CPA Australia members say proposed changes to the taxation of discretionary trusts could discourage small business and hurt the wider economy.
The Australian Labor Party (ALP)’s plan to tax trust income distributions at 30 per cent will remove much of the incentive to start a small business and stifle entrepreneurship and start-ups, says CPA Australia head of external affairs, Paul Drum.
The ALP plan would tax income from many trusts at 30 per cent regardless of the beneficiary’s marginal income tax rate. If their marginal tax rate is lower than 30 per cent, the individual will not be entitled to a refund. If their marginal tax rate tops 30 per cent, they will have to pay extra tax.
According to the party’s 2017 policy document, high income earners are using discretionary trusts to reduce their tax liabilities through income splitting, where high income earners use the trust structure to apportion some of their pre-tax income to other family members who pay less tax.
“Because normal PAYG (pay-as-you-go) salary and wage incomes can’t flow through discretionary trusts the vast majority of taxpayers don’t have access to these special arrangements,” the document says.
“As with other tax subsidies and deductions, access to discretionary trusts and income splitting is generally only accessible to wealthier Australians that have been able to accumulate passive investments such as shares and property.”
Andrew O’Bryan, partner at legal firm Hall and Wilcox, says, “What the ALP ignores, as do most politicians and commentators, sadly, is that under the current tax regime, a trustee pays 47 per cent tax on the trust’s profits if it doesn’t distribute them annually to beneficiaries. A company on the other hand pays either 30 per cent or 27.5 per cent tax on its profits, and has no obligation to distribute those profits to shareholders.”
Further, the ALP policy document states that amongst other things the new rules will not apply to farm trusts and charitable and philanthropic trusts. “This will be a veritable drafting nightmare,” O’Bryan says.
O’Bryan questions how a farm trust will be identified. It may own substantial, valuable assets but he says the income they generate can vary widely, depending on the vagaries of the weather and world markets for agricultural products.
Small business owners and trusts
Drum says the plan will hit the standard of living of many small business owners and is raising significant concerns among CPA members and their clients.
“It’ll affect a small business person’s take-home share of any business profits. You’re going to be taxed more on the same profit than you were yesterday,” he says.
“It’ll stifle entrepreneurship and business start-ups because at the end of the day, business investment is about risk and reward. If the risks exceed the potential rewards, people will not invest.”
Discretionary trusts play an important role in asset protection for small business owners who are at risk of being sued, and for intergenerational planning, because the death of a beneficiary doesn’t create any change in ownership of the assets held in trust. They are also used as a tax-effective way of distributing income.
Earnings from trusts
The 2016-17 Tax Stats issued by the Australian Taxation Office reveal the central role that trusts play in many Australian small businesses and in the wider economy.
Some 350,000 small business trusts generated A$217 billion in income and A$46 billion in net business/small business income.
Discretionary trusts generated A$232 billion in business income, A$3.4 billion in net rental income, received A$21 billion in franked dividends, and reported A$11.3 billion in net capital.
For all trusts, the median net income or loss from business was A$25,516, and median small business income was A$61,634. The median net income or loss was A$32,408.
ALP shadow treasurer Chris Bowen argues that business owners should pay themselves a regular wage and avoid the 30 per cent minimum tax rate for trusts.
“However, this view completely disregards the fact that trust distributions may be from profits on capital and not from personal exertion, and as such should not be treated like wages,” argues Drum.
Further, Drum says it is unrealistic for many business owners to draw salaries during the year because they might not have a clear picture of their business’s performance.
“It might just be a mum and dad business, and they don’t want to commit to paying themselves a salary because they don’t know if the business has made a profit or not for the year. One year, they might be drawing A$50,000. The next year, they might be drawing nothing,” he says.
There is also the potential administrative burden of both pay-as-you-go withholding and the superannuation guarantee contribution, which can be significant for a small business where there are only a couple of people involved.
The cumulative effect
Drum says that, taken together, the ALP’s announced tax policies to date – the changes to trusts, removing refundable franking credits, quarantining negative gearing, cutting the capital gains tax discount, and capping the cost of getting professional advice – paint “a very grim picture for those trying to run a small business or invest”.
“CPA Australia is concerned not only about each of these proposals, but also their collective interplay and the overall impact on individuals and families trying to run their small business or invest in the Australian economy,” Drum says.
“This cumulative effect discourages entrepreneurship and investment and it’s also going to reduce a whole raft of small business entrepreneurs’ profits and what they take home at the end of the day. That has economic implications for consumption and investment.”
Drum says the implications of the proposals could flow into the wider economy.
“If you take money out of people’s pockets, it impacts how they consume and invest. If they have less, they’ll be tightening their belts even more. As demonstrated by our Small Business Survey results, business confidence is already low.
“Investor confidence is also down, and we can see from recent figures that retail sales in shops in Australia are down – people are already tightening their belts,” he says.
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