Episode 23 — Companies v Trusts – the victor

The showdown of companies versus trusts.

In this episode of TaxVibe, Robyn chats with John Ioannou CTA, Principal Lawyer and National Head of Tax, Macpherson Kelley. Robyn and John discuss the benefits and drawbacks of both structures in a changing tax environment. But is there a victor?

They discuss:

• What is a company and how does it differ to a trust?
• Different outcomes for stakeholders
• Division 7A, section 100A and lots of other tax rules
• Do trusts still have a purpose?
• Is it just too hard to run a trust these days?

Host: Robyn Jacobson, CTA

Guest: John Ioannou, CTA

For more information about The Tax Institute: https://www.taxinstitute.com.au/

Transcript

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Robyn Jacobson:

Hello and welcome to TaxVibe, a podcast by the Tax Institute. I'm Robyn Jacobson, the senior advocate at the Tax Institute and your host of today's podcast. We love the vibe of tax and here at the Tax Institute we do tax differently. I'll be chatting with some of the tax professions, great thought leaders who will share valuable and practical insights you may not hear every day. We hope you enjoy this episode of TaxVibe. I'm joined by John Ioannou, CTA, principal lawyer and national head of tax at Macpherson Kelley in Brisbane. John has over 20 years legal experience with a focus on tax structuring, tax disputes and commercial advice.

John is respected within the industry, his expertise and knowledge. And in 2021 and 2022 was recommended as a tax lawyer in Queensland in Doyle's Guide. John has a Bachelor of Arts, Bachelor of Laws and a Master of Laws. John also sits on the Tax Institute's Strategic Advisory Committee and chairs the National Engagement Committee. John, firstly, welcome to TaxVibe, and secondly we are here in person at the tax summit. What a buzz.

John Ioannou:

I know. Thank you for having me. It's good to be back at an event in person.

Robyn Jacobson:

Look, it really is, and seeing well over 1000 people here and getting run back in person after two and a half years since we've been able to hold a proper tax summit in this manner. So this morning we've had some sessions that have looked at section 100A and Div 7A and there've been others relating to companies and trusts and I thought, let's just tackle that good old fashioned rivalry, the company versus the trust, which is better? Which one wins? And a question that I received after my session this morning, I trusted with everything going on, is there still a role for them?

John Ioannou:

Absolutely. Yeah. I can't subscribe to the theory that trusts are dead. I will concede though that I don't think they're the first go-to point if you're going to start advising clients on structuring. And that breaks my heart a little. When I started out in practice or fair to say, it would've boarded on negligence advising a client to go straight into a company instead of a trust, because people just covered that general discount and just assume that it applies to all things. But the world has definitely changed and in my mind, dropping corporate rate of tax, I think we're all better educated about how trusts work and interact with particular sections. And I just think a lot of the assumptions and myths that operated to prioritize the use of trusts have been disbanded. So I think there's still absolutely a place for them. But yeah, like I said, I don't think they're the first port of call anymore.

Robyn Jacobson:

I want to unpack all that with you a little more. But if we start even with the discount, if you are a trading business, then we're not really looking at a big capital gain at the end anyway potentially. It's really just about profits, in which case you probably did default to a company anyway. Once you start looking at access to, whether it be small business CGT concessions or the 50% discount or of course flexibility in how you distribute, we start to move into trust territory. But if I take you back, so let's go back to when you first started in practice and you said it could have been bordering or negligence had you not gone with a trust structure. What were the key factors or indicators that would lead you to choose one structure of another back then? And what I'd like to do is unpack, what's changed since then?

John Ioannou:

That's a really good question. And in my mind back in the day, I think there was a lot of assumption about what would constitute a capital asset. So I think that's one flag that that needs to go up, which we can talk about a little later. And then I guess I've always seen it from the perspective, if you are a small business, private business operator, you're constantly focused on building your business, making sure that you can get it to a point where it can operate without you. That automatically means most business owners don't superannuate themselves properly. They won't take away age, they're not thinking about that. They're trying to build a capital asset. And I think the mindset continues to be if we focus on producing a business that we can sell, the panacea is being able to do that and shelter everything from tax.

