30% Minimum Tax on Discretionary Trusts: EETs, Rollover Relief and What Comes Next

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You’re listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

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Welcome to another episode of Explain That. Today we’re talking about the proposed 30% minimum tax on trusts. A big topic, a contentious topic. We’ve had some developments recently, and I’m joined by director Rajan Verma to unpack those developments.

0:30

Thanks for having me here, Andrew.

0:33

No worries. Rajan, this is a big topic and one that’s evolving over time. What’s the latest update, and I guess, how did we get to this situation that we’re in now?

0:43

Yeah. Well, the latest update is we have exposure draft legislation, so we have a bit of a sense for what the actual rules might look like. But before we get into that, I think your other question is a relevant one: how we got here.

I suppose, taking a step back, the government has kind of flirted with this idea of trust taxation for a little while, and I think trusts always made the government a bit uncomfortable because of the income tax opportunities around streaming and splitting of income and that sort of thing. That is a theme that runs very, very strongly through the current proposed changes. I say proposed; they’re almost certainly likely to happen.

But these changes came out as a bit of a surprise in the latest Federal Budget. In the Federal Budget, we were all very distracted by changes to the 50% CGT discount. What we weren’t expecting was that there would be changes to trust taxation, and so that came somewhat by surprise because, historically, trusts have been a transparently taxed entity. Other than in particular circumstances, it’s the beneficiaries that pay tax at their own rates.

1:59

Absolutely. It’s a flow-through entity, which means that as long as the trust distributes all its income and capital, it’s the ultimate beneficiaries who will pay tax on that income or capital at their marginal rates.

In the limited circumstances where the trustee doesn’t distribute its income, the trustee would be assessed at the top marginal rate. For that reason, most trustees will not accumulate; they’ll distribute their income.

2:22

Yeah. And although it’s not as common as it previously was, there are all types of scenarios involving trusts, ranging from direct ownership of property, equity in a business or even running a business directly through a discretionary trust, and many others as well. But they are very popular vehicles.

2:41

Oh, absolutely. The government’s noted that there are a lot of trusts that have been set up in Australia. And you’re right, they’re used for a myriad of different reasons and purposes.

One of the big things is asset protection. That’s somewhat synonymous with a trust. A lot of people who are looking to protect and secure assets will use a trust as a vehicle to protect the assets of the trust from personal risk or other issues.

3:10

Yeah. Asset protection and, I guess, the flexibility, and they go hand in hand, the flexibility of distributions.

3:17

Oh, absolutely. And look, it might sound nasty, but sometimes it’s not. Sometimes it’s as simple as, you know, you might be setting up a trust for the benefit of your children, for example, and you want to provide for them.

Or it could come in the context of succession planning, for example. So it’s not always about taxation as such. It might be that you’ve got a large beneficiary class that might be the next generation of family members, and you want to have a trust that basically looks after them.

3:48

Yeah. So if we rewind back to that Budget announcement, what did we know essentially from Budget night when that announcement was made?

3:56

Well, what we knew was that the government was going to introduce a 30% minimum tax on trusts. So what that would mean is that the trustee would pay tax at 30%.

What would happen is the trust would, in the usual way, distribute its income to the beneficiaries. To the extent that the trustee has paid the minimum tax, that would flow through as a credit to the beneficiary, but it would be a non-refundable credit.

So unlike a franking credit from a company, which is refundable, it’s non-refundable. That means that if your personal marginal rate is 30% or more, no problem. You’ll get a credit for the minimum tax paid by the trustee. If it’s less, then you lose out. You don’t get a refund for the difference.

4:44

So if I’m a beneficiary, I have no other income, I’ve got the tax-free threshold, and $10,000 is distributed to me, I’d pay zero on that if it was direct. But with the trust taxation, the 30%, it’ll just be that flat 30%, and essentially, too bad, so sad for that beneficiary.

5:03

Well, that’s right. And I guess the thing is that when that legislation came out, it was identified that there were going to be a number of problems with it.

