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A New Tax System (Closely Held Trusts) Bill 1999



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Bills Digest No. 189  1998-99

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A New Tax System (Closely Held Trusts) Bill 1999

Warning:

This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official lega l status. Other sources should be consulted to determine the subsequent official status of the Bill.

Contents

 

 

Passage History

A New Tax System (Closely Held Trusts) Bill 1999

Date Introduced:  13 May 1999

House:  House of Representatives

Portfolio:  Treasury

Commencement:  Upon Royal Assent

Purpose

The A New Tax System (Closely Held Trusts) Bill 1999 (the Bill) and two associated Bills(1):

  • impose an obligation on the trustees of closely held trusts (including all discretionary trusts) to disclose the identity and tax file numbers (TFN) of the ultimate beneficiaries of net income and tax preferred amounts, and
  • if the trustee fails to do so, or there is no ultimate beneficiary, provide for taxation at a penalty rate (in the case of net income) or offences under the Taxation Administration Act 1953 (in the case of tax-preferred amounts).

This will allow the Commissioner of Taxation to check whether the assessable income of the ultimate beneficiaries correctly includes any requir ed share of net income and whether the net assets of the ultimate beneficiaries reflect the receipt of the tax-preferred amounts.

The amendments apply to present entitlements to net income or tax-preferred amounts arising after 4-00 pm on 13 August 1998 AE ST.

Background - Tax Reform Package

On 13 August 1998 the Federal Government released proposals for reform of the Australian tax system(2) of which, a goods and services tax (GST) was the centrepiece.

The tax reform plan proposes to:

  • Introduce a GST which eliminates sales tax and a range of nine other indirect taxes
  • Change Commonwealth-State financial relations by providing States and Territories with an independent revenue base
  • Implement significant changes to individual marginal tax rates
  • Implement a major rationalisation of family assistance
  • Replace the various existing taxation payment and reporting systems of company tax, provisional tax, PAYE,(3) PPS(4) and RPS(5) by one quarterly tax payment system, PAYG(6)
  • Introduce a new universal business number system
  • Move toward an entity taxation system which is directed toward the elimination of tax advantages between different business structures, and
  • Simplify the imputation system and introduce refunds for excess franking credits.

Included in the proposal to r eform the taxation of business entities, the issue of tax minimisation through complex trust structures is addressed by the introduction of a special anti-avoidance rule.

On 25 November 1998, the Senate referred issues relating to the GST and the new tax system to a Select Committee and three of its Reference Committees.(7) In February 1999 the Senate Select Committee produced its First Report.(8) The three Reference Committees produced their reports in March 1999.(9) In April 1999 the Senate Select Committee released its second report(10) and shortly thereafter, its report on Commonwealth-State financial arrangements, luxury car tax and wine equalisation tax.(11)

Background - Trusts

1. Trusts

It is difficult to define a trust in a comprehensive manner, however, the following definition is commonly referred to:

A trust is an equitable obligation, binding a person (who is called a trustee) to deal with property over which he has control (which is called trust property), for the benefit of persons (who are called the beneficiaries or cestuis que trust) of whom he may himself be one, and any of whom may enforce the obligation.(12)

2. The growth of trusts

In 1996-97 the re were 427,431 trust returns lodged in Australia. This figure rose from 331,338 trusts that lodged returns in 1993-94.

Table 1- Illustrating the increase in the number of trusts lodging returns in Australia from 1993-94 to 1996-97.

 

Number of Trusts

199 3-94 331 338

1994-95 363 198

1995-96 398 010

1996-97 427 431

Source: Australian Taxation Office, Taxation Statistics 1996-97

The Australian Taxation Office attributes the growth of trusts in recent years to the increase in the number of taxpayers who a re seeking to hold and organise their assets and businesses in private discretionary trusts.(13)

While the numbers of trusts and companies have both risen, the annual growth rate for trusts has increased and the growth rate for companies has decreased.

