Discretionary trusts and payroll tax – disclaimers work, but not retrospectively

Discretionary trusts can produce nightmarish consequences for creating payroll tax groups.

A recent decision of the New South Wales Court of Appeal has overturned an earlier decision in the Smeaton Grange litigation. In doing so, it has limited a potential solution for taxpayers looking to deal with their payroll tax grouping issues. Advisers and taxpayers can no longer rely on retrospective disclaimers to exclude a trust from a payroll tax group: they need to deal with the issue now.

For an overview of what the Supreme Court said in its decision at first instance, please see our article The problem with discretionary trusts and payroll tax – and do we now have a silver bullet?.

Why did discretionary trusts cause payroll tax issues for Smeaton Grange?

Under the payroll tax legislation, potential beneficiaries of a discretionary trust each have a ‘controlling interest’ in that trust. This means that, if one of those potential beneficiaries also has a ‘controlling interest’ in a different entity that runs a business, both entities will be grouped for payroll tax purposes. It does not matter whether the beneficiary actually controls the trust – or even receives a distribution.

Payroll tax groups are important because:

1. all of the members’ taxable wages are included in determining whether each member should be registered and the amount of payroll tax that the group has to pay; and
2. all members of the payroll tax group are jointly and severally liable for the payroll tax obligations of the group – this is the case whether or not a particular member pays wages itself.

In Smeaton Grange, grouping led to two discretionary trusts being liable for an outstanding payroll tax liability owed by a company in liquidation.

A beneficiary, Michael, was deemed to have a ‘controlling interest’ in the two discretionary trusts and a company in liquidation. One of the trusts was Michael’s brother’s family trust and Michael was an eligible beneficiary because he was a sibling of a primary beneficiary (his brother). The other trust was Michael’s parents’ family trust.

Michael signed a document disclaiming any interests he had in the trusts from the date that the trusts were settled. The aim was to de-group those trusts from the company in liquidation.

The Supreme Court found that the disclaimer was effective and operated retrospectively. The result was that the trusts were not grouped with the company in liquidation.

What did the Court of Appeal decide?

The Court of Appeal disagreed and found that the disclaimers could not retrospectively remove the trusts’ payroll tax liabilities.

The Court of Appeal acknowledged that, although effective disclaimers operate retrospectively in most situations, the effect of the provisions in the payroll tax legislation meant that the liability for each of the discretionary trusts to pay payroll tax was complete before the disclaimer was signed. Each of the trusts was already liable to pay payroll tax. While the later signing of the disclaimer meant that Michael had retrospectively disclaimed his interest as a beneficiary, this did not erase that liability.

What can you do to exclude related trusts from a payroll tax group?

A disclaimer can be effective to deal with payroll tax grouping moving forward – although there may be other tax and duty consequences to consider. At this stage, disclaimers will not operate retrospectively to remove a payroll tax liability. We expect this won’t be the final instalment in the Smeaton Grange litigation and the taxpayers may appeal the decision.

The key is to consider your structuring options and tax consequences from the start. Broad classes of beneficiaries create problems that could be fixed by removing unnecessary beneficiaries. If your entities are still members of a payroll tax group, you can consider an exclusion order de-grouping some or all of those entities.

If you would like to discuss these issues, please contact a member of our team.