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Published 28 February 2013 06:58, Updated 28 February 2013 06:59
The mandated 80-year lifespan for trusts seems to be arbitrary, but the built-in obsolescence is starting to catch up with many family businesses. Image: Bryan Cook
Across Australia family businesses face the prospect of being hit with damaging tax bills in the next decade as baby boomer owners head for the exit. And finally, policymakers have woken up to the coming exodus.
A Senate inquiry into the $4.3 trillion family business sector, which handed down its findings this week, highlighted the tax problem created by the large number of business owners who are aged over 50.
In the next decade it’s estimated that more than half of family business owners will retire, either selling, transferring or winding up their business.
Who is best suited to take over, and when, will be the subject of heated family debate. There is also the question of how to transfer the business assets without being hit with hefty tax bills. Many private family businesses use trusts as a way to protect the family’s assets.
Trusts have been around for decades. A trust offers many benefits, but it also comes with disadvantages. One of the drawbacks is that a trust is heavily taxed when assets such as land are transferred. Unlike the sale of a business to a third party, transfer of ownership may not generate cash, but it could still result in stamp duty and/or capital gains tax.
A consistent theme raised during the inquiry was that there’s no real definition of family businesses or data on the dispersed sector. It ranges from well-known philanthropists, including the names Myer, Pratt, Murdoch, Gandel and Packer, to private large family companies and small businesses. Submissions also highlighted the issue of trusts and how it could spell trouble for one of Australia’s biggest business sectors. Family-owned businesses are estimated to make up 70 per cent of businesses in Australia and employ more than half of the Australian workforce, according to a 2006 survey of family businesses by MCI Group.
Speaking to BRW just days before the inquiry handed down its findings, the chair of the inquiry, NSW Labor MP Deborah O’Neill, confirmed the crucial economic contribution of family businesses and how the trust issue might throw up future policy questions.
“We’ve got a baby boomer generation and a changing demographic situation associated with that,” O’Neill says.
“A lack of rich data on the sector prevents us from having information that we need to move forward, but certainly the alert flags have gone up and this is an area that needs some investigation.”
O’Neill, who chairs the parliamentary joint committee on corporations and financial services that held the inquiry, says her greatest concern is the economic impact that the trusts problem may have.
“I am concerned about what this might mean for jobs,” she says. “Small business is the biggest employer in the country, many of whom are family businesses. And family business being successful means keeping people employed, so we need to have data about that.”
The committee’s deputy chair, Queensland Liberal Senator Sue Boyce, says family businesses need to get greater attention.
Boyce says succession, and the related issue of tax on trusts, will have an economic impact. “It has the potential to cause a bubble if we don’t know what’s happening and why it’s happening,” she says.
Complicating the situation is a rule, applying in all states except South Australia, that imposes an 80-year limit on the period during which a discretionary family trust can exist. Large accounting firms and tax experts want that rule changed.
On the death of a trust its assets may attract capital gains, with beneficiaries forced to find up to 46.5 per cent of the asset’s value. “This forced taxing point can threaten the viability of the family business,” PwC said in its submission to the inquiry. It suggests the government abolish the termination date of trusts, “thus removing any artificial taxing points”.
The 80-year rule also complicates existing business decisions and structures. “If a family is to acquire a major asset and their trust is already 50 years old, it would be unwise of them to place that asset in the existing trust – a vehicle with just 30 years remaining,” the PwC submission said. “This will prompt the creation of a new structure to hold the asset, further complicating the family’s financial structure and increasing the cost of managing their assets.”
The mandated 80-year lifespan for trusts seems to be arbitrary. Senator Boyce asked several times for it to be explained during the inquiry, but to no avail.
“Why do trusts last 80 years? No one knows. But within the next few years there will be many trusts that need to be rolled over,” she says.
Various other submissions call for a rewrite of tax laws surrounding trusts. Deloitte Private says such reform will create “certainty and simplicity”. It says the Australian Taxation Office’s recent focus on the family business sector, and its “difficult position in interpreting legislation that is complex” has created “an atmosphere of confrontation between the ATO and family business taxpayers”.
It points to a multitude of recent tax changes and the ATO’s “increasingly complex and onerous tests” as having “significantly increased the risks and costs for family businesses”.
Changes to Division 7A rules, which aim to ensure shareholders pay income tax on amounts they receive from their companies, are complex, particularly where trusts form part of the ownership structure.
The ATO has also recently turned its focus on trusts, introducing new timing rules for trustee resolutions (which now have to be in place by June 30 each year, two months earlier than previously). This has caused headaches for small businesses and advisers who now have to frantically rush to explain how the income of such trusts is distributed among beneficiaries.
Pitcher Partners pointed out in its submission that “complex business ownership structures” are being created and are becoming even more complex to deal with because of recent ATO activity and the government’s hunt for revenue. “This distortion and the consequent reaction to it has been created by our policymakers,” it said.
The Institute of Chartered Accountants says one way a family business used to be able to transfer business assets without triggering a capital gains liability was via the practice of “trust cloning” - as the name suggests, the creation of a new trust with the same beneficiaries and terms.
But cloning was also perceived as a tax avoidance strategy and was abolished by the federal government in November, 2008. While the institute acknowledges that the trust cloning exception was too wide and needed to be narrowed to protect the capital gains tax base, it says the exception should never have been abolished.
Labor MP O’Neill says there has to be “a careful conversation with the Board of Taxation about what can be achieved to ensure [family] businesses thrive, and at the same time people pay a fair share” of tax.
“Trusts are a vital and proper part of the Australian taxation system,” she says. “The government accepts and understands that, but we need more data if we’re going to make effective and considered policy responses.”