Further to our update provided on 4 September, on closer review of the provided materials we have identified the following items that may inform your views and discussions with clients.
Internally, we have termed this Budget as the one of “unintended consequences”. Whilst proposals may seem straightforward initially, the consequences continue to unravel.
For the avoidance of doubt, our view is that clients should be waiting for final legislation before acting. That is not to say planning for all circumstances should not happen: we absolutely believe you and your clients should be planning for all potential scenarios based on available information. The below contains our views based on the draft law relating to the excluded election trust (“EET”) nomination.
1. Asset protection
In our view, the most compelling consideration is whether an election leaves a beneficiary exposed from an asset protection perspective, including but not limited to matrimonial disputes, claims from creditors, bankruptcy, etc. There are competing views in the industry. The question can be viewed as to whether the EET is more akin to a family trust election (which has been considered to be ‘effective’ from an asset protection perspective, i.e., by not of itself creating a vested interest for the entire ‘family’ within the meaning of the legislation) or a fixed trust entitlement, which is widely accepted to offer lesser asset protection as the beneficiaries will have a vested interest in the trust.
2. One year only: the FY29 election window
There is only a 1-year period, being FY29, in which the EET nomination can be made. Elections cannot be made after this period. This means that planning is required before 1 July 2028 as to whether the election is appropriate in the circumstances. This removes the viability of a tax planning strategy to delay making the EET for a number of years on the basis of it not being necessary at that time, with a view to making it in a later, more appropriate income year.
3. Testamentary trusts
Testamentary trusts have been propelled to a comparatively brilliant vehicle, as if they are drafted correctly, should fall outside the scope of the minimum tax regime. However, the draft law now requires that a company or trust can not be a potential beneficiary of the testamentary trust if it is to be exempt from the minimum tax requirement. The unintended consequence is that all testamentary trusts drafted but not enlivened (as the will maker is alive) should be reviewed and, in all likelihood, amended to exclude corporate beneficiaries or other trusts as potential beneficiaries. This will have a similar impact to the introduction of foreign purchaser additional duty and absentee owner land tax, where many discretionary trusts were required to be amended to exclude distributions to foreign beneficiaries (notwithstanding there may never have been an intention to distribute to foreign beneficiaries). This will be onerous for clients. All in all, we think the following is likely:
- Many more clients will look to include testamentary trusts in their estate due to the competitive advantage over trusts made during a lifetime and
- Existing wills with testamentary trusts will need to be reviewed to determine if companies or other trusts could benefit and, if so, amend the will/testamentary trust to make the necessary exclusions.
4. When an EET can be varied
There are two described situations where an EET can be varied:
- Relationship breakdown (consistent with the circumstances of the relationship breakdown rollover in section 126A: broadly, being in accordance with a family court order or a binding financial agreement), or
- Death of a nominated beneficiary.
In the event of death of a nominated beneficiary, the election can only be varied to benefit a beneficiary under the estate.
In the event of relationship breakdown, a variation can be made in favour of the ‘remaining’ spouse. The critical element of the relationship breakdown variation is that the spouse must have been a nominated beneficiary under the EET before the relationship breakdown. In our view, this may give rise to consideration as to whether both spouses should be the nominated beneficiaries under the EET, including in situations where it may not be entirely tax effective to do so. For example, say you wish to make an EET of 50% of entitlements to a company and 50% to spouse 1. To provide flexibility in the event of relationship breakdown, it may be more sensible to have the following nominations:
| Nominated beneficiary | Share |
|---|---|
| Company | 50% |
| Spouse 1 | 49% |
| Spouse 2 | 1% |
The reason to include spouse 2 is make spouse 2 eligible to be a nominated beneficiary without revoking the EET following a variation for relationship breakdown.
5. Income and capital entitlements must match
For the avoidance of any doubt, both the income and capital entitlements under the EET must be the same.
6. Beneficiaries must be eligible at the start of FY29
A beneficiary elected in the EET must have been an eligible beneficiary in accordance with the trust deed at the commencement of FY29. If not, the election will be invalid. This gives rise to planning opportunities ahead of FY29, including whether amendments should be made before 1 July 2028.
7. Family trust elections continue to apply
The family trust election regime continues to apply and the nominated beneficiaries should be considered in light of the family trust election requirements.
8. Which companies are ‘eligible’?
Distributions to companies made in accordance with the nomination must be to ‘eligible companies’ in accordance with the proposed law. This broadly requires that a company must have no discretionary elements. We query how this would apply to companies with different classes of shares. Although not yet mentioned, we would query the eligibility of companies with discretionary trust shareholders (assuming as an ordinary shareholder). In our view, those companies should remain eligible companies as the company itself does not have discretionary elements, merely the shareholder. The Explanatory Memorandum leaves open that the Minister may give a further legislative instrument to give clarity.
9. A significant new risk for tax agents and advisers
We think this proposal gives rise to significant risks for tax agents and advisors. For example, where the trustee does not resolve to distribute income prior to the end of the income year by way of a written resolution, there is a risk that there is considered to be no distribution in that year. The default beneficiary clause could then be enlivened in accordance with the trust deed. As a result of the default beneficiary clause being enlivened, the distribution may well be inconsistent with the EET nomination made. As a consequence, the EET will be automatically revoked, the trustee will be assessed at the top marginal tax rate in that year and there will be no further opportunity to make an election. Put simply, failure to make a trustee resolution in a year by 30 June could lead to an automatically revoked election with no capacity to make a future election. There does not appear to be any Commissioner discretion in relation to re-enlivening an election.
10. Chains of trusts: limited help where a trust is loss-making
The draft law regarding a chain of trusts appears to create a credit in the second trust for the minimum tax paid by the first trust. This does not appear to assist the very common scenario of a profit-making trust distributing to a loss-making trust, as the profit-making trust will remain subject to the minimum tax of 30% (non-refundable by the loss-making trust). This will bring concerns to established groups and their distribution strategies.
