Issues in taxation of companies and trusts Michael Walpole

Objectives How taxing such business vehicles works The issues this raises Stepping off point for discussion

Companies Widely used for routine commercial reasons Limitation of liability Certainty for investors Clear, established rules and outcomes Some ASIC scrutiny Complex structures possible – some complex tax rules Eg consolidations rules

Companies Taxed at a flat rate of 30% The general 50% CGT discount is unavailable (but small business discounts may be) Sundry anti avoidance measures e.g. div 7A loss trading and c’fwd measures share value shifting etc etc

Companies Getting money out Franking credits Salaries and fees Dividends Franking credits Dividends carry credits reflecting the (30%) tax paid by the company Included in shareholders’ income But tax obligation reduced by the credit Can lead to tax refund to the shareholder Not available to non resident shareholders

Companies The problems people see 30% is all that is paid on undistributed profit Incentives for locking profit into companies 30% is much more than (e.g.) Singapore (18%); China (25%); Hong Kong (17%) But close to others – UK (30%) US (40%) World trend in company rate is down (KPMG Corporate and Indirect Tax Rate Survey 2007)

Corporate Tax Rates ASPAC 1997 - 2007 Source: KPMG Corporate and Indirect Tax Rate Survey 2007

Corporate Tax Rates OECD 1993 - 2007 Source: KPMG Corporate and Indirect Tax Rate Survey 2007

Taxing trusts Which trusts? Many types Focus on discretionary trusts Getting money out – salaries or distributions Main tax benefit is income splitting (tax deferral through retention not a big issue) Attractiveness lies in Some shelter from creditors (like co’s) Flexibility Estate and financial planning Income for orphans etc

Taxing trusts Just how popular are they? 2006/7 609,915 trust returns (+7.1% on 2005/6) 461,073 (75.6%) of lodging trusts were discretionary trusts They account for Owen Covick’s ‘two nations’ See “Put not trust(s) in tax reform: rather do the opposite”

Source of income – Discretionary Trusts 2006/7 Source of income disc trusts No. % of all disc trusts Investment 238,008 51.6 Trading 186,105 40 Service - management 39,960 8.6

What’s the attraction? Ability to split income (and cap gains) to obtain lowest effective rate/s Flow through of CGT concessions esp. small business concessions Not as readily available through companies Lack of alternatives

Some limits on tax effectiveness of trusts Trust loss measures Beneficiary non disclosure tax Unearned income of minors rate Tax on trustee for undistributed income Family trust election for losses and div credit streaming Complexity/cost/uncertainty Not to be underestimated

Possible solution? Focus on discretionary trusts Maybe also private unit trusts? Remove competitive advantage vis a vis companies Tax Trustee at company rate (or higher?) Tax beneficiaries at own rate Give credit to beneficiaries But lock in who the beneficiaries will be from year to year – remove option to chop and change May be done by deeming or periodic (not annual) election of beneficiaries to bear the tax Leave trusts there for those who genuinely need them for reasons other than tax