Initially, they were going to extend the trustee minimum tax to discretionary testamentary trusts. A testamentary trust is a trust that’s set up under a will, usually upon a person’s death.

Sometimes they’re set up as discretionary trusts, so they operate in a very similar way to discretionary trusts. The only difference is that they’re set up on the death of the person setting it up. The minimum tax was going to apply in respect of those types of trusts too.

The other issue that it picked up is that there’s a lot of charitable giving that happens through trusts. There are trusts that actually distribute to charities, and not as a tax dodge, but as a genuine way to give money to these charities.

If the minimum tax applied, then that was effectively going to reduce the amount that the charity was going to get by about 30%, because ordinarily a charity is income tax exempt, so they get the full benefit of that distribution.

6:17

So in May, we had the Budget. We had a number of tinkering things that happened after that. Move forward to September. On 3 September, we get this exposure draft.

And it’s actually not one. I think it’s four bills. There are also three explanatory memoranda. There’s an explainer on top of that because, you know, you need a couple-page document to try to explain what any of this is actually doing, and a consultation window until 18 September to respond to it all.

6:49

Yeah, quite ridiculous, really. It’s a lot of legislation. There’s a lot of material, and the exposure draft was released on 3 September. So it’s a very short window of 15 days.

You take out weekends; obviously, it’s not really much time to consider it and provide a response.

7:09

Judging by the other consultation windows for other things, I think the hopes of any meaningful consultation are pretty low, it’s fair to say.

7:15

I suspect so, yeah.

But I guess the interesting thing, I mentioned that there were a few bugbears that were identified. The really big one that came out was, in the Budget, the government actually said that if you want to avoid the minimum tax, then you can restructure.

They were going to introduce a new rollover that was going to enable trusts to restructure out of trusts into other more fixed-interest vehicles, like fixed trusts or companies, for example, or even into individual names.

The industry very quickly identified that that was likely going to trigger duty implications. Because if you’re holding property, for example, you can’t transfer that duty-free. There’s no rollover for that. You get an income tax rollover, but there’s no duty one.

I think the bigger problem, though, was with things like businesses. You mentioned at the beginning that there are a number of people who run businesses through trusts.

Depending on the jurisdiction you’re in, for example Queensland and Western Australia, they actually impose duty on business goodwill and business assets. So if you’re transferring those as part of this rollover, you were going to be left with a fairly sizeable duty bill on top of the adviser fees that you would need to actually implement this rollover.

So that was something the profession very quickly identified. And then, to make matters worse, some senior figures within the revenue offices around the country very quickly came out and said, don’t expect rollover relief from us. This is the government’s problem. This is not our problem.

So they weren’t coming to the party. That was going to tank the government’s rollover, because who would take it on if you’re going to pay massive taxes elsewhere?

9:06

Absolutely. Well, I think that’s a good point to note. I think it’s a good segue to get into the weeds a little bit on the exposure drafts themselves and the explanatory memorandum. I guess, what do we know now?

Maybe we can start with that new concept that you mentioned, the Excluded Election Trust, the EET. This was something that took everyone by surprise a little bit. No one was expecting this.

Can you unpack what this mechanism is essentially trying to do?

9:39

Yeah. Well, it was a response to that issue I just mentioned around the duty costs and the adviser costs of using the rollover to restructure out of a trust.

So what the government came up with was effectively an election that could be made where the trustee nominates beneficiaries to receive fixed interests in the trust, to both income and capital.

Once that election is made, the trustee is then obligated to distribute income and capital in those proportions.

So it was a way, according to the government, that you could get around the minimum tax, but also achieve the government’s dream of basically removing flexibility out of how income is distributed through trusts.

10:30

Yeah.

10:32

But they also said that, well, it doesn’t require a restructure or anything. It’s not going to trigger any duty, or it should not trigger any duty, doing that.

10:40

It’s an interesting limbo land because you’ve got so much complexity in trusts already. There’s a whole system of family trust elections, which you’ve done previous podcasts about, and all the issues there.

