A Generational Threat

The Australian Taxation Office (ATO) is leveraging extensive powers to scrutinise family trust distributions, with investigations reaching back more than three decades. This aggressive compliance action is resulting in staggering bills for unpaid taxes and penalties, posing a significant threat to the wealth accumulated by some of Australia's most successful private businesses over generations.

Tax experts are sounding the alarm, warning that the financial consequences for affected families are severe, with some facing potential insolvency.

The Core of the Crackdown: A Decades-Old Tax Law

The ATO's focus is on what is known as the Family Trust Distributions Tax (FTDT), a measure introduced in 1998 to combat tax avoidance schemes. At the heart of the issue is whether certain distributions made by family trusts were incorrectly handled and went untaxed, when they should have been subject to a tax rate of 47 per cent.

According to Arnold Bloch Leibler tax partner Jonathan Ortner, the tax bills for some families are already escalating into the hundreds of millions, leading to their "possible financial ruin". He estimates that if the ATO pursues this matter broadly, the total impact could amount to billions of dollars nationwide.

A Pervasive Issue Affecting All Australians

This is not an issue confined to the ultra-wealthy. Mr. Ortner emphasizes the widespread nature of the problem.

"The consequences are severe for businesses of all shapes and sizes," he states. "The farmers are impacted by this, the fruit shop owner on the corner, the mum and dad investors and the large private groups. It is all pervasive."

Complex Laws and Innocent Errors

Experts suggest that many of the tax shortfalls were not deliberate attempts to evade tax. Instead, they were likely honest mistakes made by accountants navigating what Mr. Ortner describes as "hideously complex tax laws".

The legislation requires a family trust to make a "family trust election," which nominates a single "test individual" (such as a patriarch or matriarch) to define the family group. This election is permanent and cannot be revoked. Since the law was enacted, however, family structures have become far more complex due to divorces, de facto relationships, multiple generations, and the death of test individuals.

This growing complexity means that "mistakes are very common," says Mr. Ortner. "I truly believe that neither parliament nor the ATO in the 1990s fully thought through, or could comprehend, what a private group might look like in 2025."

Calls for Reform and ATO Discretion

In light of these challenges, there are growing calls for a review of the current laws. Mark Molesworth, a tax partner at BDO, is urging the next government to assess whether the family trust distributions tax legislation remains fit for purpose.

"There are tax rules applying that have unfair and unexpected outcomes where there is no policy rationale for those and no mischief that needs to be addressed," Mr. Molesworth says.

A key point of contention is the ATO's approach to reviewing historical periods. Critics are concerned that investigations are dating back to 1998, causing interest charges to balloon and often exceed the original tax amount owed.

While Mr. Molesworth notes the ATO has "no explicit discretion under the law to ‘excuse’ a mischief-free technical breach," Mr. Ortner argues the office can choose how far back it investigates. He points out that for other trust-related tax issues, the ATO has a practical policy of limiting reviews to four years unless fraud or evasion is suspected.

"This very practice should be adopted by the ATO in relation to family trust distribution tax to give certainty to the market that innocent and inadvertent errors (of which there are many) will not put that family group at risk of financial ruin," Mr. Ortner advises.

The ATO's Stance

An ATO spokesperson acknowledged seeing an increase in family trust election issues, attributing this to factors like "poor tax governance and a lack of understanding by taxpayers of how the relevant law applies." However, the spokesperson stated that the ATO did not "actively review periods back to 1998."

The tax office maintains that its hands are tied regarding the unlimited amendment period. It argues that because the family trust distribution tax automatically becomes a debt to the Commonwealth 21 days after a distribution is made, "compliance administrative approaches ... are not able to be applied."

The Dire Consequences of Non-Compliance

The financial stakes are exceptionally high. Mr. Ortner warns that the pursuit of back-dated taxes and compounding interest could force some trusts into insolvency. If a trustee cannot pay the debt, the ATO can pursue the individual directors.

"If the trustee can’t pay the debt, the commissioner can go after the individual directors. And if they can’t pay the debt, the family group may go insolvent and the directors may go bankrupt," explains Mr. Ortner. "That is on the horizon for groups in reviews at the moment. It is certainly a real risk, and it will depend on how the matter proceeds between the taxpayer and the ATO."