On 23 February 2022, the Australian Taxation Office issued a Draft Taxation Ruling which is likely to have a significant impact on the taxation treatment of income distributions from trusts. Specifically, the draft ruling provides the Commissioner’s position on the application of Section 100A, an anti-avoidance provision first announced as a new measure in 1978 to overcome “trust stripping arrangements”.
The ATO have taken a narrow interpretation of an anti avoidance provision that has the potential to treat as medium risk what clients and advisers have long considered normal practice by trustees. If applied by the ATO, the trustee will be assessed on a share of the trust income at the highest marginal tax rate (currently 47%), rather than the beneficiary to whom the trustee resolved to distribute to. If this includes a discount capital gain, the benefit of the discount will be lost.
The draft ruling is the Commissioner’s view, it does not hold the force of law and there has been considerable feedback from the professional bodies in relation to this. This client update is quite detailed, but please ensure that you read comments at the end and contact your Blaze Acumen adviser if you would like to discuss how this draft ruling may potentially impact you.
Section 100A of the Income Tax Assessment Act (1936) generally seeks to target arrangements where a beneficiary is made presently entitled to a share of the trust income, but the economic benefit is paid or applied for the benefit of another person and has the purpose of reducing any person’s tax liability. Importantly, the period of review for arrangements captured by s100A is, in theory unlimited (beginning in 1978) and could apply to periods beyond record keeping obligations of taxpayers and Statute of Limitations in the various states and territories of Australia.
If s100A applies, the trustee will be liable for tax at the top marginal rate as the beneficiary will not be considered presently entitled to their share of trust income. In the case of a discount capital gain, where the trustee is assessed under s100A, the benefit of the 50% discount will be lost.
Until recently, the section had largely lain dormant. There was limited guidance on what constituted a reimbursement agreement and how exceptions such as arrangements in the course of an “ordinary family or commercial dealing” were defined.
For many years, s100A was seen as a measure to counter artificial or contrived arrangements where there was no genuine intention for a beneficiary to receive the share of income that they had been made presently entitled to. “Income splitting” where amounts were set aside for adult children but the funds were reinvested by the trust were considered by taxpayers and professional practitioners to fall into the exception from s100A as an ordinary family or commercial dealing. However, the Commissioner’s views in draft taxation ruling TR 2022/D1 make it clear that the circumstances where an exception will apply have been considerably narrowed and what may have been assumed to be ordinary tax planning which was outside of the scope of s100A may now be seen as medium risk and could be subject to review.
Effect of the Draft Ruling
The draft ruling provides the Commissioner’s preliminary views on the requirements for s100A to apply, including:
- What is the purpose of reducing or eliminating income tax; and
- What is an agreement, understanding or arrangement entered into in the course of ordinary family or commercial dealing.
The application of s.100A is proposed to have retrospective application.
, is consideration of the Connection requirement. Broadly, there must be a present entitlement of a beneficiary to a share of trust income, which has arisen out of, in connection with or as a result of a reimbursement agreement.
If a Connection is established, there are three further conditions that must exist for s100A to apply.
- Benefit to another – the agreement must provide for the payment of money or transfer of property to, or provision of services or other benefits for, a person other than that beneficiary;
- Tax reduction purpose – a purpose of one or more of the parties to the agreement must be that a person would be liable to pay less income tax for a year of income; and
- Ordinary dealing exception – the agreement must not be one that has been entered into in the course of an ‘ordinary family or commercial dealing’.
Of most concern is the ATO’s narrowing interpretation of an “ordinary family or commercial dealing”. Many current arrangements generally rely on this exclusion. Going forward, an ordinary family dealing must be capable of explanation as being for the advancement of normal or regular familial objects.
An arrangement between family members which achieves a particular favourable tax result but cannot otherwise be seen to achieve any familial object, will not be an ordinary family or commercial dealing. Consequently, family objectives of distributions at the time they are made must be analysed. In terms of commercial dealings, the commercial objectives of the arrangement will similarly need to be established.