The annual growth of companies decreased from 8 per cent in 1992-93 to 6 per cent in 1996-97. For the same period the growth rate for trusts increased from 2 per cent to almost 10 per cent in 1995-96 and then tapered off to 7 per cent in 1996-97.

The Australian Taxation Office has stated that the relative rates of growth of trusts and companies could reflect the different tax treatment of trusts and companies. 'The preference for a discretionary trust over a company structure or vice versa is dependent upon a range of factors including establishment and operating costs, the taxation treatment of income from companies compared with income from discretionary trusts, the capital gains tax treatment of shares compared with interest in a discretionary trust, and the relative level of the company tax rate.'(14)

 

 

 

 

 

 

 

 

Table 2 - Illustrating the comparison in growth rates for companies and trusts

Year

Companies

Trusts

 

No.

% growth

No.

% growth

1991-92

394 447

 

300 320

 

1992-93

426 800

8.2

305 954

1.9

1993-94

459 797

7.7

331 388

8.3

1994-95

494 967

7.6

363 198

9.6

1995-96

529 630

7.0

398 010

9.6

1996-97

559 520

5.6

427 431

7.3

Source: Australian Taxation Office, Taxation Statistics 1996-97

 

The number of trusts also varies by geographic location. In 1996-97, th e greatest proportion of trusts were located in Victoria (31 per cent) followed by New South Wales (21 per cent).

 

Table 3 - Illustrating trusts by geographic location

Trusts by State 1996-97

NSW 90273

Vic 130989

Qld 64564

SA 33725

WA 56985

Tas 947 7

NT 1657

ACT 3984

Other 35777

Total 427431

Source: Australian Taxation Office

 

In 1996-97, of those trusts where the industry was known, the largest proportion, 42 per cent, were in the property industry and 27 per cent were in the finance, insurance , real estate and the business services industry.

Table 4 - Illustrating trusts by industry

Industry

Trusts

 

No

%

Property

154 097

42.0

Finance, insurance, real estate & business services

99 687

27.2

Retail trade

24 500

6.7

Primary production

18 941

5 .2

Construction

18 146

5.0

Manufacturing

11 660

3.2

Wholesale trade

8 230

2.2

Accommodation, cafes & restaurants

6 964

1.9

Health & community services

6 740

1.8

Transport & storage

6 619

1.8

Personal & other services

5 994

1.6

Cultural & recreation al services

2 810

0.8

Communication

814

0.2

Mining

605

0.2

Education

530

0.1

Electricity, gas & water

151

0.0

Government administration & defence

32

0.0

Total industry stated

366 547

100.0

Industry not stated

60 884

 

Total

427 431

 

Source: Austral ian Taxation Office, Taxation Statistics 1996-97

In 1996-97, the industry groups are coded using the Australian and New Zealand Standard Industrial Classification (ANZSIC) system. Prior to 1995-96, the Australian Industrial Classification (ASIC) system was used. Therefore this data should not be used for time series analysis as the industry groups are not comparable.

3. Taxation of Trusts

A trust is not a separate taxable entity although the trustee must usually file a return of trust income.(15)

Generally, it is the beneficiaries that are ultimately entitled to receive, or who have received, the trust income that are taxable on it. However, the trustee is taxed on the balance to which no beneficiary is immediately entitled, or to which a beneficiary cannot immediately recover due to legal incapacity, such as infancy.

4. Net income and tax-preferred amount

4.1 Net income

The calculation of the 'net income' of a trust is the first step in determining the amounts on which the trustee and/or beneficiaries are assessable.

The net income of a trust is the total assessable income of the trust calculated as if the trustee were a resident taxpayer in respect of that income, less all allowable deductions.(16)

The characterisation of a receipt for tax purposes (ie income or capital) is determined solely by reference to the provisions of the income tax law and not by the trust deed or trust law.

4.2 Tax-preferred amount

A tax preferred amount is the capital of the trust or the income of the trust that is not included in its assessable income in working out its net income.

