The conduit principle and income splitting
Did anyone ever tell you that income splitting was a great idea? Read this before you believe them!
There’s one bunch of attorneys who specialise in trusts that punt income splitting through a trust conduit as a great way to minimise tax, but they didn’t think it through properly. Here’s how it works –
The trust earns taxable income on which it would be taxed at 45%, but no problem, flow the income through the trust using the conduit principle, and pay it to beneficiaries who are on a low tax rate. Magic! The beneficiaries will pay maybe 18% or 25% tax.
However, in order to put this outstanding piece of tax planning into perspective, let’s look at why the trust is there in the first place. Isn’t it to build wealth and, whilst doing so, protect the wealth from creditors and from the taxes on death? Then surely, if you flow wealth out of the trust you are defeating the very object of its existence?
No worry, say the “experts”, once the tax has been paid the beneficiaries can return the balance of the money to the trust by means of loans. Like this –
Do you see the flaw in this argument? Sure the trust got the money back, but it now has a liability to the beneficiaries equal to the money they just lent it, so the net effect of the loans is zero and the trust has still bled away all of its hard earned growth.