As compliance costs rise, are family trusts still worth the bother?

The administrative and compliance costs of maintaining discretionary trusts are “undeniably increasing,” HLB Mann Judd tax consulting partner Peter Bardos said in the firm’s quarterly newsletter.

In recent years, the ATO has ramped up its focus on trust distributions, beneficiary entitlements and access to tax credits, Bardos said. This has led to growing compliance costs and scrutiny.

However, Bardos said that family trusts, a type of discretionary trust, remained a useful wealth vehicle despite the rising administrative costs.

“Despite the growing attention and complexity, discretionary trusts remain valuable where they are managed diligently and sufficient investment is made in their administration,” he said.

“Although the changes remain to be seen, we expect the legal flexibility will continue to outweigh the tax complexity.”

The ATO’s growing attention towards trust distributions has likely been driven by the significant economic footprint of trusts, worth over $60 billion to be distributed to 1.7 million recipients, Bardos said.

Growing ATO scrutiny of provisions, such as including the family trust distribution tax (FTDT), necessitated careful wealth planning, particularly during intergenerational wealth transfers, he warned.

A crucial aspect of this was family trust elections (FTEs), a necessary step to accessing tax benefits, including franking credits or carry-forward losses, Bardos said.

During an FTE, a trust must nominate a ‘test individual,’ and only members of the test individual’s family group could receive trust income without being subject to the FTDT, which is levied at the top marginal tax rate of 47 per cent.

“We’re seeing increased ATO scrutiny around FTDT, especially during succession planning,” Bardos said.

“For example, if a trust with ‘Dad’ as the test individual distributes franked dividends to a company owned by his daughter’s trust (with her as the test individual), FTDT applies – resulting in a $47,000 tax on an otherwise ‘tax-free’ $100,000 distribution.”

Tax advisor and former ATO director Nitin Saby told Accounting Times’ sister brand Accountants Daily that increased ATO scrutiny was sparking unexpected FTDT liabilities.

“There is a clear trend of the ATO targeting high-net-worth and multi-generational private groups for FTDT compliance, especially where structures are longstanding or involve generational wealth transfers,” he said.

“Inadequate documentation, failure to update FTEs after changes, and not properly identifying all members of the family group are leading causes of unexpected FTDT liabilities.”

Bardos added that the Bendel case, which challenged the ATO’s established view in TD 2022/11 that an unpaid present entitlement to a company constitutes a Division 7A loan, had sparked compliance uncertainty.

As the ATO was granted leave to appeal the decision in the High Court, its existing view on Division 7A would apply while court proceedings were active.

Lack of regulatory clarity on the 45-day holding rule and section 100A reimbursement agreements had also caused compliance challenges for trust stakeholders, Bardos noted. Official ATO guidance was still pending for the former, while the ATO hadn’t released guidance on the latter for a few years.

Robyn Jacobson, senior advocate at The Tax Institute, wrote in a recent column for Accountants Daily that legislative clarity was needed regarding the 45-day holding rule.

“Public advice and guidance by the ATO, outlining its position and the Commissioner’s views on the application of the repealed provisions, is desperately needed to prevent unforeseen tax liabilities arising from the loss of franking credits,” Jacobson warned.

Going forward, regulatory reform initiatives could also spark fresh uncertainty in the trust taxation space. Bardos noted that Treasury and government policy groups were reviewing discretionary trust arrangements as part of broader tax reform initiatives.

Proposed reforms included imposing a flat tax rate of 24-30 per cent on trust distributions, treating trusts like companies for tax purposes, reducing the capital gains tax discount and introducing a dual income tax system where labour income would be taxed progressively while passive income was taxed at a flat rate.

Given the heightened complexity and uncertainty surrounding the trust space, Bardos said prospective trustmakers should balance the pros and cons of the structure carefully.

“Trusts should not be set up just because someone said it was a good idea.”