Opposition Leader Bill Shorten claims that family trusts are used to avoid paying a ‘fair share of tax’. Photo: Justin McManusThe parliamentary landscape got even murkier last week with opposition Bill Shorten’s rant against “inequality” and his promise to make the rich pay “their fair share of tax”. This was coupled with an attack on family trusts, which he claims are a tax-saving device used by the rich to evade billions of dollars in income tax.
I almost choked on my breakfast last Monday morning when I heard him tell interviewer Fran Kelly on Radio National that barristers were among the chief offenders among those using trusts to rort the system. Unfortunately, Kelly does not have the tax skills to ask the tough questions, but I immediately rang a senior counsel who specialises in tax matters. His retort was “absolute rubbish – we can’t even incorporate. Barristers are required to act as sole traders”.
I followed this up with a call to the tax partner in the firm who does my own tax. He confirmed he acted for several barristers, none of whom are allowed to split income using trusts. He did mention that many have their chambers in family names and pay rent, but that is a well-known legal strategy used by many high-earning professionals who have no other way of income-splitting. It is also quite common for high-income professionals to hold the family home in the name of the trust for asset protection – the price of doing this is loss of the capital gains tax exemption.
But let’s get back to family trusts. Many of our country’s wealth producers own small businesses, and it’s a sad reality that many go broke in the first five years of operation. Therefore, asset protection is a major priority for them. If you are a sole trader, or operate as a partnership, all your assets are up for grabs if a financial calamity happens.
Consequently, the preferred structure for being in business is a trust or a company. Both have unique features. A trust does not pay tax itself: it distributes profits to the beneficiaries of the trust who then pay tax at their marginal rate. In certain circumstances trusts can save tax, but for the majority of business people the opportunities are limited. Typically the beneficiaries are mum and dad and the children, but there is little tax to be saved by distributing to children under 18 years of age because such distributions are taxed at the top marginal rate once they exceed $416 a person a year.
There is a window once the children reach 18 and are earning a low income, but even then HECS is a limiting factor, because any substantial distribution to a university student winds up reducing their HECS bill. CASE STUDY
A couple run their business through a family trust. The beneficiaries of the trust are the couple and their two children aged 20 and 22 who are at university. Both children have HECS debts of $50,000. The net profit of the business for the year is $300,000 and on their accountant’s advice this is distributed as $54,000 to each child and $96,000 to each partner. If the child’s distributions exceeded $54,869 their tax assessments would be increased by $2000 each, being 4 per cent of their HECS bill.
A company structure can operate in a similar manner to a trust. Instead of making a distribution to a family member, the company can pay that person a PAYG salary and retain any surplus profits in the company, where profits will be taxed at about 30 per cent, depending on the size of the company.
So there is a mechanism to defer profits, but the only way for the proprietors to get their hands on those profits is to pay themselves a franked dividend, which will end up being taxed at their marginal rate. It is also possible to tailor dividends to individual shareholders by allocating each one a separate category of share.
In summary, the main benefit of the company over trust is that profits can be retained and used to expand the business, or to eventually pay those retained profits to its proprietors.
There is nothing in either of these structures that enable the proprietors to evade large sums of tax, they are merely efficient structures to provide asset protection while optimising the way profits are paid to the owners, who are taking all the risk of being in business for themselves.
Shorten has flagged a proposal to tax trust distributions income at a flat 30 per cent. It would be interesting to see the legislation. Suppose Jack and Jill have a family business operated through a trust which earns $200,000 a year and they distribute $80,000 to each of them with the balance of $40,000 going to a child who is at university. If the system were changed they could simply pay each other a salary of $37,000 so as to stay in the 19 per cent tax bracket, and have the rest taxed at 30 per cent. Under the current system the balance is taxed at 34.5 per cent
It does not bode well for the future of this country that the alternative government is more concerned about attacking the producers of wealth than increasing the pie so everybody can have a bigger share.
As the Methodist minister William John Henry Boetcker said 100 years ago, “You cannot lift the wage earner by pulling down the wage payer”.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email:noel@noelwhittaker成都夜总会招聘.au