You’ve probably heard a lot about how the Ralph reforms were killing trusts, well, take this hypothetical case on board.
Your business needs a short-term loan so through your trust structure you borrow $100,000 from your mum, who is happy to help out. And, because you’re a good son or daughter, she charges zero percent interest. After 15 months you’re doing okay and so you start paying her back $10,000 a month. Under the new “profits first” rule, your big-hearted mum will get slugged with a tax bill of $4850 per month!
This is what the Institute of Chartered Accountant's Ken Traill used to explain how draconian changes to our taxation law might be if Peter Costello's draft legislation gets through Parliament. Ken, who is pretty hot under the collar over the proposal, told the Sydney MorningHerald he was off to Canberra to point out to the politicians the "sheer bastardry" involved in this would-be legislation. The numbers say there are about 800,000 trusts reporting to the ATO, most of them discretionary trusts. The accounting profession, which has been flogging this tax-effective vehicle for years with tacit government approval, now looks set to have to advise clients to give up their trust structures and live their tax life as companies. Of course, that was the intention, but some unintended consequences are bound to carry a lot of protesters to Canberra before these bills achieve Royal Assent. All of this is tipped to arrive with the "entity tax" regime on 1 July 2001.
The goal is that most trusts will pay tax at the new company tax rate of 30 percent. Accountants are advising clients to review what is being held in trusts. Sounds sensible. Fortunately, for assets in trusts before 23 December 1999 the grandfathering provisions mean only half of any capital gain when an asset is sold will be hit by the 30 percent tax rate. However, that's not the end of the story. The other "untaxed" half of the sale proceeds will only escape tax if the proceeds are distributed to beneficiaries in the same year of the sale. Now, get this. If the trust should keep the money, it will be stung by the "profits first" rule. This means that the money would be deemed to be trust profit and taxed in the hands of the beneficiaries!
There will be franking credits for this taxed portion. And for any assets bought after 23 December, any profit will be slugged at the company rate and there will be a franked dividend if distributed to trust members. Clearly, this raises issues of whether to keep or get rid of assets in trusts. It's an even bigger issue for pre-capital gains tax assets. This issue is starting to really spook accountants and vulnerable Government backbenchers. This became an issue when the draft legislation made no reference to exemption for pre-September 1985 assets. The initial recommendations of the Ralph report backed such exemptions but the no-show on the draft legislation is a worry. Another concern highlighted by The Australian's Tim Blue is the likelihood that "capital movements in and out of trusts will be regarded very suspiciously and wear the threat of full company tax, in the absence of supporting paperwork and evidence of repayment". All up it's a big discouragement for those wanting to make loans to a business controlled by a trust – and the time factor is important. Loans to a family trust paid back within 12 months will not be treated as contribution of capital and means repayments will not be potentially taxable.
In addition, there has to be formal documentation outlining the size of the loan, its term, security and the interest. Clearly, all of these changes represent great opportunities for accountants, who we need even more since the Government embarked on its meritorious goal to "simplify" the tax system. Of course, that's what all our businesses needed – a greater accounting bill to make our tax easier and more simplified. But is there another cost for a New Tax System with its crackdown on trusts? Obviously, any useful reason for securing a loan, be it for new plant and equipment, upgrading your computers for GST, investing in R&D or even just sorting out a temporary cashflow problem, could come up against the problem that your "near and not so dear" lender could be taxed to high heaven. You can see why small business, farmers, other trust beneficiaries and Government MPs in marginal seats are worried about what's rough about Ralph.
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