Governments over the years have attempted to reduce the tax advantages provided by trusts (can you remember when the previous Howard Government considered having trusts pay tax like companies).  But thanks to common sense, the lack of political will by the governments and vocal groups such as Australian farmers, trusts have continued to allow taxpayers to distribute income amongst family members and/or corporate beneficiaries to achieve the lowest level of tax applicable to that trust income.

The Australian Taxation Office doesn’t like trusts and have said so for many years.  The ATO believe trusts are used to avoid tax, and conveniently overlook the fact that trusts have existed for hundreds of years, long before Australia even had a tax system.

But there are some winds of change blowing now, with a recent High Court case called Bamford V FC of T, and the Commissioner of Taxation issuing several publications that outline his views of certain aspects of trusts, that will in fact try to reduce some of the advantages trusts have provided up to now.

One of the main issues arising from this case was the basis of how income can and should be distributed by a trust to the beneficiaries. The High Court in its decision has reminded us all that it is important all decisions with respect to the distribution of income out of a trust is in line with that trust’s deed, and that the trustee(s)’ resolutions with regards to distributions must take into account what the trust deed requires and permits for distributions.

What the court did not address (it didn’t get asked to) is the ability for trusts to “stream” income.  Streaming generally refers to the practice of trustees allocating different types of income to the beneficiaries, such as one beneficiary receiving all interest income derived by the trust, whereas another beneficiary may receive all the capital gains.  This is likely to be another matter that the ATO will give attention to in the future, but for the time being, remains unaddressed.

The practice of using corporate beneficiaries to cap the tax payable on income derived by trusts has also come under attention of the Commissioner. It has been common practice over many years for trusts to reflect the distribution to the company as an “unpaid present entitlement”, and rather than distribute monies to the company for that distribution, the trust retain the monies and look to reinvest the monies in other investments and/or business interests of the trust.  Until recently, the Commissioner has neither attached this practice nor stated there was any mischief in such strategies being adopted.

However, it appears the Commissioner has changed his mind about this practice.  The Commissioner has determined that if the distribution is not paid to the company within a reasonable time frame, it would treat the unpaid present entitlement as a loan caught under the private company loan provisions.  As a form of concession, the Commissioner has stated that the ATO will not take any direct action on such unpaid present entitlements that exist up to 30 June 2010. However after this date, the Commissioner will look to apply his new views to those unpaid present entitlements that are created after 30 June 2010.

Given this is such a significant departure by the Commissioner to previous practice, expect at some stage, a test case will be brought before the courts to challenge the Commissioner’s views on this strategy.

So, the question for all of those that have a family or discretionary trust – do you hold or know where you can find a copy of the trust deed?

If not, we would strongly suggest you get onto locating a copy of the trust deed, as everything the trust does going forward must take into account what that trust deed allows it to do.

Over coming months, we will be discussing with those clients that have trusts, the impact of the above changes, and to review the trust deeds of those trusts to ensure they do allow for the sorts off discretions to distribute income in the most appropriate tax efficient way.

Increase in the Tax Free Amounts Received by Children

With the changes in the income tax rates, a reminder of the amounts of investment type income (including family trust distributions) that children can receive without having to pay tax.  The amounts are as follows:

The tax break available to small businesses is in the form of a “one off” additional deduction equal to 50% of the cost of eligible capital purchases. 

The deadline is 31 December 2009.  By this date, the small business must have committed to the purchase of the new capital assets.  You are not required to have the asset installed ready for use – you must however be able to demonstrate you have committed to the purchase – eg have completed an order form/contract with the vendor for the purchase of the asset.

The case involved a student that was in full time university studies.  The student had a part time job to help support herself through her studies as well as received a youth allowance from the Federal Government.

In the student’s tax return, the student claimed costs associated with her university text books and stationery, student administration fees, depreciation on her computer used to help her study and some travel costs incurred, for travel between university and her part time job.  The Tax Office knocked back these deductions, arguing the costs were not incurred by the student to produce her taxable income, or were more to assist her to complete her degree to gain future employment.

The taxpayer disagreed with the Tax Office’s views and the matter was brought before the Court.  In the Full Federal Court (being an appeal by the Tax Office to a single Federal Court judge’s decision previously for the taxpayer), the Court once again sided with the student.

