Labor have proposed a change to the way in which distributions from discretionary trusts are taxed in the hands of beneficiaries. If this becomes law, how will the new changes affect you?
Discretionary trusts – can you give me the high level detail? Discretionary trusts are used for three primary purposes – tax minimisation (by income splitting), asset protection, and succession planning. It is the first of these three purposes which is the focus of Labor’s proposed changes.
What is income splitting? Income splitting is a strategy whereby income (derived from either investments, or personal labor) is distributed amongst a number of beneficiaries, with the goal of reducing the overall tax bill. The strategy is particularly effective if income is distributed to beneficiaries who do not have any other source of income, because each beneficiary will have a tax free threshold of up to $21,000. (It should be noted that, for non-testamentary discretionary trusts, this strategy does not allow distribution of trust income to minors, who are taxed at a penalty rate as a result of changes introduced in the 1980s). Some trusts might distribute income to a corporate entity instead of (or as well as) distributing to individuals, and the corporate entity would pay tax on trust income at the fixed company rate (rather than marginal rates for individuals).
What are the details of the proposed change? Labor have proposed to tax the income received by a beneficiary of a discretionary trust at a minimum of 30%, rather than allowing them to use their tax free income and marginal tax rates. This will reduce the effectiveness of the income splitting strategy – but may still be useful if the amount of income would push the tax payer into the top marginal tax rate.
Note that testamentary trusts, charitable trusts, special disability trusts, fixed and unit trusts, and farming trusts will not be affected by the changes. Testamentary trusts remain a useful and viable strategy for estate planning.
Watch this space – the finer details have not yet been announced.
Should I be worried? For the majority of Australians, there’s no need to worry – the changes will only affect tax payers who are using discretionary trusts for tax splitting purposes.
Further, the Liberal government are not likely to support this policy, so Labor will need to win the next federal election (due between August 2018 and May 2019) – so there’s plenty of time to chat to your adviser.
Tax payers who are using non-testamentary discretionary trusts for tax splitting purposes should discuss the matter with their professional advisers to determine whether a discretionary trust is still the best vehicle for them, or whether an alternative strategy (such as contributions to superannuation) should be explored.