How small businesses will be affected by family trusts tax changes

The Opposition has suggested family trusts could be in the firing line in the near future with a proposed 30 per cent tax on earnings from family trusts. This could net billions in tax revenue given the prevalence and value of family trusts in Australia. A report from The Australia Institute suggests family trusts have assets of more than $3 trillion and a revenue of $350 billion last year alone.

This isn’t surprising given the same report showed more than 21 per cent of Australia’s national income is funnelled through trusts. They’re a widely-used tool to reduce income tax, protect assets, and provide for future generations of families.

However, it would be a mistake to categorise trusts as tax havens for the wealthy. While they can help preserve wealth for already-rich families, more likely, trusts are used by families in which one adult partner is the main breadwinner. The trust structure helps lower the tax burden, preserving more of that worker’s income to support the rest of the family.

When small businesses operate through a family trust, the family takes on risk, putting in their own assets as equity or collateral to operate the business. Being able to spread the profits among family members is, arguably, a just reward in exchange for that risk. Furthermore, running a business through a company or trust structure can provide some liability protection in case there is an issue.

In an economic environment where wage growth isn’t strong and prices keep rising, it makes sense for small businesses to run through family trusts. But if trusts are slugged with a 30 per cent tax rate, small businesses may have to consider restructuring.

A small business may be better becoming a corporate entity with a tax rate of 27.5 per cent (which will potentially drop to 25 per cent) if the theoretical 30 per cent family trust tax came into effect. Or, depending on the type of business, a 50-50 partnership may make sense. This spreads out the income and potentially lowers tax but there is no corporate veil protection, so family assets would be open to action if something went wrong.

Historically, governments have been wary of trusts and it could be possible that the Opposition hopes to stamp out trusts altogether with the proposed 30 per cent tax rate. This negative view of trusts traditionally stems from the false belief that only the mega-wealthy have trusts.

The number of trusts in Australia has increased over time but more people are using trusts for commercial reasons as opposed to wealth preservation. For example, a small business or tradesperson with a $200,000 income would normally pay a high personal income tax rate. But, if they have a non-working spouse, they can spread out the income using a trust and pay slightly less tax, giving the family more money to spend in the economy.

By discouraging small businesses from using trusts, governments provide no incentive for people to work hard and do well. A better system could be a family tax return, where the husband and wife are seen as a unit and given the benefit of better tax rates. This is already done in many European countries with some success.

For now, Australian small-business owners should keep a watching brief on the threat to tax family trusts at a higher rate. If the tax comes into effect, small-business owners should immediately seek professional advice on how to restructure their business to minimise tax, protect the family assets, and ensure smooth succession planning.

Joanne Wynne, Principal, RSM Australia