By Jason Skinner
If you’ve seen the recent headlines about the Government’s “30% minimum tax on trusts” and wondered what it all means, or you don’t know what a trust is, you’re not alone.
Most people have never needed a trust, and the rules around them are rarely explained in plain English. So, let’s look at what a trust is, what is changing, and why it matters.
What is a trust?
Importantly, a trust is not a person, and it is not a legal entity. Put simply, it’s a legal arrangement with designated roles governed by a set of rules under a deed. Without getting too technical, there is a trustee who holds the assets or property of the Trust. The Trust also has beneficiaries. The beneficiaries are the people who will benefit from the Trust property and any income or assets that the Trust holds on their behalf. The Trustees’ job is to act in the beneficiaries’ interests, not their own, and follow the rules set out in the deed at all times.
Trusts are not a new concept; in fact, they are about 800 years old and date back to the 12th century. In medieval England, knights heading off to the Crusades would hand their land to a trusted friend to look after for their families while they were away at war. If the friend then tried to keep the land for themselves, the English courts would eventually step in and force them to honour the trust arrangement they had in place. Ie the friend was the Trustee and the family were the beneficiaries. That is still the principle behind trusts today.
So why do we use trusts today?
There are many reasons for using a trust, particularly in a business context.
The two main reasons are.
Tax Efficiency. In a family trust, the Trustee decides each year how to share the profits among the beneficiaries. Each beneficiary then pays tax on their share of that profit at their own tax rate. Most resident Individuals have a tax-free threshold of $18,200, so a beneficiary with little or no other income can receive a profit distribution from the trust and pay little or no tax on that income. Sharing income this way often means the family group pays less tax overall than if one person earned all the money themselves. A Trust is an effective way to distribute profits and income to lower-taxed family members.
Asset Protection. Assets held in a trust are generally not owned by yourself personally. Structured correctly, this creates a legal separation between you and the trust’s assets. So if you find yourself in legal trouble, assets held in a properly run trust are usually much harder for creditors to reach.
Trusts are common among small business owners and people wanting to protect assets, so they are more widespread than most people realise.
What is the Government changing?
For the first time in Australian Tax Law, from 1 July 2028, the Government plans to apply a minimum tax of 30% to the income of most family (discretionary) trusts. The Trustee will pay this tax before the money reaches the beneficiaries. This means that no matter how the profits are shared among beneficiaries, the trust will have to pay at least 30% tax before distributing them.
Legislation is currently before Parliament and is being heavily debated, as this new tax will have very heavy & far-reaching impacts on how we structure businesses and estate planning matters going forward.
Under the new laws, beneficiaries will generally receive a non-refundable credit for the tax the trust has paid.
Let’s look at a simple example of how this is all proposed to work:
• Sam is a university student and is given $18,200 from his family’s trust. As the law currently stands today, Sam would pay no tax on this distribution from the trust.
• Under the proposed new rules, the family’s trust will pay $5,460 (30%) tax on the $18,200 income before distributing it to Sam. Sam will still pay no tax on his $18,200 in his personal tax return, but importantly, he cannot receive a credit or refund of the $5,460 paid by the Trust.
If Sam’s personal tax rate were higher than 30%, he would get a credit for the $5,460 and pay a top-up tax to bring his tax bill up to his already higher rate.
The biggest losers from these changes are families who have been sharing income with people on low or no income, or with companies set up to receive trust profits where their tax rates are lower than 30%.
Some trusts are excluded, including fixed trusts, self-managed super funds, deceased estates and charities.
Importantly, not all trust income is included either.
Income from primary production (farming) is exempt from being taxed under these changes.
What stays the same?
The protection benefit. The new proposed tax change affects how the trust’s income is taxed, not who owns the assets. So, the asset protection features of Trusts still remain largely the same.
So, for anyone wanting to separate themselves from assets or reduce financial risk, trusts still offer the same benefit, provided the trust is set up and run properly.
The Bottom Line
The tax advantages of a family trust are being reduced, particularly for families who share income with low-income relatives or companies. However, the asset protection benefits remain.
The bottom line is that there still remains a lot of commercial benefit to owning assets in trusts, but we will now need to look deeper than simply asking “will it save tax?”
Disclaimer
This article is general in nature and does not constitute legal, financial or taxation advice.
The New Trust Laws are not law at the time of writing of this article and subject to change.
Always seek professional advice regarding your own circumstances.
Jason is a CPA Accountant and the principal of Skinner Business Consultants located locally in the Bellingen Shire, and can be contacted at jason@jasonskinner.com.au.