 

 

Main Provisions

Schedule 1

1. Summary

Schedule 1 makes amendments to the Income Tax Assessment Act 1936 (ITAA 1936) largely by inserting new Division 6D which contains provisions relating to certain closely held trusts.

The main purpose of Division 6D is to ensure that the trustee of a closely held trust advises the Commissioner of the ultimate beneficiaries of net income and tax-preferred amounts of the trust soon after the end of year of income.

If the trustee fails to do this or if there are in fact no ultimate beneficiaries of net income, Division 6D provides for taxation of the trustee (and/or the directors of a corporate trustee) at the top marginal rate plus Medicare Levy (48.5 per cent) (in the case of net income) or offences under the Taxation Administration Act 1953 (TAA) (in the case of tax-preferred amounts).

2. Closely held trust

Closely held trust is defined in new subsection 102UC(1) to mean:

  • a trust where an individual(17) has, or up to 20 individuals have between them, directly or indirectly, fixed entitlements(18) to a 75 per cent or greater share of the income or capital of the trust, or
  • a discretionary trust.(19)

It does not include excluded trusts as defined in subsection 102UC(4) such as:

  • a unit trust whose units are listed on the Australian Stock Exchange Limited
  • complying superannuation funds, complying approved deposit funds, pooled superannuation trusts, or
  • deceased estates until the end of the year of income in which the fifth anniversary of the death occurs.

3. Ultimate beneficiaries

The meaning of ultimate beneficiary is set out in new section 102UE . Other relevant definitions of trustee beneficiary(20) and listed person(21) are found in new sections 102UD and 102UF respectively.

There are three situations in which a person will be identified as the ultimate beneficiary of the whole or part of the net income or tax-preferred amount of the closely held trust (head trust amount):

  • present entitlement ( new subsection 102UE(2)
     
    Where a listed person is a beneficiary in the capacity of trustee of another trust, the listed person will be the ultimate beneficiary. 
     
    Also, where a listed person is presently entitled to the head trust amount indirectly(22) the listed person will be the ultimate beneficiary.
  • no present entitlement ( new subsection 102UE(3) )  
     
    Where a person is a beneficiary in the capacity of trustee of another trust (trust B) and no beneficiary of trust B is presently entitled to the head trust amount, the trustee of trust B will be the ultimate beneficiary. 
     
    Also, where a trustee of another trust (trust C) is presently entitled to the head trust amount indirectly and no beneficiary of trust C is presently entitled to the head trust amount, the trustee of trust C will be the ultimate beneficiary.
  • full absorption of the head trust amount.( new subsection 102UE(4)
     
    A person  who is a trustee of another closely held trust (lower level trust), and who is a beneficiary of the closely held trust or who is presently entitled to the head trust amount indirectly, will be the ultimate beneficiary where the lower level trust has income that is fully absorbed by deductions.

The trustee of the closely held trust cannot be the ultimate beneficiary of the head trust amount. ( New subsection 102UE(5) )

4. Correct UB statement

The failure of a trustee of a closely held trust to make and provide a correct UB statement to the Commissi oner within the specified period is the mechanism used to trigger liability to penalty tax or possibly offences under the TAA.

The requirements for the making of a correct UB statement are set out in new section 102UG . A statement must be in writing and include:

  • how much of the net income or tax-preferred amount is attributable to each ultimate beneficiary
  • whether the ultimate beneficiary is an ultimate beneficiary by virtue of the rules relating to present entitlement, no present entitlement or full absorption of the head trust amount
  • the name and TFN of each resident ultimate beneficiary, and
  • the name and address of each non-resident ultimate beneficiary.

It should be noted that there is no requirement to make a correct UB statement if there are no ultimat e beneficiaries.

5. Liability to pay non-disclosure tax on net income

New Subdivision C establishes liability for non-disclosure tax.

