Small business owners are at risk of having to pay thousands of dollars in retrospective taxes as a result of the ATO’s recent draft ruling regarding trust income and gains that are allocated to, but not paid to, private company beneficiaries of the trust.
If the ATO’s draft ruling goes ahead unchanged, many SMEs may reassess the way they use trusts in the future. However, trusts still provide an effective operating model, provided appropriate changes are made to the way trust distributions are accounted for, according to leading national chartered accounting and business advisory firm, PKF.
PKF’s Director of Taxation, Lance Cunningham, said that under the ATO draft ruling, funds accumulated in trusts that are not paid to private company beneficiaries, otherwise known as unpaid present entitlements (UPEs), would largely be considered as loans from the private company beneficiary to the trust, and therefore subject to further tax as a deemed dividend. This deemed divided could be taxable at a rate of up to 46.5%.
It is understood that the Tax Office’s main concern is where the trust uses the funds to acquire assets such as cars, boats or holiday houses for private use by individual beneficiaries, but the draft ruling can also apply to UPE funds that have been reinvested in the trust’s business or other income producing investments.
However, the primary risk to trust operators, many of which are SMEs, is that the ruling will, in most cases, work retrospectively and expose a significant number of Australian businesses to unforseen tax.
The ATO can assess the deemed dividend by amending trust or beneficiary assessments made over the last four years. ” said Mr Cunningham.
“This is essentially a blanket approach to a specific issue that has the potential to catch SMEs by surprise, as most will not be aware that UPE funds will be taxed retrospectively.”
“While most people in trusts can adjust their future arrangements to meet the new requirements, it is not possible to change historical trust activity. Any trust with a corporate beneficiary UPE created over the past four or five years will likely face extra tax payments if the ATO does not change its stance in the draft ruling,” he said.
Mr Cunningham said that while the Division 7A ruling was far-reaching, trusts – especially discretionary trusts – remained an effective structure for many SMEs and family-owned businesses because of the asset protection and financial flexibility they offered.
“Trusts offer business owners the ability to both distribute trust earnings effectively and protect trust, company or individual assets, provided they are structured correctly. In light of the Division 7A draft ruling, trustees may be questioning the worth of the trust structure, but with careful planning there are ways to structure their trusts so that UPE funds are not subject to extra tax,” Mr Cunningham said.