Australian entrepreneurship left in limbo whilst new trust rules kick the bucket

The Budget announcements regarding capital gains tax will, as currently announced, dramatically reduce the competitiveness of Australia’s innovation and start-up sector. The yet to be designed carve-outs for this new unsettled regime will be an invitation for talent and capital to migrate offshore if the exemptions do not preserve the existing maximum 23.5% tax rate applying to start-up founders and employees.

The changes to the taxation of discretionary trusts has been more carefully planned and is aimed at effectively eliminating the use of these trusts for operating businesses. The clock is ticking on these trusts – not only do new investments by private groups need to be made within new structuring parameters, but some trusts will require restructuring and warrant a review of their effectiveness for long-term wealth management purposes and succession planning.

CGT changes

Business founders currently benefit from a 23.5% tax on gains generated by their high risk entrepreneurial activity, and start-ups have a window of up to 10 years to reward their people with sweat equity that is taxed at only 23.5% on a liquidity event. These features are central to the competitiveness of Australian innovation and the economy’s productivity potential. The impact of the new regime is only now going to be considered following last week’s outcry when the CGT measures were leaked. Whilst consultation is to occur, the narrowness of the new (and welcome) refundable tax loss measure for start-ups in their first two years is not a positive indication that the current policy settings reflect the scale of this crucial sector in the economy and its sensitivity to changes in tax rates.

We have already seen start-ups pausing their ESOP activity in the last week; hopefully the consultation process preserves the status quo and unblocks the strait of uncertainty restraining this incentive pipeline. From a founders’ perspective, most existing structures cannot be effectively migrated offshore but a focus on new structures that can be is inevitable.

More generally the effective tax rate in Australian capital will increase in an environment where foreign capital remains largely outside the CGT regime. This inevitably makes domestic capital relatively uncompetitive and makes it harder for Australian businesses to raise capital. We expect to see investments reallocated to high yield plays, the institutional and foreign fund percentage share of the ASX increase, more debt being used in deals, new builds increasing in price as developers price in tax preferences, individuals holding onto assets longer and potentially revenue raised from CGT and State stamp duties falling (which may lead to further changes or reversals in tax policy). Accountants and lawyers are winners but not as much as valuers, with pre-CGT and other existing assets now taxable on their post 1 July 2027 value appreciation.

Discretionary Trusts

Federal Treasury has desired to end the use of family trusts for tax purposes since the 1970’s and this ambition is now finally to be realised. These trusts will essentially have to corporatise any operating businesses, a process which has already been in train over the years. Post 2028, these trusts will no longer be able to distribute to corporate (bucket) beneficiaries. This will end the practice of unpaid present entitlements beyond 2028 and is an elegant solution to the decision in the Bendel case without having to amend the corporate deemed dividend rules. It’s also a concession that Bendel will not be statutorily reversed retrospectively and is effectively an invitation for trusts to maximise unpaid present entitlements for the next couple of years. This two year window will also be the last opportunity to flush any potentially refundable franking credits out of trusts.

The changes now elevate the importance of discretionary trusts in succession planning, as the use of trusts will have less focus on income streaming and more on control, capital ownership and governance. The ability to release wealth held within a specific trust will be restricted by the inability to pay out taxed earnings into alternative succession vehicles without triggering top-up tax up to the 47% top marginal rate. A new rollover will be introduced to facilitate the restructuring of trusts, however the planning challenge is considerable especially in the absence of corresponding stamp duty relief.

Tax Loss Carry Back

There is some good news in the Budget as well – the on again, off again tax loss carry back idea of recent decades is now to be introduced permanently this time (we are told). The measure will allow sub-$1b turnover companies will a tax loss to obtain a refund of corporate tax paid in the previous two years, up to the amount of franking credits retained from those years. This is an important aid to companies in difficulty trying to survive a severe but temporary downturn. As a form of statutory relief it has added importance given the ATO’s increasingly  challenging enforcement approach in collecting tax debts and exercising its discretions.

R&D tax concession

Pleasingly the Government has taken much of the Ambitious Australia: Strategic Examination of Research and Development Final Report on board by introducing numerous measures including increasing offset rates and increasing turnover, high intensity and expenditure thresholds. Unfortunately, the removal of supporting activities from eligible activities results in a net tightening and a revenue increasing outcome for the Government from the package of changes. Whilst the concession may appear better targeted, the overall impact of the changes on Australian innovation is questionable when looking at the numbers alone.

Unprecedented new powers for the ATO

The Government intends to give the ATO even greater powers of enforcement and discretion.  This reflects an ongoing trend for more a muscular approach to enforcement by the ATO and continues the trajectory towards ever greater tax transparency.

For Boards, this signals a materially tougher enforcement environment and should heighten their focus on governance, adviser‑oversight and risk‑management expectations, particularly around the use of tax agents and intermediaries.

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Authored by: 

Peter Poulos, Partner