The next target after Chalmers’ Robin Hood super tax

For people on wages of up to $45,000, instead of paying 15 per cent tax on employer super contributions, there will be no contributions tax which retains up to $810 per year in their super account and is estimated to cost the government $435m over the next four years.

While on the other hand, people with high super balances will be taxed at 30 per cent above $3m and 40 per cent above $10m.

The extremely unpopular proposal to tax unrealised gains has been scrapped, resulting in the government being estimated to make only $2bn in tax revenue over the next four years on its new super tax instead of the initially planned $6.2bn.

As such, the government will be looking for ways to boost tax revenue to close the gaping hole in its budget as a result of the revised super changes this week.

One area that is likely to be scrutinised is family trusts, which is the obvious choice for people with higher super balances to migrate money into and lessen the effect of the new super tax.

And if they do target family trusts, strong support is likely to come from the ACTU, which recently called for more taxes for high-income earners as well as beneficiaries of family trusts. The peak union body said a 25 per cent minimum tax rate should apply to family trusts, arguing they had become tax minimisation schemes for wealthy people.

Family trusts are a popular vehicle for people to manage tax and protect assets. There are more than one million trusts in Australia holding $500bn in assets, and with this week’s super changes, the number of family trusts is only likely to rise.

The attraction of a family trust mainly stems from the ability to pick who will get taxed on income and gains generated from family trust assets, providing the opportunity to spread the tax burden among a number of people within a family group.

If an investment property and share portfolio is owned within a family trust and generates $100,000 of combined net rental income dividends, this amount needs to be distributed out of the family trust by the end of the financial year otherwise the trust gets taxed at 47 per cent.

The parents, who usually act as the trustees of the trust, liaise with their accountant and work out a tax plan regarding which family members are best to distribute to and how much they should get. Beneficiaries of the family trust under the age of 18 can receive up to $416 per year tax free and this is typically made up of children, ­nieces and nephews.

And when these people turn 18, adult tax rates apply and there is usually a three- to five-year window when their taxable income is low while studying at university and the family trust can be utilised to distribute just under $23,000 per year to them tax free after the low income tax offset is applied.

When the younger beneficiaries of the family trust eventually enter the workforce and stop being useful from a tax perspective, a bucket company can be set up as a “failsafe” to receive any unallocated family trust income and gains. The tax rate of the bucket company is 25 per cent if family trust income is less than $50m and assuming that business income makes up more than 20 per cent of the total family trust income. If these conditions are not met, a 30 per cent tax is payable by the bucket company.

Comparing the proposed super tax rates at both $3m and $10m super balances versus a family trust, the super tax rate on income above $3m is 30 per cent and 40 per cent above $10m. Capital gains still get the one third capital gains tax discount if owned for more than 12 months in super, bringing the CGT rate down to 20 per cent above $3m super and 26.7 per cent above $10m.

Whereas in a family trust, under a worse-case scenario, an individual beneficiary is taxed up to 47 per cent on income and up to 23.5 per cent on discounted capital gains. A bucket company beneficiary pays up to 30 per cent tax on income and gains, noting that a company is not eligible for the CGT discount.

Although the tax treatment of a family trust and high balance superannuation fund may seem similar, where a family trust has several low-tax beneficiaries that can be utilised, the pendulum swings strongly in favour of the family trust as the preferred structure to hold assets.

But, of note, the ATO is clamping down on “paper distributions” where beneficiaries of a family trust are only allocated distributions on paper, but in reality they never receive the money. Therefore, if you are planning to use a low-income beneficiary to distribute family trust income and gains, be prepared to transfer the money out of your control and into the beneficiary’s bank account.

Another deal-breaker for people thinking about transitioning large super balances to a family trust will be transaction cost. This consists of CGT and stamp duty, and people need to calculate how many years of estimated ongoing tax savings is required from a family trust to make back the upfront CGT and stamp duty hit to move out of super.

For those with assets in super that they have owned for decades, the numbers may not work and they just need to eat the new super tax that the government will put in place.

And this is what the government wants. Their tax forecasts are on the basis that people do not react to the increase in tax on super.

However, in reality there is likely to be a flood of assets leaving superannuation destined for ­family trusts, which will reduce actual tax receipts on the amended super tax.

The government will then have to review the taxation of family trusts and recoup some of the lost tax revenue in a game of whack-a-mole as people shift assets around in response to the government’s changing tax policy.

James Gerrard is principal and director of financial planning firm www.financialadvisor.com.au

This article first appeared in The Australian as Family trusts in Jim Chalmers’ sights after super tax backflip