The Court took into account that the Youth Allowance that the student received was fully taxable to the student.  Further, that the student had to pass a number of conditions to be eligible to receive the taxable youth allowance.  Part of these conditions included that the student had to be enrolled in a full time course of eligible study, and continue to be in that full time study whilst receiving the taxable youth allowance.  The Court then agreed with the student’s arguments that in order to continue to be enrolled in her university course, the student would need to incur certain costs to help her with her studies, so that she could successfully pass her subjects and continue to be enrolled in her university course, and therefore continue to receive the taxable youth allowance.

So chalk one up for the taxpayer.

In respect of travel allowances, the Tax Office acknowledged many years ago that it would be reasonable for such travel allowances not be included in the tax return, and not require the taxpayers to keep and produce all the receipts and documents that support the costs were incurred during this travel.  So each year, the Tax Office issues a determination of what it sees as the reasonable travel allowance that can be paid for both domestic and overseas travel.

Where an employer pays an allowance within the determination, and where the employee does not want to claim expenses higher than the reasonable allowance, no disclosure will be required of the allowance.  Whereas if the employee wanted to claim a higher deduction than the allowance received, the employee would be required to keep receipts of all costs incurred and maintain all other documentation under the Tax Act to support the deduction.

The Tax Office produces tables of what would be reasonable allowances for accommodation, food & drink, and incidental costs based on the city/location, and based on salary bands.

Now, from time to time, we are told that some advisers out there will suggest that a person can make a claim in their tax return for travel costs based on these reasonable travel allowance figures in the Tax Office’s determinations.  This is not the case – the Tax Office determination is really saying that you don’t have to keep records for these costs, nor do you need to report the income that is being paid as a reasonable travel allowance.  Certainly, it is not there to allow people to claim a “blanket” tax deduction or travel costs.

A link to the 2009/2010 year reasonable allowance determination (TD 2009/15) can be found by clicking here.

For small businesses with an annual turnover of less than $2.0 million, they have until 31 December 2009 to commit to the purchase of these new assets in order to be entitled to the extra tax deduction. 

Please refer to our last newsletter for the details on the requirements to be eligible for this bonus tax deduction, with articles on each of the following topics:

• Investment Allowance for Businesses
• Extra Incentive for Small Business
• How it applys to cars

So if you are thinking about that new car or new computer for the business and would like the extra tax deduction for the 30 June 2010 year, you had better start planning for this now.

Given the current global economic issues, the Tax Office will be even more diligent in protecting the tax collections for the Federal Government, and to this end, the Tax Office has listed a number of areas of focus, including:

1. Continued data matching processes

• Typically, the Tax Office is provided financial information from the banks, share registries and other financial institutions on interest, dividends, trust distributions and other forms of income derived from these financial institutions.
• The Tax Office will continue to match these records against what taxpayers disclose in their tax returns, and where there is a discrepancy, a letter will be quickly dispatched by the Tax Office for an explanation
• The Tax Office will also look at the recording of capital gains and losses by taxpayers, based on data it is given from share and unit registries on investment movements of a taxpayer, and data it is provided on property disposals.
• For the 2010 season, the Tax Office intends to expand this data matching to include employee share schemes, health insurance policies that don’t provide sufficient private patient hospital cover, and eligibility for tax offsets and the Medicare levy exemption.

2. For the 2010 year, the Tax Office will increase significantly its testing of Self Managed Superannuation Funds‘ compliance with the various superannuation legislation. This includes ensuring trustees are fully aware of the fund’s requirements in the areas of the in-house assets rules, and where the Tax Office identifies breaches, the trustees may find that they have to engage in reverse workflows with the Tax Office over the subject. Also, that the superannuation funds are not involved in any schemes, such as accessing superannuation benefits before the members are permitted under the law.

3. Refund Fraud. Based on the current economic conditions, the Tax Office is acutely aware there are some in the community that will either look to “boost” their various tax refunds by claiming for expenditure not incurred, or inflated. Further, the Tax Office is aware of a rise in taxpayer identity theft, where a taxpayer’s details have been “stolen” and fraudulent claims are made.

4. Wealthy Individuals. As outlined in the last newsletter, the Federal Government has indicated it wants greater focus on ensuring wealthy individuals and wealthy families are paying their fair share of tax. The 2010 compliance program indicates the Tax Office is extending its compliance activities to more closely examine the tax affairs of individuals with a net wealth in the area of $5million to $30million.