New businesses penalised by proposed new tax

Feb 17, 2010

Draft legislation spells ‘lose/lose' for trust-funded enterprises

Proposed tax law changes that have already aroused concern among small business owners may also pose serious problems for enterprises that are operated through trusts - a common structure, especially for SMEs and a likely problem for those in start-up phase.

The warning relates to proposed changes to Division 7A of the Income Tax Assessment Act 1936.

According to accountancy firm, GMK Centric, which helped prepare a detailed submission about the changes for the Taxation Institute of Australia, if the draft legislation is passed, businesses structured using more than one trust face increased liabilities - despite receiving no additional benefit.

"The draft provisions are intended to catch what became known as ‘double trust structures', whereby profits taxed at the company rate could be lent interest free to trust beneficiaries. But in effect, they extend much further than apparently intended," said Chris Wookey, a director of GMK Centric. "It's common knowledge that small and even medium businesses are still struggling to get credit in the current market. To effectively close off what is for many a viable alternative, as this legislation could very well do, seems short-sighted in the extreme." 

Mr Wookey went on to offer the following illustration of the likely unintended consequences of the legislation, citing a theoretical property development business - a common user of this type of trust structure - as an example. 

• A property development business uses separate trusts for each development, as is commonly the case.
• Some developments are mature, profitable and cash flow positive; others are in start-up phase and cash negative.
• Surplus cash is applied to the start-up, loss-making venture.
• Profits are distributed out of the profitable trust through a holding trust to a company.
• Under the proposed new rules, the loan from the profitable trust to loss-making trust can be deemed a dividend unless it is made into a ‘complying loan', and thus subject to interest and principal repayments.
• he result for the business?  A lose/lose situation, in which the losses of the loss-making trust are aggravated; the profits of the profitable trust are inflated, and the tax payable by the owners is increased - despite there being no economic gain to the group when it is viewed in totality.

"Although the legislation includes a ‘reasonable man' test as protection, it is worded so vaguely that it provides little if any protection, and in fact may give rise to more questions than it answers," said Mr Wookey.

"This is another example of the way the proposed new provisions of Division 7A of the Income Tax Assessment Act 1936 in effect hit the taxpayer with taxes for benefits that have not actually been received," he said.

"Our call is once again for these provisions to be amended before the Bill is introduced."

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