The Commissioner has also released Draft Practical Compliance Guideline PCG 2022/D1 – Section 100A reimbursement agreements – ATO compliance approach (PCG 2022/D1) and Taxpayer Alert TA 2022/1 – Parents benefitting from the trust entitlements of their children over 18 years of age (TA 2022/1).
The release of PCG 2022/D1 provides administrative guidance on the ATO’s compliance approach in relation to the application of s100A. Trust arrangements will be classified by the ATO into four zones (White, Green, Blue & Red) to differentiate their risk profile.
The highest risk zone will be arrangements identified in the Red Zone and will attract the attention of the ATO and its dedicated compliance resources. Examples, which are also highlighted in TA 2022/1 include:
- Distributions to an adult child where the funds are made available to the parent by way of loan or gift;
- Distributions to an adult child where the funds are paid to the parent in connection with expenses incurred before the child turned 18 years of age;
- Distributions to an adult family member on a low tax rate such as parents or siblings;
- A distribution is made to a private company who is also trustee of the trust and then distributed back to the trustee by way of a franked dividend;
- Distribution to an entity with tax losses; and
- Arrangements subject to a Taxpayer alert.
The above examples are considered by the ATO to exhibit the features in s100A that are of concern to the ATO (i.e a connection, benefit and tax reduction purpose that do not meet the ordinary family or commercial dealing exception).
Of interest is a recent Federal Court decision in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commission of Taxation  FCA 1619 (“Guardian”) which indicated that s100A should not apply to family or commercial dealings unless they contain artificiality. The ATO have appealed the decision and the result may re-shape the draft guidance currently on issue.
While s100A has an unlimited amendment period, the ATO have signalled that they generally won’t review arrangements entered into before 1 July 2014. For arrangements entered into before 1 July 2022, taxpayers can follow existing ATO web guidance.
Blaze Acumen comment:
Section 100A has been a “sleeper” for many years and it is somewhat disturbing to the accounting and legal professional that the Commissioner has taken a more narrow view of what it perceives to be its intended purpose when introduced into Parliament over 40 years ago. There have been very few judicial decisions and limited guidance on what constitutes ordinary commercial or family dealings which are excluded from the operation of s100A. As such, it is important to remember that draft taxation rulings do not hold the force of law and are merely the Commissioner’s interpretation of how sections of legislation should be applied in practice.
As with other draft taxation rulings, they remain open for comment and submissions from the various professional bodies. TR 2022/D1 is open for public comment until 8 April 2022.
Chartered Accountants Australia and New Zealand has received a significant number of submissions from its members expressing concerns with a number of features of the draft taxation ruling, including:
- Its retrospectivity when the ATO has failed to provide guidance on s100A previously;
- Whether the Commissioner is exceeding his general powers of administration;
- The threat of promoter penalties for accountants or referral to Tax Practitioner Board; and
- The fact that the ATO has issued the draft taxation ruling before the High Court hears the Commissioner’s appeal in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation, a case involving the application of Section 100A and one that the Commissioner lost.
For clients, it is important to follow a number of simple principles to ensure that in the event of a review by the ATO you do not attract their unwanted attention, including:
- If your trust distributes income to a beneficiary (any beneficiary) it is their legal entitlement and the actions of the parties should be consistent with this principle;
- If there is no genuine intention for the beneficiary to receive the benefit of the income distribution, you should not distribute to them;
- Parental expenses such as school fees, holiday costs etc should not be treated as an extinguishment of an adult child’s entitlement to a share of the trust income. The ATO has expressed a clear view that these are “familial expenses” and not those of an 18 year old child, for example;
- The actions of the trustee in satisfying a beneficiary’s entitlement to a share of the trust income should be recorded in detail. How and when was the beneficiary paid their share of income?; and
- If an individual beneficiary’s share of income remains unpaid by the trust and a parent or associate uses the funds for their benefit instead, consider formalising the loan to the borrower and a loan from the beneficiary in writing on commercial terms to satisfy the ordinary commercial dealing exclusion from s100A.
As the end of financial year approaches and you engage in regular planning discussions with your Blaze Acumen adviser, the above principles should be front of mind. We will provide further updates as and when industry submissions are made to the ATO and a response is issued.