Then this new election essentially specifies the beneficiaries and their percentage of income and capital that they’re expected to receive. If you do that, for an existing trust, you’re essentially outside of this new 30% tax.

11:11

Yeah. Well, that’s right. I guess one of the really not great things, there are a lot of not great things, terrible things, about this, but one of the things was that they didn’t redraft the whole of Division 6, which is basically where the trust taxation provisions sit.

What I would have expected was that a lot of those provisions could have been rationalised, or perhaps they just needed to be rewritten in full. But instead, this all sits as an overlay on top of that.

So, for example, the trustee pays a minimum tax, but it still needs to distribute every year. If it doesn’t distribute, then the trustee will pay tax under section 99A at the top marginal rate, in which case the minimum tax won’t apply because it’s paying the maximum tax of 47%.

So you still have to make distributions every year. You still have to establish present entitlements. And then, overlaying all that, the trustee has to pay. It’s almost like a bit of a withholding tax. It’s like a 30% tax that the trustee has to pay before anything goes out to the beneficiaries.

12:12

Yeah, I think that’s a very good way of explaining it. When I look through the exposure drafts and legislation, it’s very clear that you’ve still got everything that existed before, and you need to learn all of that, Division 6 and all the amendments that have happened to it over time.

Then, on top of that, you’ve got these rules that, in certain situations, can apply. And many times they can’t. The EET is made, or perhaps it’s a discretionary testamentary trust. Maybe it’s a fixed trust.

Or maybe it’s income that’s excluded because it’s primary production income, or it’s going to a person with a disability. There are so many concepts and things to work through in this.

I would say, look, if you were struggling with trust taxation before, now is the time to probably give up and find another path in life, because it has become so complicated now, all the things that you’ve mentioned.

13:11

That’s 100% correct. If you’re trying to work out who pays tax on trust income once these rules come in, you need to work out, first of all, has there been a family trust election? Has there been an EET? What kind of income are you dealing with?

Are you dealing with an excluded class of income, like primary production income, for example? You’ve got to deal with the normal: who is the beneficiary, and the status of the beneficiary.

13:37

Yeah, absolutely.

13:40

So all the stuff you had to deal with before in terms of the status of the beneficiary and present entitlements, and then you’ve got these things overlaying it too.

The other thing, which I didn’t mention earlier, was that franking credits are now not going to pass through in the usual way.

What I mean by that is, if you’ve got a company that distributes to a minimum tax trust, the franking credit will go through to the trustee, and it can offset the franking credit against its own minimum tax.

When the trust then distributes to the individual beneficiary, it can obviously pass on the credit for the minimum tax, but it’s non-refundable.

So effectively, what’s happened is a franking credit that came into the trust has now turned into a non-refundable credit that’s come out the other way.

And then the other change that you have is that the bucket company arrangements that we’re all familiar with, where a trust distributes its income to a corporate beneficiary, will attract double taxation now because the corporate beneficiary will not be entitled to the credit for the minimum tax.

That was one of the biggest issues with the Budget announcements, and it seems very clear from the exposure draft that that hasn’t changed.

14:59

That hasn’t changed in the slightest.

15:01

No. So really, the main changes that came out of the exposure draft were that discretionary testamentary trusts are no longer going to be caught up in these rules, provided, of course, that they meet certain conditions.

There are integrity measures around not stuffing the discretionary trust with other assets and whatnot, and they’re genuine testamentary trusts. So there are some measures around that, but they’ve kind of been carved out somewhat.

And then, of course, I mentioned the EET, which you’ve also mentioned as a potential way to circumvent having to actually restructure your trust using that rollover.

15:39

Yeah, the EET is quite an interesting concept. Once you make it, not that it’s stuck there, but if you ever breach it, you’re kicked out of the regime and you’re now into the minimum tax, unless one of some very prescriptive exceptions applies, really death and some marriage breakdown situations.

16:09

Yeah, that’s right. First of all, there’s a very narrow window to make it. It’s got to be done within the first income year after 1 July 2028, which is when all these rules come in.

So what that means is, if you’ve got an existing trust, it really needs to make this election effectively by the end of its first income year, 30 June 2029.

