ATO turns its eye to tax avoidance via trusts

People using trusts to shelter income and thereby avoid tax could be hit with higher bills under a review by the Australian Taxation Office.

The agency has told Fairfax Media it is conducting a pilot program to determine whether trusts are complying with tough anti-avoidance rules when they distribute income to tax exempt beneficiaries.

Tax commissioner Chris Jordan can use his discretion not to apply the anti-avoidance rules if he wants to.
Tax commissioner Chris Jordan can use his discretion not to apply the anti-avoidance rules if he wants to. Photo: Daniel Munoz

The ATO said a limited number of letters will be issued in the coming months to determine whether it needs to follow up with reviews or audits.

An ATO spokesman said the program aims to provide Tax Commissioner Chris Jordan "with an accurate picture of whether the integrity rules relating to distributions of income to tax exempt entities are understood by taxpayers and their advisors and are operating effectively". 

Former treasurer Joe Hockey, while in opposition, suggested trusts should be taxed in the same way as companies at a ...
Former treasurer Joe Hockey, while in opposition, suggested trusts should be taxed in the same way as companies at a rate of 30 per cent. Photo: Stefan Postles

The ATO will be reviewing trusts' compliance with sections 100AA and 100AB of the Income Tax Assessment Act 1936. 

These anti-avoidance rules are designed to prevent trustees using tax-exempt entities to shelter the trust's net income.

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"Specifically, we are looking at situations where a tax exempt entity is entitled to income of the trust estate and has not been paid or notified of that entitlement within two months of the end of the income year [or] their share of the trust's net income is greater than their share of the income of the trust estate," the ATO said.

Trusts to get taxed as companies?

Former treasurer Joe Hockey, while in opposition, suggested trusts should be taxed in the same way as companies at a rate of 30 per cent. 

After political backlash he retreated from his suggestion, but the issue remains one that could be discussed in the Turnbull government's upcoming tax review.

People often channel income into trusts to avoid paying income tax. 

While proceeds from trusts are taxed at income tax levels when they are distributed to a beneficiary, this tax can be minimised by distributing it people on low tax rates such as children or retirees.

Following a High Court decision in the Bamford case in 2010, tax law was changed to address a number of problems with the way trusts get taxed.

Bamford case highlights mismatch

The Bamford decision highlighted that amounts beneficiaries get assessed on for tax do not always match the amounts they are entitled to under trust law.

The ATO has previously noted that this "mismatch" can result in "opportunities for tax manipulation".

Following the Bamford case, tougher anti-avoidance rules were introduced.

These included the "pay or notify rule", which states that when a trust makes a tax-exempt entity presently entitled to a distribution the trustee must notify the beneficiary of their entitlement or pay the distribution within two months of the end of the financial period.

If this condition has not been met the beneficiary is treated as not being entitled to that income, the ATO said.

The second, the "benchmark percentage rule", applies if a tax exempt beneficiary is entitled to a share of the income of the trust estate that exceeds a benchmark percentage, the ATO said. 

If the exempt beneficiary's entitlement exceeds the benchmark percentage, the beneficiary is not entitled to that proportion of the income.

Mr Jordan can use his discretion not to apply the anti-avoidance rules if he wants to.

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