The Australian Taxation Office’s (ATO) recently released guidance on section 100A contains much that challenges the ‘lore’ that has grown up around acceptable uses for trusts in Australia.
Broadly, section 100A is an anti-avoidance provision that targets arrangements where a beneficiary is entitled to trust income, but the economic benefit is received by someone else as part of an agreement that is designed to reduce a person’s tax liability.
Interestingly, the ATO guidance has been released while there are live cases before the courts in relation to the application of section 100A. The guidance therefore also indicates the likely arguments that the ATO will be making in these cases, as well as in audits of taxpayers more generally.
How we got here
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Article ID: 228589
Trusts generally make income distribution declarations on or before June 30 each year.
Particularly in the case of discretionary trusts, distributions are made to beneficiaries who have lower marginal tax rates (e.g. non-working spouses, adult children and companies) than the primary income earner in the family (e.g. the working spouse/partner in a professional services firm) or the rate that would apply were the trustee to retain the income (usually 47%).
Such distributions are not a problem, so long as the beneficiary who is made entitled to the distribution actually receives the benefit of the money.
Where the lower tax rate beneficiary does not receive the benefit of the distribution, then section 100A comes into play.
Section 100A can apply where:
- In accordance with an agreement or arrangement, a beneficiary is made presently entitled to income of the trust;
- The beneficiary doesn’t actually receive the benefit of the distribution. Clearly this means that someone else does. This might be the trust itself – the classic unpaid present entitlement which the trust reinvests – or it might be someone else;
- One of the purposes of any person connected with the arrangement was to secure the lower tax rate. This is usually indicated where the tax rate applicable to the beneficiary is less than the rate that would have applied had the person or entity that actually received the benefit had received the distribution; and
- The arrangement is not an ordinary family or commercial dealing.
If section 100A is applied, then the income distribution is treated as if it was not made. As such, the trustee ends up paying tax on it at the top marginal rate.
To add a little more spice, section 100A is not subject to the limited period of review – it can apply indefinitely into the past.
ATO guidance
In relation to the requirements above, the ATO notes that:
- While the agreement or arrangement logically has to pre-date the present entitlement arising, the ATO states that it can rely on evidence of the actions of the taxpayers after that date to prove that an agreement existed before that date. As such, it will be extremely important that taxpayers keep evidence of their intentions – as was shown in the Guardian Case in the Federal Court recently.
- The subjective intention of the parties in relation to the tax avoidance purpose can be inferred from their observable actions. Our experience is, however, that this won’t stop taxpayers being grilled by the ATO in compulsory interviews.
- An ‘ordinary’ dealing is not one that is either ‘common’ or ‘not extraordinary’. It is one that cannot, no matter how you look at it, be explained by tax avoidance. This last point, in particular, is not exactly consistent with the Federal Court’s judgment in Guardian. The ATO is currently appealing that decision.
What does this mean for business owners?
The ATO’s Practical Compliance Guideline PCG 2022/D1 uses a traffic light system to rate various arrangements.
Practically, the ATO makes several points of which advisers should take note:
- Arrangements entered and ending on or before June 30, 2014, are unlikely to be further pursued;
- Where adult children have received a distribution, but have directed that distribution to be paid to their parents in satisfaction of expenses incurred during their upbringing, the ATO will take a particularly dim view;
- Distributions to companies that are, year after year, offset by dividends from the company beneficiary so as to avoid the application of Division 7A are also high on the ATO’s priority target list;
- If a trustee makes distributions which the beneficiary allows the trustee to retain, the arrangement will be of lower risk where the trustee holds investment or business assets sufficient to meet the entitlement if it were to be called for. Where the trustee has dealt with the underlying assets in a way that means the entitlement may not be able to be paid, a higher risk rating will apply; and
- Generally, a distribution to one member of a couple will be of low risk where the distribution is used to fund family expenses from jointly held bank accounts. However, this low risk ranking will not apply where the distribution is made to a dependant (whether a child or parent), and the funds are then advanced or gifted by the dependant to the main income earners.
The recently released ATO guidance should definitely cause a re-think by advisers of their annual tax planning and structuring. Discussions of this with clients will be crucial.