If it’s a trust that’s established after that date, then it would be whatever its first income year is. If you miss that window, then you can’t make the election.

Assuming you don’t miss the window and you make the election, as you rightly mentioned, it’s very fixed and locked in at that point. You can’t really change it.

The issue I see with that is, what if you’ve got a young family, for example? What happens if you establish a trust and then you have a child after you’ve made your EET? You can’t now nominate them.

Or say you’ve got one child and then you have a second. You can’t bring in the second child. They’re carved out of the trust now for the purposes of the election.

That’s a problem. I don’t see why that should be the case.

Moving forward, if you then decide, look, we need to distribute outside of our nominated beneficiary group, and there can be very, very good reasons for doing that, which we’ll come back to, but supposing you decide that’s the case, then you’re kicked out of the EET regime.

In the year in which that occurs, no one is taken to be presently entitled, which means the trustee pays tax at the maximum rate, and then forever after that, it’s the 30% minimum tax for that trust.

17:52

Yeah, it’s a lot there to work through just on that. We haven’t even got to the rollover, which is also part of the exposure draft.

That goes on for many pages and many provisions about how that rollover works and notification requirements. To me, it seems very prescriptive in terms of how it’s to be done.

18:13

Yeah. Well, I guess the first thing with the rollover is that there are already a number of CGT rollovers in the legislation.

This rollover was intended to be a little bit easier to use because those other rollovers can be quite prescriptive in terms of the structures you can move into.

You’ve got the small business restructure rollover, but it has these conditions around genuine restructure, which was probably going to be a bit too restrictive, and there were also turnover thresholds and whatnot.

So this new rollover doesn’t have those turnover thresholds. It doesn’t need to be a genuine restructure. There’s a sort of three-year window in which you can use it.

So they’re all things that make it somewhat easier to get into. But there are, of course, conditions. The structure that you move into can’t be a minimum tax trust.

19:11

Yes. So you can’t just go from one trust to another. It has to be into either a fixed trust, a company or an individual.

19:17

Yes. And there are obviously integrity measures around that. So, for example, if you decide you want to use a company, it can’t have any sort of material discretionary elements, so it has to be genuinely fixed in terms of its ownership and interests.

19:34

Yeah. It’s interesting. I don’t think we know the answer to this yet. I don’t think it’s in any of this material.

But one of the discussion points was about if you roll an asset using this that has an unrealised capital gain, let’s just say it’s a property for argument’s sake, what happens to that unrealised gain and who actually gets taxed on it?

Does it get taxed to the trust at the normal rates? Does it get taxed to the company at the corporate tax rates in the future, and then you’ve got a dividend and so forth? Or do you somehow get the benefit of the general discount?

I don’t think that’s specifically answered in any of this.

20:09

No, I don’t think so. But what I would expect is that, as with most rollovers in the tax legislation, the cost base generally just flows through.

20:17

Yeah.

20:19

But the interesting thing about the scenario you mentioned is that the 50% discount has also been effectively removed from 1 July 2027.

I think the risk that you run is that if you were to restructure property, or even any asset that might appreciate, you could be foregoing the 50% discount, particularly if you’ve got significant growth up to 1 July 2027 and you move into another structure.

Then suddenly you might not get the benefit of the discount. So you end up paying far more. You get a bit of a tax saving on the restructure, and then you cop it on the end.

21:01

Rajan, we’ve talked about a number of different elements. We’ve talked about the Budget announcement, some of the changes, and this explanatory draft, sorry, exposure draft, explanatory memorandum.

If I can ask you a left-field question, if we could liken this to a TV series, and I won’t limit this because TV series can go a long time, where do you think we’re up to in terms of which season we’re at at the moment?

And how many are there going to be? I know it’s impossible to answer, but where do you think this is in terms of this whole thing on taxing discretionary trusts and the 30% minimum tax?

21:37

Well, look, maybe let’s say Game of Thrones, because I think, like these trust changes, Game of Thrones was a complete cluster mess. And that’s what this is.