5.1 Liability to pay non-disclosure tax where ultimate beneficiary

By virtue of new section 102UK , where there are one or more ultimate beneficiaries in respect of the net income of the trust, if a trustee has not made and given to the Commissioner a correct UB statement by the time the trust's return of income for the year must be furnished, then either:

  • the trustee is liable to pay tax, or
  • if the trustee is a company, the directors are also jointly and severally liable to pay tax.

If a director did not take part in or opposed any decision not to make the correct UB statement, the director will not be liable to pay tax under new section 102UL .

The tax payable is imposed by the A New Tax System (Ultimate Beneficiary Non-disclosure Tax) Act (No.1) 1999 .

5.2 Liability to pay non-disclosure tax where no ultimate beneficiary

By virtue of new section 102UM , where there are no ultimate beneficiaries in respect of the net income of the trust, then either:

  • the trustee is liable to pay tax, or
  • if the trustee is a company, the directors are also jointly and severally liable to pay tax.

There is no exemption from liability to pay tax for directors in the situation where there is no ultimate beneficiary.

The tax payable is imposed by the A New Tax System (Ultimate Beneficiary Non-disclosure Tax) Act (No.2) 1999 .

5.3 Losses or outgoings will not be deductible and franking credits will not be available

Where a trustee is subject to non-disclosure tax on a share of the net income of the trust, that net income is not included in the assessable income of the trustee beneficiary. ( New paragraphs 102UK(2)(b) and 102UM(2)(b) )

The consequence of this is that when a distribution of the net income is made to the trustee beneficiary, any losses or outgoings incurred by the trustee beneficiary in respect of the income will not be deductible.

In addition if the distribution is a dividend, the grossed-up amount is not included in assessable income and therefore there are no franking credits.

6. Payment of ultimate beneficiary non-disclosure tax

Under new section 102UN the amount of ultimate beneficiary non-disclosure tax is reduced by the amount of any tax off-set to which the trustee would be entitled if an assessment under section 99A of the ITAA 1936 were made.(23)

Under new section 102UO ultimate beneficiary non-disclosure tax is due and payable within 21 days after the trust's return of income for the year must be furnished.

Additional tax for late payment is due and payable at the rate of 16 per cent per annum on amounts unpaid after 60 days under new section 102UP . The Commissioner may also remit the additional tax.

7. Commission of an offence re tax-preferred amounts

If a trustee fails to provide either a correct UB statement or a correct statement in writing that there is no ultimate beneficiary of the tax-preferred amount, the trustee is guilty of an offence against section 8C of the TAA pursuant to new section 102UT .

Under section 8C of the TAA a person is guilty of an offence for failing or refusing to comply with requirements under taxation law. An offence against section 8C is punishable by a fine not exceeding $2,000 for the first offence increasing to $5,000 or im prisonment for a period not exceeding twelve months for subsequent offences.

The trustee will not be guilty of an offence if evidence can be adduced or pointed to suggesting there is a reasonable possibility that the trustee did not know all the information required to be included in the statements, had taken reasonable steps to ascertain that knowledge and did include information that was known.

There is no definition of 'a correct statement in writing that there is no ultimate beneficiary' in the Bill. At this stage trustees will be left to speculate as to their exact obligations in this regard.

8. Special provisions about tax file numbers

Section 8WA of the TAA makes it an offence for any person to require or request another person to quote a TFN unless provision is made by a taxation law for the other person to quote the number.

Section 8WB of the TAA makes it an offence to record, use or disclose another person's TFN other than to the extent required by a taxation law.

Consequently, the Bill introduces special provisions to avoid the trustee breaching these TFN sections of the TAA.

New section 102UU provides that an ultimate beneficiary may quote his or her TFN to the trustee of a closely held trust in connection with the trustee making a correct UB statement.

New section 102UV ensures that a trustee will not commit an offence under section 8WB by recording, using or disclosing an ultimate beneficiaries' TFN in connection with the making of a correct UB statement.

