Family trusts run deep

With trusts now the structure of choice for small business, it’s little wonder ALP policy is being tagged “courageous”.

Australian Opposition Leader Bill Shorten (right) and Federal Shadow Treasurer Chris Bowen address the media on Sunday. (AAP Image/Sam Mooy)

The fact that Opposition Leader Bill Shorten’s crackdown on family trust income splitting was being described as “courageous” yesterday is a pretty good indicator of the special place that trusts have in the hearts of Australian business people.

It is, or at least should be, a no-brainer: income splitting is a device that should have been removed long ago, but ever since the failure of John Ralph’s effort to clean up trusts in his Review of Business Taxation in 1999, which was buried by the National Party, trusts have come to be the structure of choice for Australian small businesses, and splitting the income an annual accounting ritual.

These days the majority of business activity now goes through trusts; The Australia Institute reckons a fifth of national GDP sits in them.

And why not? Most small businesses are family affairs: everyone works in the business, or has to put up with mum or dad moaning about it over dinner every night, and one day the kids will be the owners (and moaners). So a family trust, with each family member as a named beneficiary, seems not only a natural way to run things, but a sort of dynastic battlement — our trust is our castle.

Oh, and you get to keep the assets from creditors and decide where the cash goes, and since it doesn’t get taxed until it gets somewhere else, spreading it around — or splitting it — can lower the average family tax rate.

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.

John Howard, then Treasurer, made a half-hearted effort to fix the problem 40 years ago by introducing Division 6AA of the Tax Act (1936) which imposed the top marginal tax rate of 45 per cent on trust distributions to dependent children. But he left out spouses and other adult relatives, presumably on purpose.

In 1998 another Coalition Treasurer, Peter Costello, appointed John Ralph to review business taxation. However he failed to abide by the golden rule that you never have an inquiry if you don’t already know the answer, and Ralph proposed uniform taxation of business entities — taxing trusts as companies.

That recommendation went straight to the bin labelled “C” for courageous and from then on, trusts took off.

Perhaps the Rudd/Gillard/Swan Labor Party would have dusted off the Ralph Review after 2007 if they hadn’t been mugged by the GFC, but they were, and they didn’t.

And now, according to the latest Coalition Treasurer, the ALP’s attempt to revive Ralph 18 years later, almost to the day, by applying the company tax rate to trust distributions is a “dark economic vision”.

These words may well haunt Scott Morrison. If the Coalition makes allowing income splitting to avoid tax an explicit part of its election platform, and it somehow manages to win the election despite that, the policy will come back and bite it on the budget.

But this political battle over the use of trusts is not superficial. In some ways it is a new front in the eternal war between capital and labour, between business owners and employees, and it’s not entirely clear how it will turn out.

At one level, it is simply about improper tax avoidance: if distributing income to a dependent child is wrong, as decreed by John Howard and embedded in Division 6AA, then so is distributing it to a dependent spouse, or to a brother or sister who promptly gives the distributed cash back as a gift.

But at a deeper level it could be portrayed as an attack on family businesses generally and the organising structure that recognises that it’s a family rather than a company or a business partnership.

At least that’s presumably what the Turnbull Government will try on, unless the Prime Minister overrides the Treasurer again because he decides they need the money.

If he doesn’t, the argument could be an interesting test of both sides’ rhetorical skills, as well as an indication of where Australia sits on what might be called the Jeremy Corbyn spectrum — are we chanting or yawning?

Alan Kohler is Publisher of The Constant Investor — www.theconstantinvestor.com