And that means being eligible for the discount capital gain, small business CGT concessions, but also having it in an environment where you can easily extract it. So if you oversimplify all of those considerations, trusts were a bit of a no-brainer back in the day. And I think the other important thing to appreciate, even if you accept having an entity that isn't able to retain profit, doesn't make a lot of sense. But back in the day, again, that was easily fixed with corporate beneficiary UPS were what they were, and properly advised you could have people build a capital asset in a magnificent environment in the sense it was easy to achieve a corporate rate of tax, they had maximum flexibility. And when realization event happened, it was easy to extract and deal with it.

Like I said, that was more than 20 years ago. A lot's changed since then. And it isn't just the ATO's attitude to UPS. I do think generally as a profession we're all better educated on the ins and outs of trusts, and that's definitely been influence when practitioners who enjoy deep diving into technical issues like me, when you start to look at jurisdictions like New Zealand or even England where trusts have been around for a lot longer and the jurisprudence is a lot more advanced, I think our choice of trusts as the first port of call was based on a lot of, I'll say assumption, naivety because we just haven't had the same rigor applied to trusts as other jurisdictions have.

And I say all of that because I still think they're a good thing. But given the change to what actually constitutes a capital asset as well as how trustees interact with particular beneficiaries in their profiles, that instantly detracts from the reasoning that you put clients into it in the first place, which was simplicity. They were simple then, the issues weren't complex, they were well managed. And you can't just say that anymore. There are issues, they can still be managed, but I don't think they're the vehicle of the people as they once were.

Robyn Jacobson:

You speak of naivety and I think also the last 20, 30 years of how knowledge has evolved. I think back to pre Bamford, which was in 2010, prior to that time, very few practitioners I think in practice were doing resolutions properly by June 30, I think that was well understood across the profession. And practice has definitely changed. And I think we've reached a point where it's understood that that's just the way it has to be done. Now when it comes to other rules, trust loss provisions, the trustee beneficiary reporting rules closely held trust reporting rules, there are 38 different sets of rules within the tax law dealing with the taxation of trust or how they relate to trust. Now there's a lot to navigate, but I'm looking at chicken and egg. Have these rules evolved because of practices and behavior that taxpayers have undertaken or if taxpayers undertaken that behavior because of the development of the tax rules?

John Ioannou:

Well, let's not talk about tax reform. And actually looking at the bigger picture, I definitely think some of the measures that we've been left to deal with are off the back of taxpayer behavior. I think other measures we have them because we just better understand the issues at play and the measures are required to ensure that all of those things are adequately addressed. But I guess my problem with that, having sat in a session earlier about structuring for professional practices and talking about a corporate vehicle, which is the other contender against a trust, but you start to think about capital management issues in dealing with the company. You have the Corporations Act, which overlays tax issues, duty issues. And if you thought the measures in relation to dealing with trusts were complex, have a look at the ones that deal with corporates, they're even more difficult.

And I just think we're in a world now where probably hesitate because I think as advisors we've got our work cut out for us already, but the world has become a bit harder because now what we actually have to do is better educate the clients on all these issues. And I think the hard bit in trying to get clients to make the choice, "Do you want to trust you want a company?" You almost have to bombard them with a bit of your crystal ball gazing to get them to understand there isn't a perfect structure. You might be perfectly suited based on what you're telling me and what you've got in your line of sight to be in a company or in a trust. But I almost feel like we're in this scenario now where they make a decision based on that, something changes that they didn't contemplate or the advisor didn't contemplate. And it's, "Well, why didn't you foresee that? If that had happened I probably should have started in a different structure."

