There are two possible "sleepers" for businesses arising out of the federal government's
decision to not tax trusts like companies, warns PricewaterhouseCoopers (PwC) partner Chris Lowe.
Last week Treasurer Peter Costello announced the government will not go ahead with touted changes to the tax treatment of discretionary trusts, but will legislate with effect from December 12 to introduce new provisions to prevent individuals who are trust beneficiaries with high marginal tax rates accessing, without further tax liability, funds that have been taxed only at the company tax rate.
The Board of Taxation also called on the Tax Commissioner to clarify and publish his views about the deductibility of interest on borrowings used to finance non-assessable distributions to beneficiaries of discretionary trusts.
While labelling the decision a "victory for commonsense", Lowe says it is not clear whether many genuine distributions of trust capital will be caught under proposed amendments to legislation.
"The board's report is ostensibly concerned with situations where tax-free distributions are made to beneficiaries out of asset revaluation reserves in an attempt to circumvent the operation of the existing legislation.
"If the amendments are limited to these types of situations fine, however, if tax-free distributions out of ordinary trust capital (eg monies settled or gifted upon a trust) are also to be caught as deemed dividends in cases where the trust owes an unpaid beneficiary entitlement to a company then this would be reminiscent of 'entity tax' and the proposed 'first profits' rule," he says.
Another move that may have serious impacts for small and medium-sized businesses (SMEs), according to Lowe, is the board's caveat that the federal government could amend existing legislation or repeal the section setting out the consequences where a trustee makes a company presently entitled to the income of a trust, but does not pay the funds to a company within a reasonable period.
"The consequences could be either that the trustee would be assessed on the amount of the income as if there had been no distribution, or that the company would have to pay a top-up tax," he says.
Lowe says such a move would have a number of serious impacts for SMEs as they would be forced to move out of trust structures into company structures, or be faced with a decision of paying tax at 48.5% or suffering a cash shortage as the cash is locked up in the company beneficiary that is separate to the trading trust.
"This would appear to be at odds to the Board of Taxation's general approach of preventing abuse of trusts while preserving them as genuine SME trading structures. I'm hopeful that the changes are, therefore, limited to amendments designed to stop tax-free distributions out of asset revaluation reserves," he says.
Lowe urges the government to make the amending legislation available as soon as possible so that SMEs and their advisers understand exactly what the impact of the proposed changes will be.