ato

ATO Trust Crackdown: Navigating New Personal Services Income Rules

The Australian Taxation Office (ATO) has sharpened its focus on how family trusts and partnerships compensate their members, triggering significant concern across the accounting and advisory sectors. At the heart of this shift is the enforcement of personal services income (PSI) anti-avoidance measures, specifically targeting structures that may be used to divert income away from higher personal tax rates.

For many Australian professionals operating through trusts or partnerships, this represents a critical juncture. The ATO’s renewed scrutiny signals a move away from "soft guidance" toward active compliance enforcement. Understanding the nuances of these rules is no longer just a best practice—it is essential for financial survival.

The Core of the ATO’s Concern

The current tension stems from the Personal Services Income (PSI) regime, a set of rules designed to ensure that income generated by an individual’s personal efforts is taxed at individual rates, rather than being split with lower-income family members or diverted to a company or trust.

According to recent reports from the Australian Financial Review (AFR), the ATO has launched a specific crackdown on trust arrangements that attempt to circumvent these rules. The central issue is whether a trust is genuinely distributing income derived from a person's skills, or if it is merely acting as a conduit for tax avoidance.

"If you are a professional operating through a trust, the days of simply attributing income to a lower-tax-bracket spouse or adult child are effectively over if that income is the result of your personal services." — Tax Industry Observer.

The ATO’s stance is clear: if a trust receives PSI, and that income is later distributed to beneficiaries, the distribution is treated as unearned income for the beneficiaries, subject to different tax treatments. This prevents the "splitting" of income that was actually earned by one person.

Recent Updates: A Timeline of Enforcement

The ATO’s current posture is the culmination of several years of policy development and warning. The official stance has hardened significantly in recent months.

SSBCrack News highlighted a pivotal update regarding the ATO’s clarity on these anti-avoidance measures. The report noted that the tax office has finalized its guidance on how PSI rules apply to family trusts and partnerships. This wasn't a new law, but a definitive statement on how existing laws would be applied, removing ambiguity that many practitioners had previously relied upon.

Simultaneously, the Australian Financial Review reported on the palpable anxiety this crackdown has caused. The "crackdown" refers to the ATO’s active data-matching and review of tax returns for the 2024 and 2025 financial years. The ATO has signaled that it is specifically looking for arrangements where: 1. An individual’s personal services business (PSB) is carried out through a trust. 2. The trust distributes income to entities that do not meet the PSI rules' strict criteria.

The SMSF Adviser adds another layer of complexity with their coverage on "Family Trust Elections." This highlights that for many, the choice of whether to make a Family Trust Distribution Tax (FTDT) election is becoming a high-stakes decision. Making—or failing to make—this election can have lasting consequences on how income is distributed and taxed, potentially locking a trust into a specific tax structure that may not be favorable in the long run.

Contextual Background: The War on Income Splitting

To understand the current situation, one must look back at the broader history of tax avoidance in Australia. The PSI rules were introduced (and subsequently tweaked over the years) to combat the practice of high-income earners setting up elaborate corporate or trust structures to lower their tax bills.

The "Diverted Profits Tax" and PSI Rules While the Diverted Profits Tax targets large multinationals, the PSI rules target the "mum and dad" professional structures—doctors, consultants, engineers, and IT contractors who operate through a Family Trust.

Historically, these trusts were used to distribute income to adult children or spouses who were in lower tax brackets, effectively reducing the family’s overall tax liability. The ATO has long argued that this undermines the progressive tax system. The current crackdown is essentially the enforcement phase of policies that have been on the books for some time but were previously in a "soft launch" period of education and guidance.

The Role of Family Trust Elections As noted in SMSF Adviser, the "Family Trust Election" is a critical mechanism. If a trust makes this election, it essentially nominates a "Test Individual." Any distribution to anyone other than the individual, their spouse, or their lineal descendants can trigger a punishing 47% tax rate (the top marginal rate plus Medicare levy).

The dilemma for trustees is that making an election provides certainty but restricts flexibility. Not making one leaves the trust vulnerable to the PSI rules and potential anti-avoidance provisions. It is a "one choice, lasting consequences" scenario that many trustees are currently grappling with.

Immediate Effects: Who is in the Firing Line?

The immediate impact of this ATO clarity is a scramble for restructuring among Australian professionals.

1. The "One-Man Band" Contractor High-income contractors who bill through a family trust are the primary target. If the ATO determines they are not a "Personal Services Business" (i.e., they don't have multiple income sources or engage employees), the PSI rules apply. The income is attributed to the individual, not the trust. This means the tax benefits of the trust are effectively nullified for that income stream.

2. Accounting and Legal Fees There is a surge in demand for tax advice. Accountants are reviewing thousands of trust deeds to ensure they are compliant. The cost of compliance is rising as businesses seek to "clean up" their structures before the ATO knocks on the door.

3. SMSF and Investment Trusts The SMSF Adviser context suggests that even Self-Managed Super Funds (SMSFs) that receive distributions from family trusts are under the microscope. If a distribution to an SMSF is deemed to be caught by the PSI rules, it could face adverse tax consequences.

Interesting Fact: Did you know that the Family Trust Election was originally introduced to protect family businesses from the "Kiddie Tax" (tax on income of minors), but it has now become a double-edged sword in the context of the PSI rules?

Strategic Implications: What Can Be Done?

The Australian Financial Review suggests that while the ATO’s stance is firm, there are pathways to compliance. For those worried about the crackdown, the following strategies are being recommended by tax experts:

1. Review the "Results Test" The primary defense against the PSI rules is proving that the income comes from a business that produces a result, rather than just selling time. If a professional uses their own tools, hires assistants, and bears the commercial risk of the project, they may qualify as a Personal Services Business (PSB), exempting them from the income splitting restrictions.

2. Assess the Need for a Family Trust Election As per the SMSF Adviser guidance, trustees must weigh the benefits of the election against the risks. If the trust has a history of distributing to non-family members, an election might trigger tax. If the trust only distributes to immediate family, an election might offer protection.

3. Consultation and Restructuring The consensus among experts is to avoid "doing nothing." The ATO has opened specific "winding down" provisions for those who wish to exit these arrangements without penalty.

The Road Ahead: Future Outlook

The ATO’s renewed vigor suggests that the era of aggressive income splitting through personal services is ending. We can expect:

• Increased Audits: The ATO has a clear mandate to audit high-income professionals in specific industries (likely IT contracting, medical services, and engineering).
• Legislative Tightening: While the current rules are strict, the government has shown an appetite for further tightening tax loopholes. Future budgets may introduce even harsher penalties for non-compliance.
• The Death of the "Ineffective" Trust: For many, the administrative burden and tax risks of maintaining a family trust for personal services income will outweigh the benefits. We may see a trend toward simpler structures, such as sole trading or company structures with Division 7A loan agreements.

Conclusion

The ATO’s clarity on personal services income anti-avoidance measures is a watershed moment for Australian tax law. It shifts the burden of proof firmly onto the taxpayer to demonstrate that their trust structure is legitimate, not just a tax avoidance vehicle.

For now, the message to Australian professionals is simple: review your arrangements, understand the distinction between business income and personal services income, and ensure your trust is working for you, not against you. The safety of ambiguity has evaporated, replaced by the necessity of rigorous compliance.