And I just say that because you use a company or a trust, I don't know anymore, I don't think there's just a go-to startup vehicle other than I'll concede if you're talking about startup business rather than passive investment, the tax world is definitely geared up towards corporate environment and not a trust one.

Robyn Jacobson:

Do you think complacency has played a role here? In other words, we can all joke about the lost trusted that you got to read it first, but before you read it you actually got to locate it. It's been very tongue in cheek that there's been of course a serious undertone there. So over the years I feel like there's been a much greater respect for trust law. We don't have federal regulation of trust. It's all of course done by state law and by the trustee. And I just wonder whether that has played a role in perhaps companies being regarded as a much more regulated vehicle. There's no national register of trust and that has been tossed around over the years.

John Ioannou:

Yeah, I think that's right. And I mean, if I was going to be the advocate for a trust, I think the lack of regulation is a good thing. I've just presented on partnerships, and why do they remain popular? Because they're easy, they're flexible, they're not regulated like a corporate environment. And for people who are just focused on making money by delivering professional services, that's really good. Life's easier. And I think trusts fit into the same box.

If I'm going to play devil's advocate and think, "Well, why is a company better?" Well, I just think from a regulation and regulator's perspective, because there's so much visibility on what they are, how they operate, what you've got to deal with them and you're not so much dependent on the controllers of the entity, that makes a lot of sense as well. So a lot of the practical issues you have to deal with when you've got too much flexibility disappear when you're in a regulated environment. And the only downside of that is sometimes they can be so regulated and so prescriptive that they kill the thing that they were designed to help, which is business development and entrepreneurship.

Robyn Jacobson:

If we also look at, there are certain needs that companies will satisfy. So if you're wanting to get into R&D and you want the benefits of the tax incentive, if you want to list publicly, revenue is obviously taxed at a corporate rate or lower. And it's interesting with the base rate entity position we're now in, where 25% at a base rate entity level is looking pretty similar to capital gain with CGT discount. Now I acknowledge that it's still in the entity and you need to extract it, but at a simple number crunching exercise, we're nearly in the same place, certainly with the capital gain.

John Ioannou:

And I've had that thinking for a little while now because I mean we all know the classic disaster situation where someone's been advised to start up business in a company, it's very profitable. They start to think, "Well what can we do with the excess money?" And the go-to places, get a trust that should acquire the investment. Money goes from company to trust, if 7A issues, they don't understand it. But I do think now there's a lot of value to get people to understand because of division 7A, because the inability for a trust to retain profit effectively, why wouldn't you just use a corporate. If you're paying 25% on your working capital and you can buy investments in another corporate and they're going to pay 25% tax on any profit, and you don't have a division 7A issue, do that.

Life's simple because access to the discount capital gain is a fallacy in my mind if you are relying on it by use of corporate money. You've got after tax money because you've made a [inaudible 00:14:16] somewhere and it's sitting in your personal bank account, absolutely go establish a trust, put it in as a loan or gift and knock yourself out. But if your primary income producing activities originate from a company, in my mind it makes sense your investments should be in a corporate environment as well if you're not wanting to deal with the dreaded top up tax.

Robyn Jacobson:

Another aspect is how do we fund retirement? Now I see that there are three main ways we do this. One is the family home where you may downsize later in life and sell off the big property and move to a smaller one or to a retirement home. The second one is the superannuation environment. And there's so much more we could say about radiation guarantee and the whole super system, but let's leave that for another day. And the third one I see is investments held outside super. And it's a really interesting question. If you start building up investments in a company income taxed at 25% if it's a base rate entity, and then depending on the type of income you are deriving, you could end up with some decent franking credits in there. So it becomes an attractive way of funding retirement.

