The two main points to come out of ATO’s (Australian Taxation Office) new income splitting ruling on family trusts are, firstly, pay out your adult children’s loan accounts at Uni. Give them an early inheritance.
Secondly, if your registered tax agent/accountant helps you to reduce your tax to a lower rate, they may be in breach of the Tax Practitioners Board (equivalent to AHPRA for doctors and allied health providers) regulations. Your tax agent may risk being severely penalised, sanctioned and possibly de-registered!
This would be like making it illegal for a GP to engage in healthcare prevention.
Quite rightly, you are probably scratching your head and asking why then would you employ an accountant? I can see a lot of my colleagues sweating over this one.
I am sure there will be some interesting and amusing consults with your accountant.
Do not take this personally. It is clear the Government’s coffers are desperate for money and have a plan on how to get it. Taxing the rich is a politically popular idea.
Unfortunately, the ATO tone seems to suggest anyone using a family trust is illegally trying to avoid paying tax. It is an unfortunate stereotype.
Trusts are typically associated with high net worth people, even though it is a common vehicle used by ordinary mums and dads who may have a small business or money they wish to protect. They are not of the same ilk of a Bill Gates or Jeff Bezos. It is primarily used for asset protection and a safe way to create wealth and help family members in need.
The main points from the biggest ruling in decades that affects your family trust can best be described here.
Take a typical doctor, Dr Good, with two adult children, a service trust that owns and runs a group practice. They have a family trust that has as beneficiaries Mum and Dad, 2 kids at uni, a “bucket company” corporate beneficiary, “Ben” the family dog, and a self managed super fund.
Remember, from 17th December 2022 to apply the new income splitting service trust or entity rules first, make sure you do not have high service fees. Factor paying an arms-length salary to the practice owner who bills fee for service for managing the practice;
No more allocating $180,000 to adult children at uni but not paying it to them;
No more allocating money to your “bucket company money” or any other entity, including Ben the family dog so you can pay a lower rate of tax.
Service trusts that allocate but do not pay family trust profit distributions may require written Div 7a loan agreements to the bucket company, so expect compliance costs and documentation to increase;
- The rules remain murky in some parts. The ATO admits they are not law but guidelines that even the ATO has admitted they are not certain of. Sounds like the payroll tax rules.
Not following the rules may attract the ATO’s attention.
Where to from here?
Document everything: Make sure you have a well-documented defence with your tax lawyer and accountant if you are planning to diverge from a ruling or seek a private ruling (be sure not to trigger a tax audit).
Don’t distribute income to questionable entities that will face scrutiny and likely an audit, for example, to another trust or entity (a superfund, a foreign company, distant relatives or the family dog).
Run joint family bank accounts with your named beneficiaries. This is the only way a trust can distribute to spouses, or dependent adult children, or if a complying Division 7A loan agreement is in place (e.g. with a bucket company).
The flow of payments matter: Just pay out before the end of any financial year any trust distribution with cash and avoid journal entries.
Pay your kids out and give them an early inheritance. Remember, this will be hard to get back.
It is not a good idea to get your kids to pay you back as soon as you have paid them their trust distribution. It may be called a “reimbursement” which they do not like.
Stop taking money out or lending money from one bank account and transferring it to another that is not consistent with your business model, and legal and tax structure. Avoid a “circular flow of funds” (see para 15).
Large loan repayments: These need to be handled carefully and are likely to cause a compliance problem, and you may not have enough money to pay your trust distributions. Make sure you have some good savings or standby loan facilities available.
Expect your accountant to go into panic mode and your fees are set to increase if they have been entering a lot of journal entries in relation to trust allocations on your books and not doing as set out above. There is retrospective application. The ATO are targeting arrangements usually implemented by using journal entries (which themselves are of no legal effect).
At a minimum, do the following:
- Ask your accountant in writing to review distribution patterns and journals in detail for the past two years for all of your entities. This is the first step to determine if any remedial action is required now.
This will be a big task, so expect a healthy bill. The new rules are long and complex.
