A crackdown by the Australian Taxation Office on rorts involving family trusts has drawn alarm from some advisers as some of the practices under the microscope have become common practice.
Tax advisers are also concerned at the prospect the ATO will be examining the past behaviour of family trusts, raising the prospect of bills for back taxes, inflated by years of interest and penalties.
They have also been put on notice by the ATO that deliberately providing advice on trusts to avoid tax risks can attract fines of millions of dollars under promoter penalty laws.
Behaviour that the ATO says falls into the “red zone” includes arrangements, such as giving money to a child who then repays their parents for the cost of bringing them up to age 18, as well as more exotic “washing machine” undertakings where money flows back and forth between a trust and a company.
As trusts aim to get their affairs in order by the end of the financial year next Thursday, the ATO this week put out new guidance designed to make it clear what sort of behaviour it will prosecute.
With hundreds of thousands of family trusts in existence in Australia, the stakes are high for both those who have sought their shelter, and the ATO.
Family trusts generally don’t have to pay tax in their own right – instead, tax is paid by whoever receives money from the trust, at the normal rate of tax for their income.
This makes it possible to use what is called “income streaming” to minimise the total amount of tax paid by paying more in distributions to members of the family who have lower tax rates because they have lower incomes.
“That’s fine, we accept or understand that that’s a part of the tax landscape,” Louise Clarke, a deputy commissioner at the ATO who runs the agency’s private wealth division, said.
What concerns the ATO is where the person who is in line to receive the money from the trust doesn’t get the benefit of the distribution and it actually goes to another party, she said.
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This can contravene section 100A of the Income Tax Assessment Act – a part of the law brought in during the 1970s, when tax evasion schemes were rife.
In one example given by the ATO, a family trust gives a university student with no other sources of income the entitlement to $180,000 – a figure that takes them to the brink of the top tax rate of 45%.
The student then agrees to pay the $180,000, less tax, to their parents, to reimburse them for the cost of bringing them up while a minor.
“I don’t know if I want to say it’s a blatant rort,” Clarke said. “But it’s certainly not what I think community perceptions would be that it’s reasonable practice.”
Another practice falling into the ATO’s red zone is a more complex arrangement where money is distributed to a company that the trust owns. The next year, the company pays the same money back to the trust as a dividend. By repeating this cycle, paying any tax at all can be put off for many years.
“I don’t know if I could say definitively how widespread those arrangements are,” Clarke said. “But I think when we actually released the guidance, we were surprised by the concern. And so our thinking was that perhaps it’s much more widespread than what we thought.”
She said that there was “an attitude that has been developed over time where the idea that it’s OK to split income and the flexibility that you get with distributions from trusts has caused a lot of tax practitioners to become quite sloppy and to push the boundaries without really thinking about 100A or whether what they’re doing is appropriate”.
Unease among tax advisers started to grow in February, when the ATO first flagged the changes.
Earlier this month, accountants Macks Advisory described it in a note to customers as a “trap” and said it was likely that the ATO would not immediately “start dropping s100A grenades into family trusts” but would instead “delay action so tax officers can levy interest and penalties or use the threat of a ‘no-declaration-before-30-June’ charge that will force small family companies to agree to concocted and inflated tax bills”.
Clarke was keen to hose down some of the industry’s worst fears. She said taxpayers and their agents could stand by decisions made on the basis of the previous guide on the topic that the ATO put out in 2014.
In addition, she said the ATO usually only looks back four years when auditing taxpayers and promoter penalties are only applied when promoters get a success fee, not just a normal fee for preparing a return.
The guide the ATO put out this week “is really making it clear about how we will approach those cases outside the four year period, and saying you’ve got some protection because of the 2014 guidelines,” she said.
“So I don’t think that there is an inequitable or unfair outcome because of the way that we actually approach our compliance program.”
However, Lance Cunningham, technical leader in accounting firm BDO’s Australian tax practice, said the 2014 guide “wasn’t very well written”.
“I guess I’m hopeful that the tax office, what they’re saying is, look, we’re not going to be looking too had at the old ones,” he said.
“Now it’s right there on the website, pretty plain and clear, to say this is a red zone one, don’t go there.”
He said the crackdown, and the excitement around it, had resulted in a lot more work for accountants – but not necessarily a lot more billable hours.
“We’re getting a lot of work where we’re just dealing with our clients as you do on a year-by-year basis, talking about the issues,” he said.
“So I wouldn’t say it’s been a big windfall for accountants, in fact, in a lot of cases in these sorts of situations accountants spend more time talking through the issues with their clients than the clients are prepared to pay for.”