John Ioannou:

It does, and I've often described corporates that are used for investments as de facto super funds. People can have the discipline to leave the money in there, let it accumulate, pay tax at the corporate rate. Depending what else you're doing with superannuation and the like, it would make sense that that should be pseudo super fund. So when you're not earning other income, you're able to draw down on those profits. I don't want to delve into tax reform because I think you're talking about how to deal with retirement. I think there's some work to be done generally in respect of how people are able to retire with the limits on what you can put into super. And that I think mixes in with refundability of tax credits, which were introduced at a time where the tax landscape was a little bit different in respect of how super funds were taxed and tax free threshold. Those things have changed. Refundability of franking credits haven't-

Robyn Jacobson:

Transfer balance cap.

John Ioannou:

Yep. So I think broadly that retirement discussion is a juicy one. But I think if it gets tackled, it needs to be tackled with proper reform because I, in my mind, see a number of moving parts that need to change. And I think you can only have reform if you get people to understand what the actual big picture is, what all the moving parts are that need to change, why they need to change, and get them to understand if you only change a couple, that's not enough. And I think tax reform generally that's been our problem. There's nobody there who's able to tell people, "This is the whole picture. This is where we were, this is where we currently are. This is how we got there, this is where we need to be, and this is how we need to do it." I just think we keep talking about tax reform in piece mill context and tackling it. And that's why it's hard because nobody understands what the big picture is.

Robyn Jacobson:

John, it's music to my ears because of course at the Tax Institute we are so supportive of and committed to holistic tax reform, not tinkering, not playing with little provisions on the edges, but actually getting into the thrust of the core design of the system and how it works. There is so much we could do with tax reform and maybe we'll get you back another time to chat about that. Can I focus back on retirement?

John Ioannou:

Yes.

Robyn Jacobson:

If we are looking generational passage of wealth, we've got our vesting periods with trust, we've got perpetual life with companies. So there's another fundamental difference there between them. And while we set these things up, I've done my basic maths, there's a whole chunk of trust that was set up back in the '70s and '80s, assuming they actually do have an 80 year vesting period and some of them actually have shorter periods than that. There are going to be hundreds of thousands of trust investing in the next 20, 30, 40 years.

John Ioannou:

Absolutely. What do you do about that? I don't know. I think we're better educated on the actual consequences of vesting. So whilst there may be some tax consequences for particular trusts that vest, for others, there won't be. Does that create a problem? I don't know. I mean if all that happens is a discretionary trust stops being discretionary and instead requires the trustee to send amounts to particular beneficiaries, I don't know, where's the evil in that?

Robyn Jacobson:

Because it doesn't necessarily mean that the trust has to end of course, you don't need to pull the wealth out of the trust. It just means you haven't got the discretion as to where you send it anymore.

John Ioannou:

Correct. There's no easy answer. I think even just if each state followed South Australia and just said, "Hey, no more perpetuity period," or it may not necessarily help all deeds that are in existence, they may not be able to deal with that as easily. Most people also forget. I think South Australia, even in eliminating its perpetuity period, has provisions in its property law act that still allow beneficiaries of trusts that'll never vest to go and call for real estate after a perpetuity period expires. But again, it's probably just getting people understand the whole picture and knowing that there is no quick fix for any of the issues we have to deal with.

Robyn Jacobson:

Let's go down another rabbit hole. You've got one structure you like to be in another. There are various forms of rollover, so you're not necessarily wedded to the original structure you're set up with, but of course there are a lot of hurdles you need to jump over to get to that other structure.

John Ioannou:

Yes, I mean the majority of rollovers are all aimed at getting into a corporate environment. We've only got the small business restructure, which should have been the panacea. But again, trusts have caused a little bit of an issue in respect of the interplay of how that rollover works when you have a non-fixed trust. But in theory, if we had true reform, you'd preferably want to get to a point where you structure agnostic so that you're not penalized or disadvantaged by virtue of being in a particular restructure.

Robyn Jacobson:

We certainly raised that issue or concept in our case for change report in July last year. The idea that you tax the type of income, not the structure that it happens to be derived in.

John Ioannou:

Yep.

