Family trusts and tax dodges
Scott Morrison began his attack even before the opposition had announced its plans to crack down on tax avoidance through family trusts. On Friday last week, he told Sky News the Labor Party was coming after small business and farmers “with a meat cleaver”.
Certainly, Labor is planning to take a big slice of tax revenue out of trusts: when Opposition Leader Bill Shorten formally announced the policy two days later, he said it would impose a standard minimum 30 per cent tax rate on the distributed earnings of discretionary family trusts, expected to yield $17.2 billion over 10 years.
Morrison was wrong about the farmers, though. They were spared the cleaver. But given that there are only some 19,000 farm trusts, and a total of nearly 650,000 such “discretionary” family trusts in Australia, Morrison was about 98 per cent right.
And he was 100 per cent right with something else he pointed out in that interview: in 2011 Shorten stoutly defended trusts.
The record shows that in early April that year, when the idea had been floated by then treasurer Joe Hockey that trust income should be taxed at the same rate as company tax – 30 per cent – Shorten was scornful. The then assistant treasurer in the Gillard government said Labor supported trusts as “legitimate tax arrangements” and decried the fact that such a change would “see thousands and thousands of family businesses pay far more tax than they do at present”.
Now, just six years later, he is proposing that the income from trusts should be taxed at 30 per cent.
“So I don’t know what’s changed,” Morrison said.
In one respect, he is right to wonder. If Shorten thought a crackdown on family trusts was a bad idea in 2011, why does he now think it a good idea? The reality is that a host of tax experts – at least those without a vested interest in maintaining the status quo – have long called for reform. The Ralph review of business taxation, commissioned by then treasurer Peter Costello in 1998, recommended taxing trusts in the same way as companies in the interests of uniformity. Serious people have been pointing to the need to fix this inconsistency in the tax laws for decades. High Court Justice Sir Isaac Isaacs expressed major concerns about the use of trusts for tax avoidance almost a century ago.
So at one level, nothing has changed. The idea of fixing the tax loophole of discretionary trusts is no more or less valid in 2017 than it was in 2011, when Shorten rubbished it. In other ways, though, a great deal has changed.
There has been a steady accretion of evidence of growing inequality in Australia. Morrison chooses to deny it and say Australia is becoming less unequal, but the numbers – not to mention Philip Lowe, governor of the Reserve Bank – say otherwise. Just this week we saw more evidence in the Household, Income and Labour Dynamics in Australia (HILDA) survey: household incomes lower than in 2009, plunging levels of home ownership among younger Australians, declining social and economic mobility, less full-time work.
There is a widening gap between the “haves”, who are asset-rich and able to make money off money because taxes on capital are relatively light and often avoidable, and the “have-nots”, who are asset-poor and reliant on what they earn from their labour, and whose wages are flatlining.
In 2011 it was widely assumed the global financial crisis was just another in a series of economic downturns, rather than an indicator that the whole neoliberal economic model might be broken. Shorten’s defence of trusts preceded the Occupy movement and Thomas Piketty’s surprise bestseller, Capital in the Twenty-First Century. It was before institutions such as the Organisation for Economic Co-operation and Development and International Monetary Fund began hammering the message of “inclusive growth” and seriously questioning the nostrums of trickle-down economics.
More importantly, in political terms, it was before the punters let it be known they had woken up to this inequity. This week’s Essential poll was another indicator of that. It found 52 per cent of respondents thought inequality in Australia was increasing. Only 12 per cent thought it wasn’t, despite Morrison’s claims. And, when asked about tax reform to prevent income-splitting through trusts, twice as many were in favour as were opposed.
Perhaps Scott Morrison and others in the government have not clocked the hardening public mood on these things, any more than they have clocked changing popular opinion on things such as same-sex marriage and climate change.