9. Application

The operative provisions o f new Division 6D will only apply where present entitlement to net income or tax-preferred amounts arose after 4 p.m., by legal time in the Australian Capital Territory, on 13 August 1998. ( Item 3 )

Item 4 contains transitional provisions, which in effect, extend the deadline for the making of a correct UB statement to 90 days after commencement of the Bill (ie 90 days after the Bill receives Royal Assent) in the situation where the due date upon which the trust's income tax return must be furnished (generally 31 October) occurs before the Bill receives Royal Assent.

Schedule 2

1. Consequential amendments

A number of consequential amendments are made to other provisions in the ITAA 1936, Income Tax Assessment Act 1997 (ITAA 1997) and Superannuation Contributions Tax (Assessment and Collection) Act 1997 (SCT Act 1997) to deal with the effect of the introduction of new Division 6D . These include:

  • the insertion of new paragraph 26(b)(iii) (ITAA 1936) to ensure that the assessable income of a taxpayer shall include amounts on which ultimate beneficiary disclosure tax is payable
  • the insertion of new paragraph 128(3)(l) (ITAA 1936) so that a liability to non-resident withholding tax will not arise where a trustee is subject to non-disclosure tax on a share of the net income of the trust
  • the amendment of section 170(10) (ITAA 1936) so that the four year limit on further amending assessments will not apply for the purpose of giving effect to the new provisions relating to certain closely held trusts, and
  • the amendment of paragraph (aa) of the definition of 'adjusted taxable income' in section 43 (SCT Act 1997) to include income that would have been included in assessable income of a trustee beneficiary if it wasn't excluded because it is subject to ultimate beneficiary non-disclosure tax.(24)

Concluding Comments

1. 'Draconian lack of trust'

The aim of the legislation is purportedly to enable tracing of ultimate beneficiaries through complex chains of trusts. The meaning of 'closely held trust' is, however, defined to incl ude all discretionary trusts. Therefore, whether or not there is a complex trust structure in place or not, all trustees of discretionary trusts will be subject to the new provisions.

This has been described as 'draconian' and a move that will cause up to 60,000 trusts to engage in yet more paperwork for no real reason.(25)

Critics may argue that the Bill imposes disproportionate compliance costs on many to control cheating by a few.

2. Wider application than indicated in tax reform plan?

The proposal in the tax reform plan stated that 'The Tax Office has evidence that certai n taxpayers are using complex chains of trusts to minimise tax. … A special anti-avoidance rule will be introduced, with immediate effect. …This will apply regardless of the number of trusts through which distributions may pass. The measure will help establish tax liabilities by providing an administrative audit trail.'(26)

The tax reform plan did indicate that the special anti-avoidance rule 'will require the identification by trustees of discretionary and closely held fixed trusts of the individual or company beneficiaries, and their tax file numbers if they are residents, that are ultimately entitled to trust distributions'.(27) However, the setting within which the rule was described clearly related to complex chains of trusts used to minimise tax.

The Bill is not restricted in its application to such complex trust structures and may therefore be beyond that contemplated in the original statement of intention on this subject, to which the date of effect of the provisions has been linked.

Endnotes

 

