The Federal Government have finally released their consultation in relation to the proposed minimum tax to be imposed on trusts (discretionary trusts) that was originally flagged in the May Budget.

Below we have summarised the main points of the consultation paper noting that there is often a long way to go between a consultation paper and legislation, however, given the Governments majority and eagerness to effect reform, it should be anticipated that some changes will materialise into real legislation.

Trusts Subject to Tax

The consultation paper identifies on discretionary trusts (albeit that it acknowledges that this term needs to be better defined) as the trusts that the minimum tax will apply to whilst confirming that certain exclusions will be available (eg primary production income).

Testamentary trusts are also to be excluded (following a last minute about face from the Federal Government), however, its not all plain sailing on that front as the exclusion appears to be limited to testamentary trusts where only individuals and income tax entities can benefit.

Minimum Tax

The minimum tax to be applied by the trustee is 30% of the taxable income of the trust.  As previously announced individuals will receive a non refundable credit, so too will trustees of other trusts, however, companies will not be receiving any credit.

Worked examples of how the minimum tax is to apply can be found here for individuals, trusts and companies

If law is enacted in line with the consultation paper, then the common use of corporate beneficiaries receiving distributions from discretionary trusts will no longer be commercially appealing with an effective tax rate being 60% at the corporate level before increasing to over 80% when paid out as a dividend to an individual.

It should be noted that individuals will not be able to use the non refundable tax credit as an offset against the Medicare levy.

Trustees who receive a distribution with a non refundable credit in excess of their own requirement to withhold will not be entitled to a refund nor able to pass the excess credit onto its beneficiaries.  As such, this represents a potential tax trap within existing structures.

Rollover Relief

The consultation paper has provided more guidance on the proposed rollover relief that is to be available for 3 years with effect from 1 July 2027.  The paper provides:

• that rollover relief will be based on the existing small business reconstruction relief principles, however, there is proposed to be no turnover threshold cap and no limitation to active assets (ie passive assets can be rollover over).
• guidance about what will not be accepted under the rollover relief proposed. Where the new structure contains an ability to substantially retain an equivalent discretionary distribution outcomes then rollover would be denied (eg companies with dividend access shares, partnerships with non fixed entitlements, or companies with subsequent changes in memberships within a certain period).
• The rollover would require essentially all trust assets to be transferred to the new structure.
• A proposed new family unit definition to ensure the ultimate economic ownership is maintained and it is proposed that this can include entities where family entitlements are fixed.

Excess Franking Credits

The consultation paper makes it clear that where a trust has excess franking credits (ie over the 30% minimum tax required to be paid), then the excess will not flow to beneficiaries.

Two alternatives are being considered – either a refund of the excess credit to the trustee or carrying forward the excess for the trustee to utilise the credits in subsequent years.

Division 7A

Whilst not part of the Federal Budget, the government have responded to the Bendel case by re-enlivening a proposal in the 2018-19 Budget concerning UPE’s.  If this measure proceeds all UPE’s (even those that are currently ring fenced from Division 7A application) would be brought within the remit of Division 7A.

The Government are seeking feedback on how to implement this previously announced but unenacted measure.  Whilst this measure would provide further clarity around Division 7A, given the announced trust taxation measures and the loss of the CGT discount, it may be that companies become once again the preferred investment vehicle.

 

Whilst there is clearly a long way still to go between the consultation paper and legislation being drafted and becoming law, it is clear that the announcements within the Federal Budget are being strongly pursued by the Government despite the feedback received to date.  Given the lack of effective opposition, it should be expected that some if not all of the proposals will become law.

Should you have any questions on how these latest announcements impact you, please reach out to your ESV Engagement Partner.