House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. Paul Keating, M.P.)

MAIN FEATURES

Trust Recoupment Tax Assessment Bill 1985

As indicated above, the Trust Recoupment Tax Assessment Bill is the main Bill in a package of 3 Bills which are designed to recover the income tax sought to be avoided under new generation trust stripping schemes.

New generation trust stripping schemes seek to exploit sub-section 95A(2) of the Income Tax Assessment Act under which a beneficiary who has an indefeasible vested interest in income of a trust estate, but who is not presently entitled to that income, is deemed for assessment purposes to be presently entitled to that income. In those circumstances, the trustee is not required to pay tax on the beneficiary's share of the income under section 99 or 99A of the Assessment Act. Instead, the beneficiary's share of the trust income is, subject to any tax exemption available to the beneficiary, either included in the beneficiary's assessable income or taxed in the trustee's hands under section 98 of the Assessment Act generally at normal individual tax rates including the zero rate bracket. The result is that tax is not payable on the income if the beneficiary is a tax exempt body or association or if the amount of the income is below the tax free threshold and the beneficiary concerned is entitled to the benefit of the zero rate bracket.

A simple version of a new generation trust stripping scheme would involve income of a family trading trust (the "head trust") being distributed to another trust (the "charitable trust"), the principal beneficiary of which is a tax exempt charitable institution. Under the terms of the trust deed of the charitable trust, the charity is given a vested and indefeasible interest in the income of the trust, but is not entitled to payment of the income until the vesting date, 80 years hence. The trustee has a discretion as to whether any income from the investment of the charity's accumulated income is to be paid to, or applied for the benefit of, the charity or other beneficiaries who are members of the family seeking to avoid tax.

In practice, a token payment is made to the charity and the bulk of the funds representing the purported income distribution remain with the head trust, being recorded in the trust accounts as a loan from the charitable trust to the head trust. It is the family members, not the charity, who enjoy income from reinvestment of the amount in which the charity is represented as having a vested and indefeasible interest.

Unlike earlier trust stripping arrangements, the stripped income is, at least on the face of it, to go to the charity in the fullness of time. However, the present value of what would ultimately be received by the charity is substantially less than the amount of the income. For example, the present value of $100,000 payable in 80 years time, assuming an interest rate of say 10% per annum, is less than $50.

If a new generation trust stripping scheme had not been entered into then either the trustee of the stripped trust would have been assessed on accumulated income under section 99A of the Assessment Act at the maximum personal tax rate or the income would have been distributed to, and included in the assessable incomes of, the beneficiaries really intended to benefit from the income. Under the Bill, the tax to be recovered will, at the option of the family concerned, be either the tax that would have been payable by the trustee of the stripped trust or the tax that would have been payable by the beneficiaries if the scheme had not been entered into.

Liability of the trustee of the stripped trust

In more detail, clause 5 of the Bill will look to the existence of a tax avoidance arrangement entered into on or after 1 July 1980 under which an indefeasible vested interest in a share of trust income is conferred on a beneficiary and where the present value of the benefit that will be derived from that interest is less than 50% of the amount of the income. If the trust in whose income the beneficiary has an indefeasible vested interest derived the income from another trust, the income stripped under the arrangement will be traced back to the head trust.

Where the stripped trust (usually a head trust) still exists and beneficial interests in it have not been sold since the tax avoidance scheme was entered into, the trustee will initially be liable to pay trust recoupment tax on an amount equal to the stripped income at the rate of 60%, that being the rate applicable to a trustee who is assessed on accumulated income under section 99A of the Assessment Act. That tax is to be imposed by the proposed Trust Recoupment Tax Act 1985.

Election arrangements

However, a right of election will be available under clause 7 to the persons (other than persons in the capacity of trustee of a trust estate) who could reasonably be expected to have benefited from a distribution of income of the stripped trust if one had been made immediately before the tax avoidance scheme was entered into and had been successively distributed through any interposed trusts. They will be able to elect that they be assessed on amounts of trust income equal in aggregate to the stripped trust income. In special circumstances, the Commissioner of Taxation is to be authorised to accept an election even though it is not made by all the relevant persons (e.g., where one of the beneficiaries has died).

Where such an election is made and the Commissioner is satisfied that the allocation of the trust income between the electors is reasonable and that the persons concerned will, where appropriate, pay tax on the amounts to be included in their assessable incomes (or, in the case of company beneficiaries, on the amounts to be treated as taxable amounts), the liability of the trustee of the stripped trust to trust recoupment tax will be eliminated.

Where a party to an accepted election is a prescribed person - broadly, individuals, tax exempt bodies, superannuation funds and certain non-profit or government controlled public companies - that person, etc., will be treated as though he, she or it had been presently entitled to a share of the income of the stripped trust of the year of income in which the stripping arrangement occurred. The trust income so allocated will be treated as either assessable income or exempt income, as the case requires.

Where a party to an accepted election is a company (not being a prescribed person) the company will initially be liable to pay trust recoupment tax on its share of the stripped income at the rate of 75% representing the combined effect of the primary company tax at the rate of 46% and the personal tax at the maximum marginal rate that would have been paid had the company been assessed on its share of the trust income and, after taking into account a retention allowance of 10%, had made a sufficient distribution. However, a further right of election will be available to the prescribed persons who would have benefited from a dividend payment by the company if one had been made immediately before the tax avoidance scheme was entered into and had been successively distributed through any interposed companies and trusts. They will be able to elect that they be assessed on imputed dividends equal in aggregate to the dividend that the company would have needed to pay to make a sufficient distribution of its notional share of the stripped trust income. If the election is accepted by the Commissioner the rate of trust recoupment tax payable by the company on its share of the stripped income will be reduced from 75% to 46%.