Or maybe they are in wilful denial, given that the wealthy and tax savvy are core to the conservative parties, and that many of them have trusts. Indeed, a survey of the federal parliamentary register of MPs’ and senators’ interests by Fairfax Media a few months ago showed that 49 of the 105 Liberal and National Party politicians have a personal or family interest in a discretionary trust, including 10 of 20 cabinet members.
The register doesn’t tell us much though. We don’t know what assets those trusts hold, what they earn, the identities of other beneficiaries or the amounts distributed, although Morrison’s entry in the register says his family trust is “dormant”.
But the figure is still telling: 47 per cent of the government has a discretionary trust, compared with about 5 per cent of the general population.
Labor proposals for reforms of capital gains tax, negative gearing, superannuation tax breaks and now trusts might once have been politically courageous. Now, however, they simply reflect the realisation that such policies are good politics – even if personally awkward for some in the party. Twenty-one Labor members and senators, Shorten not among them, also have interests in family trusts. So do a couple of crossbenchers, including Nick Xenophon and Derryn Hinch. Greens leader Richard Di Natale, by contrast, lists a charitable trust.
It is not just the popular zeitgeist driving the push for reform of the tax treatment of trusts, either. There are two other big factors. First, government is strapped for revenue. More importantly, trusts have proliferated hugely. According to an analysis of data from the Tax Office, released last week by The Australia Institute, there were 823,448 trusts with assets of $3.1 trillion and revenue of $349.2 billion in 2014-15 – the latest period for which numbers are available.
Of those, 642,416 or 78 per cent were discretionary trusts, which are the ones Labor’s proposed changes are targeting. They are called “discretionary” because, as The Australia Institute explains, the trustee is able to decide “at his or her own discretion, the amount of money that will be paid to each beneficiary under the trust”.
And therein lies their attraction for high-wealth people seeking to cut their tax bills: trust income can be apportioned strategically among beneficiaries – who might include spouses, adult children, parents, spouses of children and often a company held within the trust. The deeds under which these trusts are established are often complex, but the principle is simple: by spreading the money around, you lower the tax payable, because each beneficiary gets the advantage of a tax-free threshold and the intermediate rates under our progressive income tax system.
The Australia Institute’s analysis reckoned a fifth of national GDP sits in these trusts, and that almost 95 per cent of it is held by people in the wealthiest 20 per cent of households.
“More than half of distributions (51.2 per cent) related to just 0.43 per cent of all taxable individuals, those with taxable incomes of $500,000,” it found.
The institute estimated the revenue loss to the government at $3.5 billion a year. Other estimates are lower. Dale Boccabella, associate professor of taxation at the University of New South Wales, estimates the revenue loss at $2 billion per year. Still, that’s a lot of money.
And growing fast. The number of such trusts has almost doubled since 1996-97, and tax experts say the anecdotal evidence – although there are as yet no official numbers – that more high-wealth people are using trusts since the recent changes to the rules around superannuation made it a less effective tax dodge.
“Tax avoidance is like a balloon,” one expert said. “You squeeze it in one place and it bulges out somewhere else.”
Trusts have been around for hundreds of years. We inherited them from Britain. Essentially, they are a clever legal fiction designed to allow the upper class to protect the family silver.
Says Boccabella: “They split the ownership of an asset into legal and beneficial ownership, so the legal owner holds it for the beneficial. Therefore any legal responsibilities imposed on the beneficial owner don’t exist. That has a couple of ramifications, a big one is that if the beneficiary was a drunk or a gambler, who runs up debts, creditors can’t come to him or her for the assets of the discretionary trust.”
They were very useful in succession planning, ensuring that family assets passed to the right, select people.
In Australia, their application comes with the introduction of the Income Tax Assessment Act of 1915.
Until that time there had been no federal income tax in Australia, although there were small state income taxes. In 1915, the Commonwealth began levying it to help with the expense of fighting World War I. The rate was steeply progressive, with nine different brackets, the highest of which – 33.6 pence per pound – cut in at £2000, or almost 14 times the average male income.
