goes to another family member because they feel the only reason this would happen is to reduce taxes (and they would be right)!
It gets worse for the accountants because the ATO goes so far as to call this type of arrangement a “sham” and “ineffective for trust law purposes”. The ATO rarely uses this type of language and now accountants find themselves in a position where they have advised this behaviour for decades only to be told by the ATO that it may be illegal. And that is the reason a lot of accountants including the accounting bodies have taken this so personally.
How do you tell a client that what you have advised for years is going to mean more taxes, and by the way, may be illegal. Not a nice conversation.
At the WOW! Advisors Group we have always told clients that if anyone is due a distribution it must be paid to them as I could see this was going to become a major issue. And as a result, we believe our clients are in a good position and this will not affect us.
However, we are aware that there are many businesses that have done this and they may get caught up in the storm. If you happen to be one of them, talk to your accountant first and see what they say. If you don’t like the answer, get a second opinion. In the meantime I would not distribute any income to family members unless you are going to give them the money.