‘It’s just too political’: Why the discretionary trust tax cannot be perfect

For UNSW School of Accounting, Auditing and Taxation Associate Professor Dale Boccabella (pictured), the discretionary trust regime has been in need of change for decades, and the government’s proposed reforms announced last Wednesday (14 October) could provide an opportunity for positive change, he said.

“The current system is a joke. It really is a joke. No credible tax policy person would come up with what the position is now,” Boccabella told Accounting Times.

“Both of the major sides of politics, the Liberal National coalition and the Labor side, they both tried over the last 35 years to fix the problem – they’ve always failed at the last hurdle.”

While CPA Australia argued that discretionary trusts are a widely used structure for family businesses and investors, and have been for over 80 years, Boccabella stressed that running a business was not the original purpose of a trust.

He said that trusts were not invented to take on risk, and thus, discretionary trusts are not meant to operate a business through.

“We badly need this reform. The current rules around taxation of discretionary trusts are just completely deficient. They don’t even come close to having credibility on tax policy grounds,” he said.

Second-best solution

Boccabella broadly supports reform to the discretionary trust regime, saying that it is crucial to crack down on tax avoiders.

“It is not the perfect solution, but it’s really close to it. But you’re not going to get the perfect solution and the reason for that is it’s just too political,” he said.

“But this solution is the second-best solution, but overall, it’s a pretty good solution.”

In light of the current regime, Boccabella poked a few holes. He noted cases where the male in a relationship declared that they do not own the discretionary trust, so it could not be added to the property pool for division; and went on to argue that the system is bad for creditors as well.

“Asset protection, beautiful word; but honestly, sometimes it’s code for economic injustice,” he said.

“Unsecured creditors of a discretionary trust, that operates a business that’s going to be pear-shaped, I don’t hold much for them getting paid their money, and they might actually be small businesses themselves.”

“Let’s just put a little bit of a full picture on the asset protection thing; let’s be a bit honest.”

Issues with the reform

While the government has proposed an alternative for small businesses to exit the discretionary trust structure while avoiding a restructure, Boccabella said there are also issues with this proposal.

The proposal, an Excluded Election Trust (EET), which aims to allow the discretionary trust to be converted into a fixed trust, is this option designed to avoid the compliance and cost burdens that arise with restructuring.

“I think the government needs to be a little bit more open here, and Treasury needs to probably be a little bit more open here – that is, there’s a real problem with this election. Even though it’s technically there, the election might not be practically there based on general trust law rules,” Boccabella said.

“The whole point of a discretionary trust is that the trustee has to exercise their discretion every year for the income. What’s effectively happening here is that the law that’s going to be passed by the Parliament is effectively saying to a trustee, ‘well, no, you can’t exercise your discretion every year’.”

“I think that election there might not be that valuable. It might not be that valuable after all.”

Bad apples

“This is the idea of the rotten apples in society. It’s the old story – you’ve got people who really stretch things, potentially ruining it for everybody else. That’s really what’s going on here,” Boccabella told the brand.

He said there are some “bad apples” who use the discretionary trust vehicle to avoid responsibilities.

“It’s those people that are doing the right thing, not abusing the rules, sticking by the real technical rules, who might end up paying a little bit more extra tax,” he said.

Further, he said the new proposal that the government is putting forward for its minimum tax on discretionary trusts also does not deal with the potential duty imposts.

“It would be good if the government could talk to the states here, the federal government, because I think, in some cases, there might be some duty. There might be some of that payable under transfer to the more fixed entity under the restructure rollover,” Boccaballa said.

“I think that needs to be explored a little bit; it would be good if [there was] some sort of rollover.”

In its bid to be re-elected, the NSW Minns Labor government said it would amend existing regulations to ensure that the initial choice to become an EET is not a taxable event.

“By advancing this approach, a re-elected Minns Labor government will make sure small-business owners can focus on doing what they do best: trading, investing, and creating local jobs,” NSW Minister for Small Business Janelle Saffin said.

A better solution

“I think there is a very strong case from a principle tax policy point of view, to basically have the social security rules operate in the income tax area.”

Like many other practitioners and people in the profession, Boccaballa thought the consultation period was much too short.

“Our tax profession has incredible skill to find a hole and make the hole bigger. There’s no ifs or buts about that – not even a shadow of doubt about that,” he said.

“People have got other work to do; the time for putting in submissions for both the consultation paper and the exposure draft legislation was too short.”

While unhappy with the brevity of the consultation period, Boccabella said the government should get a move on so that trustees can start to have some more certainty about their trust structures.

“It would be good to get that legislation through in the next three or four weeks. It would be good to get it through quickly, so people can actually have a bit of certainty,” Boccabella said.