The ink was barely dry on the new legislation before rich people began trying to find ways to avoid paying. A Queensland grazier by the name of Thomas Purcell clearly thought too much was being asked of him, even of it was to fund the war effort.
It wasn’t as if he couldn’t afford it. His income for the 1916-17 financial year was assessed by the deputy federal commissioner of taxation to be £35,129. The average wage at the time was about £145 for men, and about half that for women. Adjusted for inflation, in today’s terms Purcell’s was earning about $20 million per annum.
Purcell took the taxman to court.
He argued, says Professor Miranda Stewart, director of the Tax and Transfer Policy Institute at the ANU, that he had “declared a trust of the beneficial interest in the farming property for himself, his wife and his daughter equally.
“This produced the result that the income of the farming property was distributed to each member of the family as a beneficiary of the trust so that each individual included that one-third share of farming income in their individual tax return.”
Thus three of them should have access to the lower rates of tax that applied to the first £2000 of their income – a big tax saving for the Purcell family.
The case went all the way to the High Court, where the majority of judges upheld the arrangement.
“Only one judge,” Stewart says, “considered such income splitting amounted to tax avoidance. Justice Isaacs (dissenting) concluded that the restructure was a ‘device’ for Mr Purcell to avoid taxation and remarked, presciently, that the case ‘will afford a comfortable refuge to many an enterprising debtor or taxpayer desiring shelter from the financial obligations of the law’.”
Stewart and Boccabella hold the same view. So, obviously, does The Australia Institute, which calculated that tax minimisation through trusts costs each average taxpayer $354, or $202 per annum on Boccabella’s more conservative estimates.
There are those who see it differently, of course, such as Michael Evans, senior fellow at the University of Melbourne law school, former tax partner at KPMG and an adviser on tax matters to various governments in Australia and internationally.
He is furious at the mooted changes to discretionary trusts, including his.
He is a big advocate of them.
“In the event of death it makes things very simple. Everything just continues. That’s why trusts were established in the first place. It’s about succession,” he says.
“They are saying I can’t use a mechanism to provide for my wife and daughter so we have an equal sharing of wealth.”
Evans objects strongly to the pejorative term “income splitting”, preferring to describe the discretionary allocation of income thus:
“At various times during our life stages, the income will benefit different ones of us, depending on when we need it. So a trust is totally logical. It is the very structure that gives effect to what I intend.”
He says various tax reviews over the years “all came at it from the same perspective – that is that income properly earned by an entity is taxed at the beneficial rate of the beneficial owner.
“That’s our system. And if that means that the more wealthy can shift assets to other family members, to benefit from them, then that’s a question you should address by other means, like gift and capital gains tax.
“We should be doing as much as we can to ensure that assets are owned and controlled, and the income is derived, by the family and not by individuals.”
His argument, however, ignores a couple of realities. The first is that most Australians don’t have access to trusts and don’t have sufficient assets to pad them.
And, more importantly, as Alan Kohler noted in The Australian recently: “Trouble is that the income tax system is designed around taxing individuals, not families. Maybe there’s a case for averaging taxation across family members, especially in family businesses, but that’s not the way it works and we’re not having that discussion.”
No, indeed. The discussion we’re having, ever more urgently, is about equality.
Scott Morrison’s rhetoric has been quite hyperbolic. Bill Shorten was a “till raider”, pushing policy “dripping with envy and higher taxes”.
Shorten, in contrast, has opted to project reasonableness, which he lacked in 2011, acknowledging in his announcement “a range of legitimate reasons” for having trusts, “such as asset protection and business succession”.
He continues that, in some cases, trusts are being used for the sole purpose of tax minimisation
“While artificial income splitting is completely legal,” he says, “that doesn’t mean it is fair.”
Note that small word “fair”. Expect to hear it a lot on the way to the next election.
This article was first published in the print edition of The Saturday Paper on Aug 5, 2017 as "Family trusts and tax dodges". Subscribe here.