Breeders Amongst The “winners” In Government Trusts Backflip

MAGIC MILLIONS DISCLAIMER: This media release is provided to Magic Millions by Carrazzo Consulting. Please note this a copy of their release presented with their permission and the details of the release are the views and opinions of Carrazzo Consulting.

A welcome Christmas present was handed to approximately 23,000 Australian farmers who have trusts when on 16 December 2010 the Government issued a media release advising that the tax law would be amended so that trust beneficiaries can continue to use the primary production averaging provisions (see below) and farm management deposits (FMD) provisions in a loss year.

N.B. The FMD scheme is designed to allow primary producers to, in effect, shift income from good to bad years in order to deal with the adverse economic events and seasonal fluctuations.

The Assistant Treasurer also announced that a public consultation process would be the first step in updating the trust income tax provisions.

There is little doubt that the Government caved in to the enormous lobbying conducted by bodies such as the National Farmers Federation (NFF), CPA Australia and the Institute of Chartered Accountants. The Government also honored the Henry Tax Review recommendation to rewrite the current trust tax laws.

Breeders amongst the “winners”

The significance to the horse industry is that taxation breeders, who are classified as Primary Producers at tax law, can continue to use trusts in the manner intended and its beneficiaries not be treated any differently to individuals earning primary production income in their own right.

Numerous horse breeders conduct their horse activities via trusts as they have many benefits compared to the more conventional tax structures such as companies and partnerships.

This release revolves around the status of income derived by breeders in trusts and whether, in the hands of beneficiaries, it can be subjected to the special Primary Producer income averaging provisions

What is income averaging?

Averaging is designed to ensure that primary producers (e.g. breeders) with fluctuating incomes pay no more tax over a number of years than those on comparable but steady incomes. This is achieved by making an “averaging adjustment” in each year in which the averaging applies.

Averaging clearly reflects that, due to the vagaries of being on the land, incomes from year to year can fluctuate wildly through things such as floods, droughts, viruses, bushfires, insect plagues etc. No better example than the current “biblical” type floods affecting so much of Queensland at the moment where so many primary producers have had their income from 2011 crop and animal breeding activities virtually wiped out by this amazing occurrence.

How does averaging work? In high income years (when average income is less than current year taxable income) the adjustment takes the form of a tax offset that reduces tax. In low income years (when average income is greater than current year taxable income) the adjustment is made by increasing the tax that is payable.

Example – Averaging saves tax!

Brad is a beneficiary of the Brad Bloodstock Trust. In the tax years 2009, 2010 and 2011, the trustee allocated the following income distributions from his trust:

2009 – $50,000

2010 – $80,000

2011 – $200,000

These trust distributions were his only source of taxable income in these years.

Brad’s average taxable income over these three years is $110,000 ($330,000/3 yrs). Brad’s trust had an exceptional year in 2011, where it had many yearlings that realized in excess of $100,000.

Brad is entitled to a tax offset in the 2011 tax year as his basic taxable income of $200,000 exceeds his average income of $110,000.

In this instance, after a complex calculation, Brad’s averaging tax offset in 2011 is $12,043, this amount reducing his tax payable (excl. Medicare Levy) from $63,550 to $51,507, a significant reduction in his tax payable of nearly 19%.

The problem – ATO designated breeding income of trusts as “normal” income

It has been a long held ATO position that breeding/primary production income of a trust maintains that character even when distributed to an eligible income “beneficiary” of a trust, i.e. even where the individual beneficiary does not conduct a primary production business in his or her own right. This is important as it ensures that a beneficiary in receipt of breeding trust income can access the primary producer income averaging provisions.

This rule could also be relied upon by beneficiaries even in a year where the trust makes a loss or derives no trust law income and may not be entitled to make a trust distribution.

However, this all changed on 30 June 2010 when the ATO withdrew the 1995 tax ruling giving authority to its previous above position. The ruling met this fate as a result of the decision in a landmark trust tax case called “Bamford’s”, a tax case that gave greater certainty to the taxing of trust income. The ATO considered that keeping this ruling in place would conflict with the principles in this new landmark High Court tax case.

Justifiably, this harsh and unforeseen ATO decision caused uproar to thousands of rural family businesses who conduct their primary production activities via a trust, (for reasons primarily of asset protection and tax efficiency). In times of fluctuating incomes within rural Australia, potentially stripping trust beneficiaries of the averaging provisions seemed extremely inappropriate and inequitable given the increase in tax likely for trust beneficiaries.

You are welcome to contact the writer if you wish me to clarify or expand upon any of the matters raised in this release.

End of release.

DISCLAIMER

Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information’s applicability to their particular circumstances with an accountant specialising in this area.

Prepared by:

PAUL CARRAZZO CPA

CARRAZZO CONSULTING CPAs