Expert says trust use to avoid tax 'bordering on a joke'

Small business advocates say it is a misconception that trusts are only used by wealthy families to minimise tax, but one expert says the current system is "bordering on a joke" and in urgent need of reform.

On Wednesday, Treasurer Jim Chalmers introduced a bill that would impose a 30 per cent minimum tax on discretionary trusts starting July 2028 to try to discourage people and businesses from using the arrangement to minimise taxable income. 

Discretionary trusts differ from other types of trusts as they allow the trustees to change beneficiaries and how much they receive each year. 

Associate Professor Dale Boccabella from the University of New South Wales's Business School of Accounting, Auditing and Taxation told The Business some trusts were being used to distribute income in a way to offset tax bills. 

"A 17-year-old beneficiary of a discretionary trust, not allocated anything for years and years, and all of a sudden they turn 18, this is a child of the parents, and they get $22,500. Now why do they get $22,500 allocated? It's tax-free. It's under the effective tax-free threshold.

"In a discretionary trust, you can have a two-day-old baby born on the 28th of June being allocated $22,500. I mean, you can see how silly it is."

He said in some cases, the income allocated did not get paid to the children and stayed with the parents.

The treasurer said the reforms would affect less than 10 per cent of small businesses; however, Housing Industry Association managing director Jocelyn Martin said there were costs beyond the tax changes.

"Even before they know whether that structure is going to impact them, they have to seek advice from their lawyer or their accountant, and our members are saying that that could cost anywhere between $10,000 and $25,000," she said.

"It's not enough to say that these changes just impact a small proportion; they impact a large proportion.

"Maybe the result might be that they don't have to restructure, but they need to do the work to find out whether that's what's going to happen or not."

Growing number of trusts

More than 1 million trusts are operating in Australia, with about 84 per cent of them discretionary.

The number of discretionary trusts has doubled since 2001–02. 

About one in six small businesses used discretionary trusts in 2022-23, the last year of available data, with Treasury analysis suggesting 140,000 businesses of an estimated 350,000 would not need to pay the new tax.

Ms Martin said about three in five small businesses in the housing industry used a trust structure.

"I think there's an assumption that a trust structure is just something that wealthy people use to avoid or minimise taxes," she said.

"What we see are small businesses that are using the legitimate structure of a trust to manage their business, manage the cycles, the cash flow cycles, to actually pay themselves in a lot of instances as well, because some of our members have said they will pay themselves in good times and not necessarily be able to in bad times," she said. 

Questioned on how much tax tradies currently pay, given that the proposed change introduces a 30 per cent minimum, Ms Martin said the HIA's concern was that the change was an additional cost to residential construction.

"Already we know that the tax that is paid by our residential businesses is extremely high," she said.

"But not just that, the cost that they pay to comply with some of these business measures is also escalating all the time.

"So I think our concern really when we say there's another tax on tradies is really it's just another kick in the gut."

Asset protection or 'economic injustice'?

Dr Boccabella said other features promoted by accountants such as asset protection, flexibility and succession planning were not being changed as part of the government's plan, although he believed they probably should be overhauled.

"The other thing with discretionary trusts is that you can set them up so that they have limited liability, a bit like a company," he said.

"If the small business and discretionary trust fails, you might actually end up with creditors not getting their payment.

"You can call that asset protection if you want, but a lot of people would turn around and say, 'Well, isn't that economic injustice, someone not getting paid for their services and goods supplied?'"

Property Council executive director of capital markets, Torie Brown, said the government had ignored the legitimate concerns raised by industry during an expedited consultation process.

"Industry was given almost no time to consider how these radical changes will affect their businesses. Despite the warnings from industry, the government had decided to push ahead and introduce this legislation anyway," he said.

"Changes to trusts is incredibly complex — pulling one thread unravels another. The government announced these changes without considering the impacts they would have on small business and housing supply."

There are also concerns that restructuring trusts would incur stamp duty at a state or territory level, something the New South Wales government has promised to waive if re-elected next year.

The Australian Council of Social Services (ACOSS) welcomed the changes, with CEO Cassandra Goldie saying the current system was being exploited.

"It is not fair that someone earning $200,000 or more, who would usually pay 47 per cent tax on extra income, can bring that rate down to 30 per cent or less by passing income through a discretionary trust to their adult children or a private company, while an average worker pays tax at a rate of 30 per cent of the next dollar earned," Dr Goldie said.

"This reform helps fix this severe unfairness in the system so people on higher incomes contribute according to their ability to pay."