Opinion – Labor’s tax plan for trusts misses the real tax reform opportunity

07 August 2017

Mark Molesworth , Partner, Tax |

Disclosure: the author has a discretionary trust, the beneficiaries of which will not be affected by the proposed policy. Opinions expressed are my own and not necessarily those of BDO.

The Labor Party’s proposal with respect to the taxation of trusts has been both lauded and derided for what it attempts to do to high income earners who allegedly use trusts to not pay their fair share of tax. I don’t intend to quibble with whether this alleged behaviour is moral, ethical or otherwise. My concern with the proposal is that it potentially puts a barrier in the way of entrepreneurial activity.

In my experience as a Chartered Accountant, small businesses are the lifeblood of communities and employment in the economy. Politicians of all persuasions have stressed this point regularly in the press and in their party platforms.

Therefore, my concern with the implementation of Labor’s proposed policy is for small business people who are ‘successful’ by Bill Shorten’s standards. He says that a nurse who earns $70,000 is successful. I agree. Everyone who is earning at their potential is successful.

But rather than comparing the representative nurse to the typical fat cat, what if we compare them to a more representative small business.

Consider a husband and wife, each of whom is a nurse earning $70,000 per year. They will pay, in aggregate, $31,400 in tax on total family income of $140,000.

By comparison, a husband and wife, each of whom is a plumber, carry on business through a discretionary trust and earn a net profit of $140,000 (ie each is just as ‘successful’ as the nurse). They will pay, in aggregate, $42,000 under Labor’s plan. That is, the plumbers will pay $10,000 more in tax than the nurses on the same family income. Is this really what is intended?

The shadow Treasurer’s position on this was that the small business people could simply pay themselves wages to avoid the operation of the 30% minimum tax. While that may be true (although I would expect some anti-avoidance provisions in this area) there are at least two objections to this course of action.

The first is that business income is never smoothly distributed through the year. All businesses that I have worked with have their high and low seasons. As such, trying to properly match wages to the ups and downs of a business’s typical year will take up a considerable amount of energy on the part of the business owners.

The second issue is that forcing one type of business structure to pay wages to its owners, where others are not, imposes red tape costs unequally across the economy. Essentially, the policy picks winners and losers from among small business structures.

Imposing additional costs on structures commonly used by small businesses will not encourage entrepreneurship. In my view, all areas within the government’s control, including the tax system, should be pulling in the same direction – that of encouraging small business activity.

So what is the solution? It would be possible to redesign the system to draw a distinction between income earned from active business undertakings and income earned from passive investment activities. While not without some complexity of its own, at least such a distinction would not penalise small businesses in one type of structure as compared to another. Over time, it may even be possible to design benefits, using that distinction, to positively encourage entrepreneurial effort and reward those willing to take on the risks of running a small business.