  1. The A N ew Tax System (Ultimate Beneficiary Non-disclosure Tax) Bill (No.1) 1999 and the A New Tax System (Ultimate Beneficiary Non-disclosure Tax) Bill (No.2) 1999.
  2. Treasurer, Tax Reform: not a new tax - a new tax system ; Tax Reform Plan, 13 August 1998, Commonwealth of Australia.
  3. Pay As You Earn
  4. Prescribed Payments System
  5. Reportable Payments System
  6. Pay As You Go
  7. Senate Select Committee on A New Tax System; Senate Community Affairs References Committee; Senate Employment, Workplace Relations, Small Business and Ed ucation References Committee and Senate Environment, Communications, Information Technology and the Arts References Committee.
  8. Senate Select Committee on A New Tax System, First Report , February 1999.
  9. Senate Community Affairs References Committee, The Luck y Country Goes Begging, Report on the GST and a New Tax System, March 1999; Senate Employment, Workplace Relations, Small Business and Education References Committee, Report of the Inquiry into the GST and A New Tax System, March 1999 and Senate Environment, Communications, Information Technology and the Arts References Committee, Inquiry into the GST and a New Tax System, March 1999.
  10. Senate Select Committee on A New Tax System, Main Report , April 1999.
  11. Senate Select Committee on A New Tax System, Report on Commonwealth-State Financial Arrangements Bills, Luxury Car Tax Bills and Wine Equalisation Tax Bills , April 1999.
  12. Underhill, Law of Trusts and Trustees , 12 th ed, p 3.
  13. Australian Taxation Office, Taxation Statistics 1996-97 , Chapter 10, Partnerships and Trusts.
  14. Ibid.
  15. '[I]t would appear that before the provisions of Division 6 may be brought into operation there must be income arising from property under the control of a  trustee.'  CCH Australia Limited, Australian Federal Tax Reporter , Volume 4 at p 29, 915.
  16. Section 95 of the ITAA 1936 . The effect of the definition of net income is that the trustee is deemed to be a resident taxpayer and that, therefore, income from sources both in and out of Australia and all allowable deductions relating thereto are taken into account.
  17. An individual and his or her relatives are treated as being one individual. Thus an individual cannot circumvent the 20/75 rule by having family members or their nominees holding interests in the trust. ( New subsection 102UC(3) )
  18. Generally, if a beneficiary has a vested and indefeasible interest in a share of income or of the capital of a trust, the beneficiary has a fixed entitlement to that share of the income or capital.
  19. Discretionary trust means a trust that is not a fixed trust within the meaning of section 272-65 of Schedule 2F of the ITAA 1936. A fixed trust is one where persons have fixed entitlements to all of the income and capital of the trust.
  20. A person is a trustee beneficiary of a closely held trust if the person is a beneficiary of the trust in the capacity of trustee of another trust.
  21. A person is a listed person if the person is:  
     
    (a) an individual who is not a trustee  
    (b) a company that is not a trustee  
    (c) the trustee of a trust that is not a closely held trust  
    (d) a pooled superannuation trust, a complying superannuation fund and a c omplying approved deposit fund 
    (e) a charitable, educational, scientific or religious institution whose income is exempt, or 
    (f) a gift deductible entity
  22. That is, through one or more interposed trusts or partnerships.
  23. The tax rate applicable to the net inc ome of a trust to which no beneficiary is presently 
    entitled depends on whether the income is assessed under section 99 or section 99A of the ITAA 1936. Section 99 only applies to the income that section 99A does not apply to. The tax rate under section 99A is the maximum rate of personal tax (ie 47%), which reflects the fact that this section was introduced to counter tax avoidance. The Commissioner has discretion to assess the trustee under section 99 and income is then taxed at progressive rates. The Commissioner will generally exercise the discretion to assess deceased estates under section 99 unless there is tax avoidance involved.
  24. The object of the SCT Act 1997 is to provide for the assessment and collection of the superannuation contributions surcharge payable on surchargeable contributions for high income individuals. But for the amendment proposed to the definition of 'adjusted taxable income' there may be opportunities for distributions to be deliberately made the subject of ultimate beneficiary non-disclosure tax in order to reduce the income of an individual to a level where the superannuation contributions tax could be avoided.
  25. Richards R, New bill shows 'draconian' lack of trust, say advisers , The Australian Financial Review, 26 May 1999, p 5.
  26. Treasurer, Tax Reform: not a new tax - a new tax system ; Tax Reform Plan, 13 August 1998, Commonwealth of Australia, p 122.
  27. Ibid., p 122.

Contact Officer

Lesley Lang

1 June 1999

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