Electable regime for trusts ‘unworkable’ as drafted, warns accounting firm

“For the many discretionary trusts that hold real property, or other dutiable property such as interests in landholding companies and unit trusts, it is the only practical path,” said Hilltop Tax Advisory.

“The only other means of leaving the regime without transferring assets is to remove the discretionary elements from the trust itself, so that it becomes a fixed trust under proposed section 272-65 of Schedule 2F and ceases to be a minimum tax trust. That requires a variation of the trust instrument and carries its own capital gains tax and duty consequences.”

However, the tax advisory firm warned that as currently drafted, the electable regime cannot be relied on with confidence and will therefore be largely under-utilised by affected trusts for a few reasons.

One key reason, the firm explained, is that the nomination does not accommodate beneficiaries born after 1 July 2028.

Under the draft legislation, an excluded election trust (EET) nomination must specify each beneficiary to whom the trustee may confer a present entitlement, and each beneficiary’s share of the trust’s income and capital, which must be equal and total 100 per cent. An individual cannot be specified unless they were capable of benefiting under the trust on 1 July 2028.

Hilltop Tax Advisory said this effectively creates a “birth tax”, as a child or grandchild born after that date cannot be specified at all, and the nomination cannot be varied to include them. The only variations permitted are on the death of a specified individual and on certain relationship breakdowns, it noted.

“A trustee who confers an entitlement on the later-born child in any event has decided not to confer present entitlements in accordance with the nomination, which automatically revokes the election,” the firm said.

“The trustee is therefore put to a choice between excluding the child permanently and accepting 47 per cent on all trust income for an income year, together with permanent exclusion from re-electing back into the regime. The same choice arises on a marriage and on an adoption.”

The firm also noted that the exposure draft is inconsistent on the breadth of beneficiaries, which it should fix.

“A family group is defined by reference to a test individual under the family trust election rules, which carry their own problems of overreach and unintended non-compliance,” the submission read.

“Under those rules, the family group expands automatically as lineal descendants are born, without election, variation or consequence. The Exposure Draft sets aside that existing family group machinery, and we can identify no compelling policy reason for it doing so.”

The submission also warned the government that the eligible company test is uncertain and unworkable.

For a company to be nominated as a specified beneficiary of an EET under the draft legislation, there must be no material discretionary elements affecting the rights or interests of the company’s members.

“Subsection 102UYC(2) lists, without limitation, matters that suggest there are no such elements, where the matters listed are indicative only,” the submission read.

“Those matters are extensive, and as drafted appear to be most readily satisfied by a single member company, or two-member company held in equal proportions, operating under a standard constitution or the replaceable rules without bespoke features.”

The third indicator is satisfied only where a power to change the company’s constituent documents can be exercised only with the consent of all members, or in a way that does not adversely affect members’ rights or interests.

The firm also argued that the EET election constrains the trustee’s discretion.

The trustee of a trust with an EET election in force is required to confer present entitlement to shares of the income and capital of the trust in accordance with the EET nomination, the firm noted.

“Each beneficiary’s share of income must equal their share of capital, and the shares must total 100 per cent. Any departure from the nomination automatically revokes the election, exposing the trustee to 47 per cent tax on the entire trust income for that income year, and subjects the trust to the minimum tax permanently thereafter,” it said.

“In exercising its dispositive discretion, the trustee must either act in good faith and with real and genuine consideration of the beneficiaries when making a distribution  – at the cost of the adverse tax outcomes – or follow the EET nomination and risk challenges from beneficiaries like in the case of Owies.”

The firm also pointed out that the election can also be lost without any choice by the trustee.

“It is automatically revoked if a nominated company or trust is wound up, vests or is deregistered, ceases to be an object of the trust, ceases to be an eligible company, or has a change of shareholder other than on death or relationship breakdown. The trustee controls none of these events, yet the trust bears the full consequences,” the firm said.

The firm recommends that the nominated class be capable of being defined by reference to a family group within the meaning of section 272-90 of Schedule 2F to the Income Tax Assessment Act 1936, or alternatively that the variations permitted under section 102UYE be extended to births, adoptions and marriages, under which percentages may be redistributed among the class without a revocation arising.