Company-tax cuts make trusts more attractive as tax minimisation strategy – experts

An ATO ruling is being interpreted as allowing ‘bucket companies’ linked to trusts to be eligible for lower tax rate
The federal government’s company-tax reforms are making the use of family trusts even more attractive as a tax minimising strategy, experts have warned.

The Coalition’s company tax rate cut from 30% to 27.5% has already been implemented for some small businesses. The federal government had clearly intended the lower tax rate not be available to passive companies, including so-called bucket companies.

Bucket companies – companies that are beneficiaries to discretionary trusts – are used as a common tax avoidance structure, and can be used by wealthy families to warehouse their investment income.

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The government wanted the lower tax rate to be only for small companies actively operating, or “carrying on a business”, in Australia.

But a ruling by the Australian Taxation Office earlier this year has caused considerable confusion.

The ATO appeared to define companies with passive investments, which would include bucket companies, as “carrying on a business” in Australia. Some groups have interpreted that as allowing bucket companies to be eligible for the lower tax rate.

The ATO is now working to clarify who is eligible for the 27.5% rate, and Chartered Accountants Australia and New Zealand has urged for a legislative fix immediately, Fairfax Media reported this week.

A spokesman for financial services minister, Kelly O’Dwyer, said the ATO was yet to determine whether bucket companies qualified for the lower rate.

But he said the policy decision was not meant to apply to passive investment companies and that “if any further direction is required, the government would provide it”.

Tax Justice Network member and Australian Council of Social Service (Acoss) senior advisor Peter Davidson said the tax changes increased the benefits of using bucket companies linked to private trusts.

“This is a separate problem to tax avoidance using private trusts, which must also be fixed, and the opposition’s proposal is a welcome first step,” Davidson said.

“The solution to tax avoidance using private companies, as we argue in our budget submission, is to restore arrangements in place in the 1980s to tax income ‘parked’ in private companies at the top personal tax rate, minus a reinvestment allowance for active businesses,” he said.

“This is another example of the need to progressively clamp down on all major tax shelters: we know that high-income earners deprived of some of the tax benefits they receive through superannuation will turn to private trusts, and if that loophole is closed many will turn to private companies.”

Regardless of the current confusion, a second bill currently before the lower house will gradually make the lower rate available to larger corporate tax entities until 2023-24, and then progressively reduce the rate to 25% by 2026-27.

That means all small companies, regardless of whether they are active, or bucket companies, will pay 27.5%.

Tax Institute senior tax counsel Bob Deutsch said that will make the use of trusts by corporates “even more attractive” as a way to minimise tax.

“The plan is that bucket companies – which basically means a corporate beneficiary of a discretionary trust – they’ll ultimately get taxed at 25%,” Deutsch told Guardian Australia.

“Which of course would make trusts even more attractive than they are now,” he said.

But Deutsch says the use of trusts is a product of flaws in the structure of the income tax system, most notably the discrepancy between the top marginal rate for personal income tax and the company tax rate.

“We need to look very seriously at the structure that drives these things, rather than these Band-Aid solutions, which I think is what we’re seeing now,” he said.