Revisit tax planning for the future. There maybe systemic issues. Serious sanctions can apply to your tax agent if you do not do the right thing. Do not expect any favours. No client is worth losing their livelihood over. The same principles apply in medicine.
It should be a buy once cry once experience. However, budget for constant compliance changes as the rules keep being modified by regulators and Court decisions. It is the cost of doing business, like paying for your car to be serviced regularly.
The bottom line, at least pay your kids their $180,000 trust distribution. Make sure it is not a book entry where you have no intention to pay. For example, pay their schools fees from a joint family account. I hope you get the gist, more to come!
At least you will not have to worry about asset protection if the payroll tax commissioner comes knocking on your door.
One major conflict I do appreciate is how a major Federal Court ruling late last year on a number of the issues raised above did not stop the ATO from publishing what appears to be a conflicting guide.
The case confirmed bucket companies are legitimate, and it is not tax avoidance. The main argument could be they are there for wealth creation and asset protection. The ATO seeks to challenge this notion.
For those who like the gory details of the case, I have made a brief reference below.
Justice Logan of the Federal Court handed down his decision on the 21st December 2021 in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation  FCA 1619, in relation to section 100A and the Part IVA anti-avoidance provisions. This case concerned what has come to be described as a typical ‘washing machine’ arrangement: that is, an arrangement where a trust makes a distribution of income to a corporate beneficiary, and the corporate beneficiary in sequence distributes a dividend back to the trust. The ATO is appealing this decision.
I do not blame you if you are confused, so are we.
Normally, Court decisions have precedence over tax rulings. I would not be surprised if some elements of this ruling are watered down. However, key parts will remain, such as proving you are making actual bank payments, with no funny side deals. The burden of proof is on you and you would be a fool to ignore it.
All I understand is that the Tax Office is not the law. It simply administers it. I am happy to stand corrected on anything I have said here. Just be prepared to clearly defend your position. It should prevent an expensive and time-consuming full-scale audit.
You may feel you are flying off the seat of your pants, but do not panic.
The bottom line: do not change your tax structures or arrangements without consulting your tax advisor first. This is not the end of family trusts, they are important for asset protection. Just administer them properly and do not begrudgingly pay your adviser to do it. It is in your family’s best interests. Triggering and defending an avoidable tax audit can be more expensive and demoralising.
There is no need to get rid of it or Ben, the family dog. Both will keep you happy and safe.
As a footnote: For those of you who like doing your own tax returns or research, here are all the new rules you can read up on with heaps of examples.
23rd Feb 2022, the Australian Taxation Office released their long-awaited draft guidance on section 100A and Division 7A of Part III of the ITAA 1936.
The draft guidance materials consist of:
- TR 2022/D1 — Income tax: s 100A reimbursement agreements
- PCG 2022/D1 — Section 100A reimbursement agreements — ATO compliance approach
- TA 2022/1 — Parents benefitting from the trust entitlement of their children over 18 years of age
- TD 2022/D1 — Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of ‘financial accommodation’2021
Chartered Accountant, Chartered Tax Adviser, Registered Tax Agent, Former AGPAL Surveyor 10 years of service
David Dahm is CEO and founder of the national medical and healthcare chartered accounting firm Health and Life and global Founder and CEO of the not for profit project the International Healthcare Standards and Ethics Board (www.ihseb.org)
After a serious work related car accident in 1989, and nine operations later I continue to be a patient and provider advocate. I enter my third decade as a national Chartered Accountant for Medical and Healthcare practices in Australia. I am a former 10-year Australian General Practice Accreditation surveyor. I come from a medico family. I have served on the AAPM national Board and was the inaugural national Chair of the Certified Practice Manager CPM post nominal. I continue to provide accounting tax and practice management advice to many practices all over Australia.
You know who you are and I thank you for this real honour and privilege to serve you and your community through you. Note, I am not a lawyer please seek appropriate legal and accounting advice. This information is for general information and discussion only.