Robyn Jacobson:

Another fundamental difference between the two is whether or not there's a separate legal entity in existence. We're all taught in uni that the company is a separate legal entity and a trust is more like a relationship or a marriage. And John, it just reminds me of a story that I heard on radio some years ago. A fellow was driving down the LA freeway in the transit lane, but it was one of those transit lanes where you have to have two persons in the vehicle and the police pulled him over and they fined him, and he objected to the fine and was so insistent that he took his matter to court.

Now I'm not familiar with the particular LA Freeway Law Act or whatever is applicable in that particular city, but let's just say it needed two legal persons in the car. And his argument was there was another legal person in the car because his corporate register was sitting on the passenger seat next to him. Now I'm going to surmise that in that particular piece of legislation, it required a breathing human being to be in the car with him, not merely another legal entity. But I love the story, he lost the case. But I think it just goes to the legal framework within which we operate. It is a person.

John Ioannou:

That is such a good example, and I did touch on it in my session where it's no one's fault, but there's clear confusion between a person, a legal entity that exists at law and then an entity for taxation purposes. They're all three different things and being one doesn't make you another, but it's amazing. Our world is so complex how people latch onto a concept for one context and then use that to make sense of others and it goes horribly wrong.

Recent case of RCF where I touched on a limited partnerships, that limited partnerships are supposed... Well they are corporate tax entities for taxation purposes, general law partnerships, which as you say isn't an entity, it's just a relationship between partners and their property deemed to be a corporate tax entity for income tax purposes. Great for limited liability in the context of limited partners being shareholders in a company. But people forgetting, being deemed a corporate tax entity doesn't mean you're actually a body corporate like a company. So partners in a limited partnership still being jointly and severally liable for tax obligations. And again, I feel bad for people because our world's hard. How are you supposed to get structuring right when structures mean different things for different purposes and people getting caught out when they use a meaning for one purpose for another and it doesn't work?

Robyn Jacobson:

Little tip for first timers reading tax law, if it uses the word person, it means any type of taxpayer. If it uses the word individual, it means a breathing human being.

John Ioannou:

Good point.

Robyn Jacobson:

So when we've got all these different structures and then we start layering it, we just start doing partnerships of trust and we start putting in trustee companies and corporate beneficiaries, and hopefully you haven't got the trustee also being the corporate beneficiary. I'd prefer that it's always separate. But it just adds so much more complexity and then we add in new developments. 100A of course is a really significant view that's being put forward by the ATO in their draft guidance. And we've had a good chat about that this morning, but it's making people rethink how they're using trusts and are they better off using companies. So as we draw this discussion to a close, John, if I can put you as an advocate wearing two hats at the same time. One is fighting for trusts and one is fighting for companies, which one's going to knock the other one out?

John Ioannou:

Don't make me choose. I go back to my lawyer response and say it depends.

Robyn Jacobson:

Absolutely. It does depend though on all seriousness.

John Ioannou:

It does. But if you're going to... Well, I'll give you an answer, but it's a qualified answer. If we're talking about business enterprise, I'd be inclined to go a corporate, will be one that's owned in the trust. And if I go back to my simple example, if you've got excess cash that's after tax and you're looking to invest, go down the trust. I don't think we're at a point where we can say avoid trusts at all costs-

Robyn Jacobson:

And they're certainly not dead.

John Ioannou:

No.

Robyn Jacobson:

John, thank you so much for your time.

John Ioannou:

Pleasure. Thanks for having me.

Robyn Jacobson:

Thanks for listening to this episode of TaxVibe. I've been chatting with John Ioannou, CTA, principal lawyer, and national head of tax commercial at Macpherson Kelley. We recorded this episode of TaxVibe live at the biggest tax event of the year, The Tax Summit in Sydney. The Tax Summit is three days of tax, technical insights, thought leadership, and world class networking opportunities where the professions best and brightest come together. Next year, The Tax Summit will be coming to Melbourne. We hope to see you there.

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