21:47

How many seasons was that? Was it eight seasons?

21:51

It was eight seasons, was it? Okay.

21:55

I’d say we’re at season five. And the reason I say that is because there have been so many iterative changes that have happened.

I don’t think we’ve seen the end of it because people will no doubt find problems in this.

But the other thing, too, is that we have a federal election in May 2028, which is barely a month and a half before these rules are supposed to come in. Anyone who follows politics, it’s very interesting what’s happening out there.

22:26

Yeah.

22:29

If there is a change of government, I’m not sure that these will continue on. There’s every likelihood that they’ll get deferred, that they’ll get rewritten, or possibly scrapped entirely if it’s a different government.

So, yeah, there’s still a bit to play out.

22:42

I think there’s still a bit to play out. And, you know, I was a big Game of Thrones fan. I remember season seven and season eight: are the White Walkers just going to wipe out society?

Now, this is not to put an analogy to that, but essentially, it’s that we won’t really know, to your point around the election, until very late in the piece whether or not any of this will actually transpire.

23:06

Yeah. And the real challenge with that is the advice at the moment is, don’t restructure yet. Just wait and see what happens, which I think is sensible for this point in time.

But at some point, you’re not going to be able to say that because if you’re waiting for the outcome of the next election, supposing that Labor comes back in and the rules proceed as proposed, you’ve only got a month then.

23:32

Yeah. It’s not enough time.

23:36

It’s not enough time. Good luck finding an adviser who can restructure you in that space of time.

23:40

Yeah. So you kind of have to make a call on it earlier than that. I’m not saying that’s...

At some point in 2027, you’re going to have to decide what you’re going to do about this. And at that point in time, you’re not necessarily going to have certainty on this either.

24:00

I think that’s an excellent way to sum up where we’re at now. So for those Game of Thrones fans, we’re about season five. We’ve got the exposure draft. There’s still, I think we agree, quite a bit to play out.

But at some point in time, decisions need to be made about structures, and that probably can’t wait all the way until 1 July 2028.

24:16

No, not at all. And the thing is that it was already somewhat difficult trying to work out, what structure should I be in?

If you’ve got an existing business, then you just continue on as you are until something changes and you need to.

But for someone who’s setting up a new structure, a new business, and their question is, well, how should I set this up? It was never really that easy a question to answer, and it’s made far more complicated by all of this.

24:49

The thing that I am particularly concerned about is the proposed EET because practitioners have expressed concerns that, if for tax purposes you’re fixing how distributions are going to be made, could that be a dutiable event anyway?

It’s very clear from a duty perspective that when you fix beneficiary entitlements, that is a change of beneficial ownership, which is dutiable.

Now, the counterargument to that is, well, that’s only for tax purposes. You’re not actually changing the trust.

25:20

But then the other aspect to it is that trustees at law are not permitted to fetter their discretions.

And there are decades of case law, maybe even centuries of case law, that make this principle clear: a trustee is required to genuinely consider the needs of the beneficiaries, and it can’t predetermine what its distributions are going to be in future years.

Yet this EET concept requires just that, so it sits at odds with trust law.

25:51

Yeah. It sits very contrary to that.

25:56

And then you have other cases like Owies, for example, which talked about considering the needs of beneficiaries.

How is this going to sit when you’ve got a trust that might be for the future benefit of your family, but you’ve got family members who aren’t born yet, or you might have circumstances that change in the future?

Do you want to commit yourself to fixed distributions forever and a day in the future? What’s the likelihood you’re going to have to deviate from that?

And in the year that you do so, you’re going to have a massive tax bill, 47% in that year.

26:28

Yeah.

26:31

So, yeah, it feels like a bit of Russian roulette.

26:34

Yeah. But anyway, I’ve probably gone a bit too deep into that.

26:38

No, it’s all valid. I encourage any listeners, if they’ve got any issues either with a new structure or an existing structure, and they’re grappling with these questions, to reach out to Rajan for his expertise.

Thanks once again for being on this episode.

26:53

Thanks very much, Andrew.