Trust tax sets up decades of litigation, lawyer says

“The government keeps saying trusts are used for income splitting. They’re not. A trust doesn’t earn income and then split it up,” Cartland told Accountants Daily.

“The beneficiaries are taxed on their share at their own rates. The money passes through. Everything that follows comes out of that. If you don’t understand what a trust does, you can’t write a definition that sorts them. That’s what has happened here.”

The fixed trust definition

Whether a trust pays the new 30 per cent minimum tax depends on whether it is a fixed trust, Cartland said.

Under the new definition, a trust is fixed if its beneficiaries have fixed entitlements to all of the income and capital of the trust, or if there are “no material discretionary elements capable of significantly affecting” their entitlements or rights to that income or capital.

According to Cartland, the first test “fails” on its opening words.

“Who are the beneficiaries of a discretionary trust? Until the trustee appoints something, nobody is,” he said.

“If I appoint all of the income to one person, at that moment they have a fixed entitlement to all of the income. On those words the trust is fixed for that year. Next year I appoint to somebody else, and it is fixed again.

“So, is every discretionary trust a fixed trust? I don’t know. Neither does Treasury.”

Capital is the next problem

Cartland asked what the capital of the trust is, highlighting that it is not defined.

“Do they mean capital gains? Capital gains are taxed as section 95 net income, and come within the definition of income in most trusts. Do they mean corpus? What about accumulated income?” he asked.

“Further, to have a fixed entitlement to all of the capital you have to be able to call for it. That is absolute entitlement. And you cannot call for it while the trustee’s right of indemnity is unsatisfied, because until that is dealt with you cannot say what the trust fund is.

“Therefore, the first test is satisfied by almost nothing, or by almost everything, depending on how you read it.”

The second test, he said, is a list of indicators rather than a rule, each of which has to be worked through, which could require a substantial amount of advice.

“Every one of these is a question somebody has to answer in writing, for every trust, every year. That is a 20-page advice to find out whether you are taxed at 30 per cent,” Cartland said.

The explanatory memorandum concedes the point, he added, as it said there “remains the risk” that applying the new principles to a particular set of circumstances “may cause different minds to reach different conclusions”.

The bill also lets the minister decide, by legislative instrument, what does and does not count as a material discretionary element.

“So, you pay for the advice, and then the minister can move the line either way, after you have already structured around it,” Cartland said.

“The section is unsalvageable. You cannot fix it by amendment, because the problem is that whoever wrote it does not know what the words mean in trust law.”

Cartland cited the example of NSW having a statutory fixed trust test for its land tax, under which any equitable interest of the trustee is disregarded, so the trustee’s right of indemnity does not prevent a trust from being fixed.

“NSW saw the problem and fixed it in the act. Their test is more specific, it is far closer to a bright line, and it carves out the trustee’s indemnity expressly. There has still been something like a dozen cases on it.

“That is one tax, on one kind of asset, in one state. Whereas the minimum trust tax applies to every trust in Australia and it is drafted worse.”

The all-assets requirement

Cartland also noted that to get the rollover relief offered by the bill to trusts that restructure out, the trustee has to move every asset of the trust to a single new owner before the three-year relief period ends. 

But if the trustee misses one asset, he warned the relief is lost on all of them, and the commissioner can amend the assessments.

“Everything has to go, including assets you don’t know about, like a refund right sitting in a tax dispute. Find one afterwards and the whole thing unwinds, including the assets you transferred years earlier,” he said.

A handful of things can stay behind, he said, including assets that cannot be transferred, assets needed to pay the trust’s debts, and assets that cost $1,000 or less.

Cartland noted that Treasury’s explanatory material said the rollover only applies to the extent the trustee “can lawfully undertake the restructure”, and that trustees “must consider the terms of the trust deed and their duties under general trust law”.

“That’s Treasury washing its hands of it, and the two rules collide,” Cartland said.

“There’s an exception for assets that can’t be transferred. There’s nothing for an asset that can be moved, just not properly.

“So, a trustee who looks at their duties and decides an asset shouldn’t go has just lost the relief on everything else.”

Cartland said the courts have held that a trustee who uses a power for a purpose it was never given for has acted beyond the power, and the decision is void.

“Think about who gets left out,” he said.

“The wastrel son. The former spouse. The bankrupt nephew. Any one of them can look at the restructure and say the trustee moved the assets for tax reasons, and not for the benefit of the potential beneficiaries.

“And they would be right. It was done for tax. That is what the rollover is for.”

Cartland said that if they win, the assets never leave the trust, and the rollover goes with them.

“Every trust in Australia is going to be transferring assets out for tax purposes. That sets up decades of litigation,” he said.