Date posted: August 7, 2017

Nathan Fenner discusses the Australian Labor Party (ALP) policy in relation to the taxation of discretionary trust distributions.

On 30 July 2017, the Leader of the Opposition, Mr Bill Shorten, announced the Australian Labor party (ALP) policy in relation to the taxation of discretionary trust distributions. Prior to this, speculation had existed that the ALP would seek to ‘tax trusts as companies’ – effectively reviving a policy first proposed by the Howard Government in 1998.

Ultimately, the proposed ALP Policy stops short of ‘taxing trusts as companies’. This is a welcome outcome. Instead, it proposes to introduce a minimum 30 percent tax rate for discretionary trust distributions made to adult beneficiaries (i.e. individuals over the age of 18) after 1 July 2019.

As noted in the policy document accompanying the media release by Mr Shorten: “…distributions from a discretionary trust will incur a minimum rate of 30 percent, instead of the current arrangements where tax can be paid at a much lower rate (or no tax at all if below the tax free threshold) if income is split amongst beneficiaries in low tax brackets. In circumstances where the minimum tax rate on discretionary trust distributions is lower than what would be paid under the normal marginal tax scales, the higher rate would apply.”

So, rather than imposing income tax directly upon a trust estate (which would be the outcome if trusts were ‘taxed as companies’), the income tax liability instead falls upon the individual beneficiaries of the trust in the form of supplementary personal income tax.

The fact the 30 percent minimum rate does not override the normal marginal tax scales that would apply to a beneficiary if the income tax at marginal rates would otherwise be higher, raises the question of how the ALP Policy will deal with beneficiaries who have income from other sources (e.g. salary/wages). Specifically, for such beneficiaries the question arises as to whether a discretionary trust distribution received:

  • represents the ‘bottom slice’ of the individual’s taxable income – therefore otherwise being subject to the lowest marginal tax rates, and potentially giving rise to a liability under the “30 percent minimum tax proposal”
  • represents the ‘top slice’ of the individual’s taxable income – therefore being subject to the individuals highest marginal tax rates and potentially not giving rise to a liability under the “30 percent minimum tax proposal” or
  • is assumed to have been taxed at the individual’s ‘average’ marginal tax rate, with a ‘top up’ liability being imposed if that average marginal tax rate is less than 3 percent. 

The difference in outcomes is highlighted below, for a theoretical taxpayer who derives $45,000 of salary/wage income and a $35,000 discretionary trust distribution: 

Detail Current law
Top slice approach
Bottom slice approach
Average rate approach
Salary & wage income 45,000
Trust distribution 35,000
  Total income 80,000
Gross tax payable 17,547
Tax on salary & wage 6,172 14,355 6,172
Tax on trust distribution 11,375 3,192 11,375
  Gross tax payable 17,547 17,547 17,547
Effective income tax rate on trust distribution       32.50% 9.12% 21.93%
Additional tax under ALP Proposal 7,308 2,823

The example illustrated in the discussion paper accompanying the ALP Policy appears to adopt the ‘average rate’ approach. Without a clear statement on which approach is to be adopted, taxpayers are unable to quantify exactly how the ALP Policy will impact them.

Outside of this, it is worth noting that:

  • the ALP Policy excludes ‘farm trusts’ from the proposed 30 percent minimum tax – a decision which raises difficult questions of ‘equity’ from the perspective of tax policy design
  • without strong anti-avoidance provisions to accompany the change, the ALP Policy will incentivise taxpayers to ‘re-characterise’ discretionary trust distributions into another type of income in the hands of a beneficiary (such as interest/employment income or private company dividends)
  • to the extent that the ALP Policy is targeted at ‘income splitting’, it should be noted that a range of statutory provisions, anti-avoidance laws, and Australian Taxation Office (ATO) rulings already address this issue comprehensively. 

If the ‘income splitting’ practices are currently outside of the ALP’s preferred policy settings, targeted reform of the existing laws and ATO rules noted above would be more appropriate than a sweeping change to the taxation of trust distributions. 

Article provided by KPMG