Investment Bonds Insights August 2017

5 August 2017

Welcome to our August 2017 edition of Investment Bond Insights

Labor sets its sights on discretionary trusts

Although the next federal election is not due until November 2019, the Australian Labor Party has been busy rolling out policy announcements. Here, Neil Rogan, General Manager of the Investment Bonds Division for Centuria, looks at Bill Shorten’s recent announcement about the taxation of distributions from discretionary trusts.

What are discretionary trusts and why are they used?

A discretionary trust, often called a family trust, is a structure often used by small to medium size business owners. A trust can be used to hold passive assets, such as the family home, as well as business assets. A trust’s key purpose is to provide asset protection and succession planning for the family members for which the trust was established.

Each trust appoints one or more trustees, who have the discretionary power to distribute funds and assets from a trust to benefit of one or more of the beneficiaries specified in the trust deed. This discretion is absolute; in other words, the trustees decide what the beneficiaries should receive and when they should receive it – beneficiaries do not have a fixed interest in the trust until the trustee distributes either income or capital of the trust to them.

There is no requirement for a trustee to make a distribution – they may choose to retain capital and income in the trust for the future benefit of the beneficiaries.

In July 2017, The Australia Institute released a discussion paper, Trusts and Tax Avoidance. In it, it quotes ATO data from 2014-15 (the latest data available) that shows there were 823,448 discretionary trusts in Australia, with assets of $3.1 trillion and revenue (total business income) of $349.2 billion. These numbers suggest that trusts are a popular vehicle, not least because of the benefits that can be derived from using the structure. These include:

  • Flexibility – the trustee/s can decide how to distribute capital and income from the trust.
  • Asset protection – many small and medium sized businesses include personal and business assets in a trust to protect them from creditors should financial issues arise.
  • Bankruptcy – assets that are held in a trust are generally protected from creditors in the event of bankruptcy, although any assets transferred to the trust just prior to bankruptcy may not be protected.
  • Estate and succession planning – a trust enables the smooth transition of control of the assets to beneficiaries, and at the same time keeps assets safe from unsecured creditors, former business partners or others who may believe they have an interest in the assets.
  • Tax minimisation – the distribution of income to beneficiaries of the trust on a lower marginal tax rate has been used by some to minimise taxable income.

The potential benefits of a discretionary trust are directed by the trust deed; anyone using a trust should ensure the trust deed is tailored for their specific circumstances.

Why is Labor proposing to make changes?

While the Labor Party acknowledges that many of the benefits provided by discretionary trusts are important for families, farmers and small to medium sized businesses, it’s the ability to minimise tax by income splitting, or sharing income among beneficiaries on a lower marginal tax rate, that has them fired up.

Of the trusts represented in the ATO data used by The Australia Institute, 642,416 – or 78 per cent – were discretionary trusts; in other words, trusts that could be used for tax minimisation purposes. That this represents a potential tax windfall of $3.5 billion has Shadow Treasurer Chris Bowen excited – he wants that money available for the budget. After all, tax revenue underpins health, education, welfare and other important social and physical infrastructure..

How might this effect you and your clients?

The most obvious impact will be on those using discretionary trusts to reduce their taxable income; the proposal is to tax all trust distributions, regardless of the marginal tax rate of the beneficiary, at 30 percent.
However, there are several unintended consequences that could potentially result from these changes. Examples include:

SMSFs often use discretionary trusts as a vehicle to hold property assets. Distributions to the super fund from the trust are currently taxed at between zero and 15 per cent; there is the potential for this distribution to be taxed at 30 percent.
Intergenerational transfers of wealth to the beneficiaries of family trusts may be subject to a tax rate higher than that beneficiary’s marginal tax rate, eroding the value of the assets or capital.
The transfer of business assets or capital as part of a business succession plan could also become subject to 30 percent tax.
While Labor has been at pains to say there will be exceptions and exemptions, will a blanket legislative change unintentionally create issues for trustees and beneficiaries who are using discretionary trusts for a range of legitimate purposes?

Investment Bonds could be an alternative

An investment bond can fill some of the gaps that may be created by the proposed changes. While it can’t protect the family home or a business’s plant and equipment, an investment bond can provide a secure environment for personal or business capital. An investment bond operates like a tax-paid managed fund, with a range of investment options available. Income earned is re-invested into the bond, not distributed. If the bond is held for 10 years, all proceeds, capital and investment returns, are distributed to beneficiaries tax paid. Estate and succession planning is made easy with investment bonds – the proceeds of the bond are paid to the nominated beneficiaries in the event of a death, do not require probate to be paid out. Assets in an investment bond may not be touched by creditors in the event of bankruptcy. There is no limit on the amount that can be invested, and additional contributions can be made each year, up to 125% of the previous year’s contribution. Money can be accessed at any time prior to the 10-year tax-free threshold, but depending on the timing, some of the tax benefits will be forgone.

See our latest net returns below:

BondNet Performance*
1 year 3 years5 years
Centuria Growth Bond Fund5.74%7.28%8.63%
Centuria Balanced Fund6.80%5.95%7.77%
Centuria High Growth Fund5.71%6.89%9.65%
Centuria Australian Shares Fund6.38%7.71%10.74%
Centuria Implemented Portfolios Dynamic Asset Allocation Bond3.92%1.88%
Centuria Cash Plus Fund6.99%

* Performance of this tax paid bond is measured as a 12 month rolling return from 31 July 2016 to 31 July 2017, after taxes and fees. Past performance is not indicative of future performance.

 

As a reminder, we have a number of Lunch & Learn session happening in Queensland, NSW and Victoria. Book today for your chance to hear the latest strategies in protecting your assets.

13th September in Melbourne Victoria – Register here

14th Septemmer in Sydney NSW – Register here

12th October in Brisbane QLD – Register here

 

For more information on how Centuria Investment Bonds can form a core component of your client solutions please call 1300 50 50 50 or email enquiries@centuria.com.au. Alternatively please call your Business Development Manager.

VIC/TAS/SA – Jason Lien (03) 9616 6547

NSW/QLD – Allison Macfarlane (02) 8923 8920

We would be delighted to assist you and your clients prepare for the post 1 July 2017 environment.

 

Kind regards,
Neil Rogan
General Manager
Investment Bond Division