Legal and financial advisors have long advised clients on the advantages of structuring their affairs using discretionary trusts, the two most notable of which are asset protection and income splitting. Assets held in a discretionary trust cannot be said to be owned by any specific beneficiary as no beneficiary is absolutely entitled to any such asset, and passive trust income can be split amongst beneficiaries to achieve the most beneficial tax outcome for the trust as a whole.
In the last 15 years the asset protection benefits of a discretionary trust have been eroded by the powers of the Family Court in family law matters, and since the decision of the Federal Court in the Richstar decision1 in 2006 there has been an argument that such erosion should also apply to matters involving the insolvency of trustees of discretionary trusts, by equating effective control of a trustee to a proprietary interest in the assets of the trust.
More topically, the income splitting benefits of discretionary trusts have come under attack from the Australian Labour Party, which is seeking to ameliorate the advantage should they win power at the Federal election to be held on 18 May 2019. The ALP’s plan is to tax all distributions from discretionary trusts to adult beneficiaries at 30%, regardless of the marginal tax rate of the beneficiary, from 1 July 2019. This policy targets the ability of the trustee to direct passive trust income to adult beneficiaries who currently earn less than $38,370 per year (taking into account the low-income tax offset) and whose income is therefore subject to a maximum 19% marginal tax rate. The ALP cites the independent Parliamentary Budget Office in claiming that these changes will lead to an additional $4.1 billion in taxes raised by the end of the 2022 financial year.
So where does this leave the discretionary trust if the ALP wins power at the election? It should be noted that the income splitting benefits of such trusts would only be reduced rather than entirely abolished. In taxing distributions to individual beneficiaries at 30% the ATO would be bringing all beneficiaries under a discretionary trust into line with “bucket companies” the income of which is taxed at a flat 30%. This means that a distribution of $139,000 or more to a beneficiary who has no assessable income in a given financial year will not be affected by the changes. Below this level of distribution, however, the changes will be felt.
Regardless of whether the ALP wins the election, discretionary trusts will remain an important structuring tool from as asset protection perspective. The fact that no one beneficiary can be said to have an entitlement to an asset of a discretionary trust allows risk of individual beneficiaries to be quarantined. In this context it is important to acknowledge that the Richstar decision has not been followed subsequently by courts, has been confined to the particular statutory context in which that case was decided and has been subjected to significant academic criticism. The flexibility of a trustee to distribute income and assets to beneficiaries will remain and, while the ALP has suggested in a separate policy a reduction in the percentage of the capital gains tax discount, there is no suggestion that it will restrict access of discretionary trusts to the discount. Moreover, where allowed by the succession legislation of the relevant jurisdiction, discretionary trusts will continue to be effective in estate planning.
Rostron Carlyle Rojas Lawyers is a full service law firm with expert Lawyers in Brisbane and Sydney. We offer our services globally, in wide array of legal areas including: Corporate and Commercial Law, Insolvency Law, Construction Law as well as Family Law to mention a few.
Don’t hesitate to contact us if you would like to discuss the use of discretionary trusts or structuring in general.