In certain cases it may not be practicable for a company which would have shared in a distribution of the stripped trust income, but for the stripping scheme, to be a party to an election (e.g., the company may no longer exist). In such cases the prescribed persons who directly or indirectly owned the company may choose to be parties to an election instead of the company. In these circumstances they will be required to pay amounts of trust recoupment tax equal in aggregate to 46% of the company's share of the stripped trust income and will be assessed to personal tax on imputed dividends equal in aggregate to a sufficient distribution of that share.

Liability at the secondary level

Under clause 6, a process of tracing liability for trust recoupment tax from the stripped trust to the persons who, in effect, benefited from the stripped income will be necessary in three situations. These are, very broadly, that the stripped trust-

(a)

no longer exists;

(b)

now has different beneficiaries as a consequence of sales of beneficial interests; or

(c)

is unlikely to pay the trust recoupment tax on its stripped income and the relevant persons behind the trust have not elected to be assessed on the stripped income.

Once the need to trace liability from a stripped trust has thus been established, a joint and several liability for the tax will be placed on all the persons included in the "eligible beneficiaries class".

The persons included in the beneficiaries class will be those who have directly or indirectly derived a benefit that is attributable to the stripped trust income. Among the persons who would be treated as beneficiaries under this test would be -

•

a beneficiary (or associate) of the stripped trust who enjoyed the benefit of the stripped income under arrangements whereby the funds were lent interest free to the beneficiary for, say, an 80 year term;

•

a beneficiary who capitalised the benefit by disposing of his or her beneficial interest in the trust;

•

a trustee of a sub-trust in a case where the income was actually paid by way of a distribution to the sub-trustee who effectively retained the amount for its (or its beneficiaries') benefit; and

•

a person who stripped moneys from the stripped trust representing the stripped income by way of a loan that is not intended to be repaid.

Certain persons will, however, be expressly excluded from the beneficiaries class. Excluded from the class will be a third party who derived a benefit as a result of a bona fide arm's length transaction. A charity that is a nominal beneficiary under the scheme will also be excluded from the beneficiaries class.

In cases where liability for trust recoupment tax has been traced to an eligible beneficiaries class by reason that the stripped trust has ceased to exist or beneficial interests in it have been sold, the beneficiaries of the stripped trust at the time of the tax avoidance scheme will be able to eliminate that secondary liability by exercising the same rights of election as were outlined earlier in relation to a liability imposed on the trustee of a stripped trust that still exists and whose beneficial ownership has not changed.

Rights of contribution and apportionment of liability

As the liability of an eligible beneficiaries class for trust recoupment tax is a joint and several one on the members of the class, it could occur that one or more of the members of the class is obliged to pay the trust recoupment tax that is the responsibility also of other members of the class. To enable the weight of the trust recoupment tax to be appropriately shared amongst members of the class, clause 10 gives a member of an eligible beneficiaries class a right of contribution against other members of the class in respect of trust recoupment tax that he or she has paid. The right is to be exercised in a court of competent jurisdiction, which may order such sharing of the tax as appears to the court just and equitable.

A further provision in clause 10 enables a person in the eligible beneficiaries class who is sued by the Commissioner of Taxation for unpaid trust recoupment tax to act to have other members of the class joined as co-defendants to the recovery suit. Where that option is exercised the court will, having regard to levels of benefits enjoyed or to be enjoyed, have power to determine how much of the unpaid amount it is just and equitable that the person sued, and each of the persons joined, should be liable to pay as trust recoupment tax.

Penalty tax

By clause 12 of the Bill additional penalty tax will be statutorily imposed in each assessment made in relation to a trustee or other person under the legislation in its application to new generation trust stripping schemes entered into after 28 April 1983 - that being the date on which the then Minister for Finance spelt out in a ministerial statement the Government's policy on retrospective anti-tax avoidance legislation. In relation to a scheme entered into after 28 April 1983 and prior to the commencement of this legislation, the penalty tax will, broadly, be equal to that amount which, based on movements in the Consumer Price Index, will make the tax to be recovered under this legislation equal to the tax that ought to have been paid at the time increased to maintain its value in present day terms. In relation to new generation trust stripping schemes entered into after the commencement of the legislation, the penalty tax will be equal to double the basic tax arising under this legislation. In both situations, the statutory penalty tax will be subject to a general power of remission vested in the Commissioner.

Safeguard against divestment of assets

The proposed legislation also contains (clause 13) provisions - foreshadowed on 28 April 1983 - to render void arrangements entered into after that date which have the dominant purpose and the effect of directly or indirectly defeating, evading or avoiding a person's liability to pay tax arising under this legislation. Where a scheme involves a transfer of, or diminution in the value of, any property of a person liable to pay such tax, that scheme will be void in any proceedings commenced by the Commissioner or by a liquidator or trustee in bankruptcy which are designed to recover such tax. A scheme of this nature entered into for the purpose of rendering a person unable to meet a potential liability to tax arising under the legislation will also be void if, at a later time, that person is assessed to pay such tax and fails to pay that tax.

More detailed explanations of the clauses of each of the Bills are contained in the notes that follow.