16 February 2011
Family businesses make up a significant proportion of the Australian SME landscape, and many use discretionary trust structures to provide a level of risk management – separating the business from personal assets and it offers the flexibility to distribute income in a tax efficient way.
In late 2010, the ATO announced that it would be changing how it treats certain aspects of discretionary trust structures, in particular unpaid present entitlements. Unpaid present entitlements occur when a trust appoints income to a company but does not pay all or any of the income to the company. This allows beneficiaries of income to limit the immediate tax cost to 30 cents in the dollar.
Apart from limiting the amount of tax payable the main reason for not paying the entitlement was because often the profits of the business had not fully realised into cash. Most businesses find that some of their profits can be tied up in stock, debtors, depreciable assets or other working capital. The profit has been made; it is just not cash in the bank at the end of the financial year. Practically, you can't pay out profits that haven't turned into cash. This sounds sensible to most of us but the Tax Office doesn't see it that way.
The ATO has announced that where there is an unpaid present entitlement between a trust and a company beneficiary that continues past the financial year, they will treat this as a loan from the company back to the trust. The implication of this is that it could cause the amount to be a deemed dividend. Income appointed by a trust to a company after 16 December 2009 is affected by these new rules (and could affect your 2010 income tax return).
Many small businesses have used this strategy as a way of managing their tax and cash flow position and dealing with the differences between their accounting profits and available cash. There are still a number of options available to you in how you manage this situation.
If you operate your business through a trust and have used a related company as a beneficiary, call us to discuss what needs to change and review your tax strategy and position.
Follow Bates Cosgrave News on Twitter @batescosgraveCA
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.