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In brief: A recent NSW payroll tax case shows again the potential problems of widely drawn beneficiary classes in discretionary trusts. A company owned and controlled by Michael Gerace had been issued with payroll tax assessments of nearly $2M and was put into liquidation. The Chief Commissioner of State Revenue (NSW) was successful in an appeal to group that insolvent company with a trust controlled by Michael’s brother and one established originally for their parents, despite an apparent lack of commercial connections. Grouping was achieved because Michael was a discretionary beneficiary of both those other trusts, so he was effectively taken to have a controlling interest in each of those trusts (as well as the insolvent company that he owned). And members of a payroll tax group are jointly and severally liable for the tax payable by every group member.
More: Having wide trust beneficiary classes is an outdated practice that potentially creates substantial tax disadvantages, yet serves no real purpose – Tax Strategies’ trusts have for several years been created on a different basis without wide beneficiary classes, substantially minimising the risk of such tax disadvantages. There was no doubt about the grouping in this case, but Michael disclaimed his interests under his brother’s and parents’ trusts in an attempt to retrospectively sever his connection with them. However, the Court held that that did not affect payroll tax liabilities that had already arisen, irrespective of its impact as between Michael and the respective trustees. It is traditional drafting practice to have wide beneficiary classes in a discretionary trust, including many family members who are not intended and will never benefit under the trust. But that can give the payroll tax Commissioners a very easy grouping mechanism. It has also caused significant problems in relation to the recently introduced duty and land tax surcharges for foreign purchasers of residential real estate in a number of States. (Chief Commissioner of State Revenue (NSW) v Smeaton Grange Holdings Pty Ltd [2017] NSWCA 184)
In brief: The ATO has released a Position Paper on its views for the application of the event-based reporting regime to SMSFs from 1 July 2018. This follows a recent draft legislative instrument to lay down the timing framework for the reporting regime. The basic rule proposed is that reporting must be done within 10 business days after the end of the month in which the reporting event occurred, although that will be subject to further concessions (at least for a transitional period).
More: The purpose of the event-base reporting regime is to enable the ATO to track and administer the application of super fund members’ $1.6M (initially) transfer balance account cap. The ATO is seeking feedback about the options outlined in its Position Paper. The first option is the basic rule of 10 business days after the end of the month, but 28 days after the end of the quarter in which the reporting event occurs for reporting of the commencement of a retirement phase income stream and relevant repayment events relating to limited recourse borrowing arrangements. Also, extensions will generally not apply in relation to commutations of income streams. The second option proposed by the ATO is 28 days after the end of the relevant quarter in which the reporting event occurs for an initial 2 year period, reverting to the basic rule of 10 business days after the end of the month for all relevant events (again, except in relation to commutations). (ATO Position Paper; Transfer Balance Cap & SMSF ‘Event-Based’ Reporting Framework, 18 August 2017)
Tax planning arrangements can fail for a number of reasons. One of those reasons has little to do with technical tax rules. With a real-life example, this episode of Tax Solutions illustrates how tax planning can go wrong because of a fatal legal flaw in the underlying transactions or circumstances on which the tax plan is based. With the result that the practitioner involved is highly exposed.
The small business CGT concessions provide very substantial benefits in situations where they apply. And given the policy intent to direct the concessions to business assets, one of the central conditions that must normally be satisfied is the ‘active asset test’.
This episode of Tax Solutions emphasises a class of CGT assets that achieve a special status for the purposes of the small business CGT concessions. Those assets continue as active assets indefinitely – retaining that status even long after they have ceased being used in any business controlled by the owners!
Widely drafted beneficiary classes in discretionary trusts can create headaches in dealing with various State taxes. A recent example is Victoria’s new 3% additional duty on foreign buyers of residential property – where a trustee is the buyer and a family beneficiary lives overseas. A starker example that applies in all States and Territories is payroll tax grouping of businesses controlled by family relatives, where at least one of the businesses is operated by a discretionary trust.
Having extraordinarily wide beneficiary classes is an outdated practice that creates problems, rather than serving any useful purpose. There is really no point in including a whole range of relatives who are never intended to benefit. A narrow class of beneficiaries is required, with a simple and practical mechanism to add others to whom it is desired to distribute.
Frustrations with ATO views about UPEs of corporate beneficiaries have led to companies more frequently being used to acquire and operate small and medium sized businesses. But the problem is not discretionary trusts owning businesses, it is Division 7A. And there will usually be ways to deal with Division 7A anyway.
Some advisers believe that a business owner can still access the small business CGT concessions on a future business sale, by selling shares in the company that owns the business. But how realistic is it to hope that that is the way things will turn out. This edition of Tax Solutions emphasises 2 reasons why clients with a business owned by a company may not actually benefit from the CGT concessions.
One of the best things you will ever do for some of your small business clients is to deliberately trigger a CGT event and capture the small business CGT concessions. In the right client circumstances, this strategy can produce several very substantial benefits. That will particularly be so if 100% CGT exemptions can be achieved without duty applying to the transaction.
A restructure for this purpose should always be kept in mind, particularly for clients who may grow to the point where they can no longer satisfy either the $2M turnover test or $6M net asset value test. But it warrants greater consideration at the moment, given the apparent increased political risk of changes to CGT concessions.
