Whenever a tax advantage arises through the interpolation of a trust, care should be taken to assess the application of the anti-avoidance provisions.
Trusts allow income that might otherwise be taxed at the trustee rate, or to a beneficiary on the highest marginal rate (currently the same as the trustee rate), to be diverted to a beneficiary on a lower marginal rate. This is the case whether the trust is actively trading or a passive investor.
Trusts can also play a role in a structure where although overt avoidance is not intended it can arise through the advantages derived from the structure.
For this reason the anti-avoidance provisions of the Income Tax Act continue to be an important element in tax-planning considerations. The general anti-avoidance provision has two components. The first provides for a tax avoidance arrangement (s YA 1) to be voided against the Commissioner for income tax purposes (s BG 1) and the second allows for any tax advantage under the arrangement to be counteracted: s GA 1.
For the purposes of the Income Tax Act, a “tax avoidance arrangement” is defined in s YA 1 as an arrangement that has tax avoidance as:
“Tax avoidance” is defined in s YA 1 to include directly or indirectly:
The breadth of the definition makes it difficult to determine with any certainty the demarcation between acceptable “tax planning” and unacceptable “tax avoidance” that is subject to anti-avoidance provisions.
While care is required, not every advantageous structure will amount to tax avoidance. Consider this example from QB 14/11.
Scenario 1: Interest deductions where shareholder loans replaced
Company A, wholly-owned by a family trust, received $1 million in shareholder loans from the trust. Company A has used the shareholder loans to finance its business operations for the purpose of deriving assessable income.
Company A borrows $1 million, secured over the assets of the trust, from a third-party lender at arm’s length market interest rates to repay the shareholder loans to the trust.
The trust uses the repaid funds to acquire a holiday home for use by the trust’s beneficiaries.
Company A deducts interest incurred on the loan from the third-party lender from its business income.
The Commissioner’s view is that, without more, s BG 1 would not apply to this arrangement to deny Company A interest deductions under s DB 6 or s DB 7 for the interest incurred in respect of the loan from the third-party lender.
The general anti-avoidance measure is complemented by specific tax regimes that have the effect of re-characterising any arrangement in contravention of those provisions to a transaction that is conducted at arm’s length: subparts GB, GC. These general and specific anti-avoidance provisions, neither of which override the other, work in tandem.
It is also important to appreciate that the Goods and Services Tax Act 1985 has its own anti-avoidance provisions that can have application to structures involving a trust that may not always be appreciated. See Corporate Trustees Associated for GST Purposes.