ATO tries to soften the blow of trusts crackdown with new guidelines

The Australian Taxation Office has extended something of an olive branch to the thousands of entrepreneurs who operate trusts with corporate beneficiaries by releasing a guide to help trustees deal with a new tax crackdown on trust arrangements.

In June, the ATO released guidelines on a tax planning arrangement used by up to 200,000 entrepreneurs, attacking the ability of trustees to minimise their tax through a corporate beneficiary and retain funds in a business for working capital.

Under the relationship, a trust distributes income to a corporate beneficiary, which then pays tax on that distribution at the corporate tax rate of 30%. But no cash actually moves between the trust and the corporate beneficiary – instead, the funds remain in the trust, where they can be used by the business owner as working capital to fund further growth. This is known as an unpaid present entitlement.

But the ATO sought to classify those unpaid present entitlements as “loans” or deemed dividend to the trust, meaning the “loan” is taxed at the highest marginal tax rate, on top of the 30% corporate tax rate.

Experts including Robert Jeremenko from the Taxation Institute of Australia have said the ruling could end up costing SMEs and family trust owners “hundreds of millions of dollars” and send some businesses to the wall as they seek to repay loans to avoid tax.

A big part of the problem for SMEs was the way unpaid present entitlements have been described in SME company accounts. Where the UPE was described a loan – even if it wasn’t actually a loan – the ATO considered this a deemed dividend under Division 7A.

However, the ATO’s new practice statement has given trust owners who have made this mistake a way out by allowing trust owners to had misclassified unpaid present entitlement as a loan to correct their mistake by December 31, 2011.

If a trust owner has a genuine unpaid present entitlement, they will be able to retain the unpaid present entitlements in a sub-trust by paying the corporate beneficiary interest on the loan at a seven-year-hosing benchmark or the 10-year small business rate. Alternatively, the trust can re-invest the unpaid present entitlement in an income producing asset and pay dividends to the company.

However, where the trust does not pay interest and dividend, the ATO will consider this to be a normal loan and it will be taxed accordingly, with repayment over seven years.

Additionally, trust owners who have incorrectly labelled an unpaid present entailment that is actually a loan will be able to apply to the Tax Commissioner for discretion.

Tax experts Marc Peskett of MPR Group and Peter Bembrick of HLB Mann Judd in Sydney say the ATO’s concessions are welcome.

“Any concessions from the ATO are always welcome. They are obviously trying to be practical,” Bembrik says.

“We’ve been saying this for years, but I still see balance sheets with the word ‘loan.’”

Peskett says the ATO has realised that many SMEs may have incorrectly labelled loans and it is positive to see them given a chance to correct genuine mistakes.

“As accountants start to get ready for trust tax returns, it’s time to review all this, see how it’s been classified and take corrective action where necessary.”

“But there are certain conditions hanging off these concessions, so not everyone will qualify.”

However, Tamera Lang from the Taxation Institute of Australia remains less than impressed.

“While this does address some concerns, it’s not fixing the ruling, which we still think has flawed legal basis. A UPE is not a loan.

“We need some sort of legislative fix or a test case to help solve this situation.”