With many legal practices operating through structures involving discretionary trusts, Labor’s recent announcements to ‘crack down’ on discretionary trusts may appear to have particular relevance to the legal industry. However, there are a number of rules already in place to limit income splitting in legal practices. As such, it is timely to consider the rules as they currently stand and the consequential impact of Labor’s announcements.
Labor’s Announcement on Discretionary Trusts
Labor has announced plans to tax distributions from discretionary trusts at a minimum tax rate of 30%. This rate will apply to distributions to beneficiaries over the age of 18. While little detail has been provided in relation to the announcements, they are aimed at stopping high-income earners from splitting income with family members in lower tax brackets.
Current Ability to Split Income – ATO Guidelines
The Australian Taxation Office (‘ATO’) will allow limited income splitting from discretionary trusts where income is derived from a business (rather than from an individual’s personal exertion). The ATO guidelines provide that a certain level of income derived from a legal practice must be included in the practitioner’s personal income tax return. The ATO provide three tests under which this level of income can be determined and will not open a practitioner up to an ATO review or audit if one or more of these three tests are met.
It should be noted that the ATO does not permit a practitioner with no employees to split income, as the ATO consider this income to be derived from the practitioner’s own personal exertion. Therefore, a lawyer operating as a sole practitioner through a discretionary trust cannot split professional income with family members by distributing to them.
Accordingly, the ability to split income is already significantly limited by the ATO, appearing to confine the potential scope of Labor’s announcements in this context.
The impact of Labor’s announcements may only be felt if beneficiaries of income are not otherwise taxed at 30% or higher. It is difficult to quantify this impact with the limited detail of the changes currently available.
However, any impact on a legal practice should be considered in light of the ATO rules and guidelines that already limit or prohibit the potential to split income. It is also a timely reminder that practitioners need to be mindful if determining to split income.
Pitcher Partners can assist in reviewing legal practice structures to ensure a practice is operating under an effective structure, while also following the ATO guidelines and not opening itself up to ATO review.