Nationals hit the brakes on trust tax reform

Peter Costello made a serious ­effort to have trusts taxed in the same way as companies almost 20 years ago, while Joe Hockey proposed the same reform in 2011, only to recant five days later.

On both occasions the Nationals undermined the reform proposals pushed by Treasury, reflecting widespread use of trusts as the holding structure for family farms.

Farmers, business proprietors and the wealthy all make use of discretionary trusts both to protect their assets and to manage their tax. Their use has increased exponentially, with numbers rising from 340,000 when the Costello reforms were considered to about 850,000 today.

The ability of trusts to split income among family members has been a constant thorn in Treasury’s side.

Trusts were a feature in the “bottom-of-the-harbour” tax scandals of the 1970s and it was John Howard, as treasurer in 1981, who pushed through the last major reform of discretionary trusts, ordering that distributions to minor children be taxed at the top marginal tax rate.

A trust which owns assets is not taxed but is required to distribute all its income each year. It does so at the discretion of the trustee. University of Griffith tax expert Brett Freudenberg says this allows trusts to protect assets from creditors (or divorcing spouses).

“If you have a share in a company and you get divorced or go bankrupt, that share is an asset in your estate. But if you’re a beneficiary in a trust, the benefit has no value and your creditors can’t go after the trust assets.”

Business owners and investors use them to split income. In the simplest form, someone with a $200,000 income could use a trust to pay $18,200 (the tax-free threshold) to their non-working spouse and child at university and get their remaining income taxed at 37c rather than 45c in the dollar.

A more sophisticated structure includes what is known as a ­“bucket company”, which is also a beneficiary and is used to receive additional income paying tax at the company rate of 30 per cent.

Discretionary trusts allow income to be “streamed”, so capital profits could be directed to the person with capital losses, while franked dividends could be channelled to someone on a higher marginal rate.

University of Sydney professor Richard Vann says one of the most problematic strategies is used by trusts owning real estate which is appreciating. The trustee has the property revalued and is able to distribute the capital to beneficiaries completely tax free.

Mr Costello’s proposed change would have treated trusts in the same way as a company for tax purposes.

Following an avalanche of criticism, Mr Costello dropped the change, saying the draft bill was “unworkable”.

Mr Hockey revisited the issue in 2011, telling an accountants’ conference that the different tax treatment for trusts had “no basis in logic”. Trusts, he said, should be taxed “in their own right and at the same rate as companies”.

After a call from then Nationals leader Warren Truss, Mr Hockey put out a statement that he had “no plan to alter the tax treatment of trusts”.