ATO’s relief from trust crackdown won’t help all SMEs: Expert

Just days after the Australian Taxation Office soften its stance on its crackdown on 200,000 trusts that use corporate beneficiaries, a leading tax expert says the escape clause offered by the ATO might not help thousands of entrepreneur trust owners.

The ATO’s trust crackdown relates to a tax structure commonly-used by SME owners, whereby a business that is owned through a trust distributes income to a corporate beneficiary to take advantage of the lower 30% company tax rate. However, the income typically remains inside 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 is seeking to crackdown on unpaid present entitlements that it sees as “loans” from the corporate beneficiary to the trust and wants to tax these “loans” at the highest marginal tax rate, on top of the 30% corporate tax rate.

The ATO’s ruling on this issue, delivered in June, was met with anger from many tax professionals, who claimed entrepreneurs who had mistakenly labelled unpaid present entitlements as loans would be exposed to large tax bills and loan repayments.

However, late last week the ATO softened its stance, saying it would allow trust owners who have genuinely mislabelled their unpaid present entitlements as loans the chance to self correct their mistake by December 31, 2011.

While this was welcomed by accounts, tax expert Chris Wookey from Melbourne accounting firm GMK Partners says the concession might not be the escape clause every trust owner hopes.

Not all mislabelling will be able to be self-corrected.

In some cases, a loan may actually exist between a corporate beneficiary and a trust, even if the trust owners believe it should be labelled as an unpaid present entitlement. Wookey says many trust deeds (particularly older ones) essentially set up an automatic loan from the corporate beneficiary to the trust via the wording of the trust resolution, which says that income paid from the trust to the corporate beneficiary will be “applied” back to the trust.

“I am becoming aware of so many accountants out there who have done things like that,” Wookey says.

Where a loan like this does exist, the trust owner can still re-label the loan provided they can show that the trust and the corporate beneficiary are both small business entities – that is, they both carry on actual businesses.

Wookey says this would be difficult.

“It would be extremely rare for the corporate beneficiary to be carrying on a business. They have made the conditions so tight that’s its almost never going to be available.”

This leaves the trust owner with the option of applying to the ATO’s discretion to re-label the loan as an unpaid present entitlement.

Wookey says that can be like “playing Russian roulette. In the past people have been very reticent to do that for fear of baring their soul and not having any guarantee of the ATO coming down on their side.”

Wookey says the test for trust owners should be relative simple – if your trust deed talks about income or distributions being “applied” rather than “set aside”, you probably have a problem.

Like many experts, Wookey says the case highlights the need to re-write Australia’s trust rules, which in some cases are more than 80 years old.

“The rules as they were written are not suited for modern businesses.”