Date created: April 10, 1997

Last modified:18 December 2002

Maintained by: John Quiggin

John Quiggin

A relationship taken on trust,

Australian Financial Review, April 16, 1997.

As the debate over the Budget policy continues it is becoming apparent that the main source of the government's fiscal difficulties is the erosion of the tax base through the resurgence of various forms of tax avoidance and evasion. One area that has been identified as a major source of revenue loss is the exploitation of family trusts. The basic method of avoidance is simple. A trust enables income accruing to a taxpayer on a high marginal rate earner to be treated as if it had accrued to another family member on a low-income rate. Hence, it undermines the progressivity of the tax system. Greater reductions in tax can be achieved through more complex structures.

In responding to measures suggested to curb some of the more extreme uses of trusts, accountants and others involved in the tax minimisation industry have expressed concern that 'legitimate' family trusts may be affected. The answer to this concern is simple. There are almost no trusts in Australia established for legitimate purposes.

Trusts became popular as a legal device in the 19th century, and were used to deal with two classic problems of the Victorian era: the fortune-hunting husband and the spendthrift heir. In countries governed by English common law, until the passage of Married Women's Property Acts, a husband gained complete ownership of any assets his wife brought into the marriage. In these circumstances, the wife's family could provide her with an income, while protecting the principal, by putting money into a trust. The trustee was a third party who was obligated to act in the interests of the beneficiary, and would therefore prevent a husband from running through his wife's money. The problem of the spendthrift heir was similar. By holding assets in trust until the heir reached a suitable age, such as 30, it was hoped that the estate could be protected from the depredations of the racetrack, the card table and the demimondaine until the young man had sown his wild oats and settled down.

It did not take long for sharp operators to realise that trusts could be used for less beneficent purposes. By making themselves the trustee of a suitably designed trust , they could retain effective control of assets while keeping them out of the hands of their creditors. This rapidly became the dominant use of trusts and remains so to this day.

Over time, ordinary creditors have gained some protection from the misuse of trusts. A trust which is deliberately set up to defraud creditors is deemed to fail. But two classes of creditors are not nearly so well protected. The first are the ordinary taxpayers of Australia. The vast majority of trusts are set up with the primary purpose of avoiding tax that should be paid by high income earners and thereby transferring the burden on to the rest of us. It is these trusts that are typically referred to as 'legitimate family trusts'.

By an odd irony, the other main group who are cheated by trusts consists of married women. Trusts are largely protected from property settlements under the Family Law Act. A husband who anticipates divorce well in advance can put himself in a very strong position by transferring as much as possible of the couple's joint wealth into a trust under his own control. (Of course, in the majestic equality of the law, the same device is open to any wives who can avail themselves of the services of high-priced tax lawyers and accountants.)

A very simple reform which would eliminate much of the abuse of trusts would be to treat trust income as accruing to the trustee for taxation purposes except in cases where the trustee is a genuinely independent third party, like the Public Trustee for deceased estates. This would be no problem for the few legitimate trusts but would eliminate the vast majority that are set up with the sole aim of cheating ordinary taxpayers.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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