The 2019 Federal Election will take place on May 18. Labor has announced that, if elected, they will make significant changes to the tax rate on distributions of income made by trustees of discretionary trusts.
As it stands, a discretionary trust doesn’t pay tax on income distributed to beneficiaries. Instead, the beneficiaries of the discretionary trust pay tax at their (applicable) marginal income tax rate. This means that discretionary trust structures can be used both as a trading vehicle and investment vehicle to provide a number of benefits, including:
- flexibility as to which beneficiaries receive a distribution of income
- asset protection by ensuring at-risk assets are separated from lower risk assets
How will Labor’s tax crackdown change how discretionary trusts are taxed?
Under Labor’s proposed measure, from 1 July 2019, all discretionary trusts will be subject to a minimum income tax rate of 30% for discretionary trust distributions to beneficiaries over the age of 18, despite the income tax bracket of the beneficiary.
Labor argues that the proposed changes will create a fairer tax system and is targeting high-income earners who use the loophole to reduce their tax bills by distributing income to relatives in lower tax brackets.
The policy, which Labor alleges will only affect 2% of taxpayers and is estimated to raise $17.2 billion over 10 years, is part of the party’s ambitious plan to raise revenue and curb Australia's growing debt, which is in the trillions under the Coalition government.
The Coalition argues that the policy is a “tax grab” that will hit hard the other 200,000 small businesses across the country legitimately using these trust structures for asset protection and income security, with more than two-thirds of affected trusts belonging to families who run small businesses.
How will Labor’s trust policy impact your income tax liability?
Labor’s proposed policy for discretionary trusts could increase the overall income tax liability of your family. There are exemptions for some groups, including farms, charities and deceased estates. The policy will not apply to distributions made by trustees of:
- special disability trusts
- testamentary trusts (deceased estates)
- fixed trusts
- cash management unit trusts
- fixed unit trusts
- public unit trusts (listed and unlisted)
So, how will these changes affect your income tax liability? Consider the following example. The trustee of this Australian trading trust intends to make an equal distribution of income to two adult beneficiaries of $75,000 each. The income tax payable would be as follows (disregarding any income tax rate changes):
* the difference in the effective income tax rate is higher as the distribution amount reduces
What can you do to protect your discretionary trust?
Despite Labor’s proposed policy, discretionary trusts remain a useful asset protection structure. Individuals, family groups and businesses can legitimately use these structures to purchase and hold assets.
Because the beneficiary does not own any assets in the trust, the assets remain protected despite any claims against the beneficiary. This means that small businesses or individuals that house property, shares or investments in a discretionary trust can protect that property, even if their businesses are wound up or the individual claims bankruptcy.
However, the proposed changes could increase the amount of tax your family or small business will pay. As this is just one change of many, it’s important to always stay on top of tax legislation in order to determine the best structure for you and your business.
“Discretionary trusts are still a useful vehicle for asset protection and succession planning. However, existing structures should be reviewed in light of Labor’s intended policy.” – Team BlueRock.
If you need more information on how the policy will impact your discretionary trust or would like to discuss options for restructuring your business, we can help.
Get in touch to speak to your BlueRock advisor today.