ATO releases guidance targeting trust distributions both retrospectively and in the future
The ATO has released a package of guidance materials (“Guidance”) targeting trust distributions under section 100A. The ATO outline that they could seek to apply section 100A where tax benefits are being obtained from arrangements in connection with such distributions.
The consequence of the ATO applying section 100A is that the trust distributions would (instead) be taxed to the trustee at the top marginal tax rate (currently 47%). The views set out in the Guidance challenge the effectiveness, for tax purposes, of many practices that have become common in year-end tax planning involving trust distributions. In many cases, the ATO are seeking to apply their views retrospectively and for future income years. Given the retrospective nature of the Guidance, it is important for taxpayers to review prior year trust distributions in light of the new Guidance materials and to also consider the Guidance in planning their 30 June 2022 trust distributions.
The basis of trust taxation
Under the general regime for the taxation of trusts, the liability for tax is allocated by reference to the concept of present entitlement to the distributable income of the trust (i.e., based on trust distributions). To the extent that one or more beneficiaries are made presently entitled to a share of the distributable income, those beneficiaries will be liable to tax on an equivalent proportion of the net (tax) income of the trust. To the extent that there is some distributable income to which no beneficiary is presently entitled, the equivalent proportion of the net (tax) income will be assessed to the trustee.
Section 100A
Section 100A is an integrity provision that operates where a beneficiary’s present entitlement arises out of, or in connection with, an arrangement (referred to as a “reimbursement agreement”) that a) involves a benefit being provided to another person other than the beneficiary, b) is intended to have the result of reducing someone’s tax liability, and c) was entered into outside the course of ordinary family or commercial dealing.
Where it applies, section 100A deems the beneficiary not to be presently entitled with the result that the trustee is taxed (at a flat rate equal to the top marginal tax rate (currently 47%) on that beneficiary’s share of the trust’s net (tax) income.
ATO guidance material released
After 43 years, the ATO has decided to release its first comprehensive tax ruling outlining its view on the operation of section 100A, as part of a suite of three documents.
- Draft Taxation Ruling TR 2022/D1 (link) ( “Draft Ruling”) is the more technical of the Guidance documents setting out the ATO view on the interpretative nuances within section 100A. The ATO also provide a number of examples within the Draft Ruling.
- Draft Practical Compliance Guideline PCG 2022/D1 (link) (“Draft PCG”) explains how the ATO proposes to risk rate a range of trust distribution arrangements. It identifies four risk zones: white (low risk) covering most arrangements relating to income years ending on or before 30 June 2014; green (low risk); blue (medium risk) and red (high risk). The ATO will not generally dedicate compliance resources to consider section 100A in respect of white and green zone arrangements.
- Taxpayer Alert TA 2022/1 (link) (“Alert”) which outlines how the ATO will apply section 100A where parents benefit from the trust entitlements made to their children over 18 years of age.
Key interpretive issue with the ATO guidance
As noted above, a key determinant of whether section 100A applies is whether the exception for arrangements entered in the course of ordinary family or commercial dealings applies. The ATO have taken a narrow view of scope of that exception in their Guidance. Accordingly, the ATO believes that certain distributions to family members or to corporate beneficiaries can be caught within the operation of section 100A. As a result, the ATO see section 100A applying to many arrangements that taxpayers may have thought were outside its scope.
When do the changes apply from?
While the ATO’s ability to issue amended assessments is normally subject to a 4-year limit, that limit does not apply to amended assessments based on section 100A. The ATO has an unlimited amendment power in respect of section 100A, that is otherwise only generally available where there has been fraud or evasion. The Guidance is stated to apply to present entitlements arising both before and after the date of finalisation of the drafts.
The ATO states in the Guidance that, for present entitlements conferred before 1 July 2022, it “will stand by any administrative position reflected in Trust taxation – reimbursement agreement, … to the extent it is more favourable to the taxpayer’s circumstances”. In particular, the Fact Sheet seems to accept a wider variety of loan arrangements involving the trust that could be considered ordinary commercial and family dealings as compared to the PCG.
Furthermore, the draft PCG outlines that the ATO will not seek to dedicate compliance resources to arrangements entered into in income years ended prior to 1 July 2014, where the arrangements are not ongoing and all relevant tax returns were lodged prior to 1 July 2017.
As noted above, the ATO has released PCG 2022/D1 aimed at categorising arrangements and risk weighting these arrangements for purposes of section 100A.
Examples contained in the tax ruling
The Draft Ruling contains nine (non-exhaustive) examples, which demonstrate when the ATO may seek to apply 100A. Following is a summary of those examples. Please refer to the ruling for more details.
| # | Summary | ATO comment |
| 1 | The will of a deceased person provides that the grandson (currently 15) is entitled to all the trust income each year, although it is not to be paid to him until he is 25 years of age. | Section 100A should not apply – ordinary family dealing. |
| 2 | Each year a family trust creates a present entitlement in favour of an adult beneficiary (in equal proportions with their spouse) where the beneficiary makes the funds representing that entitlement available to their spouse in circumstances where the couple ordinarily pool their financial resources. | Section 100A should not apply – ordinary family dealing |
| 3 | Each year a family trust creates a present entitlement in favour of an adult beneficiary. In one year, that beneficiary applies part of the funds available from the trust to pay the deposit on their child’s first home. | Section 100A should not apply – ordinary family dealing |
| 4 | The family trust makes a beneficiary, an adult full-time student, presently entitled. The entitlement is determined so her taxable income does not exceed certain marginal tax rate thresholds. The beneficiary gifts her entitlement back to the trustee. | Section 100A may apply. Likelihood increased if arrangement repeated. |
| 5 | A family trust creates a present entitlement in favour of an adult beneficiary. The entitlement is determined so her taxable income does not exceed certain marginal tax rate thresholds. Funds representing the entitlement are set aside on a separate trust for the beneficiary’s sole benefit who indicates she may not call for the entitlements until she purchases a home or makes a similar investment. | Section 100A should not apply – ordinary family dealing |
| 6 | Each year, the trustee of family trust resolves to make each of the parents and their three adult children presently entitled to 20% of the distributable income. In one year, the father lends one child an amount similar to his entitlement to help the child move out of home. It is agreed that the loan is interest-free and repayable when the child can afford to do so | Section 100A should not apply – ordinary family dealing |
| 7 | An investment trust (a fixed trust) with twenty unrelated unitholders undertakes to acquire an industrial property from an arm’s length vendor. To partly fund the acquisition, each unitholder agrees to loan back an amount equivalent to their pending income entitlement for that year. The loans are on commercial terms requiring payment of market interest, which is capitalised over a fixed term of five years. Interest and principal are repayable at the end of the five-year fixed term. | Section 100A should not apply – ordinary commercial dealing. |
| However, section 100a might apply if there was no genuine intention to pay the interest or principal. | ||
| 8 | A company wholly owned by a family trust undertakes a share buy-back. The trust deed is subsequently varied so the distributable income of the trust is determined according to ordinary concepts. This has the effect of excluding the dividend component buy-back proceeds ($70,000) from distributable income. On 30 June, a corporate beneficiary is made presently entitled to all the distributable income ($10,000 of other interest income). As a result, that corporate beneficiary’s assessable income includes the interest income and fully franked deemed dividend (including $30,000 franking credits). The buy-back proceeds are the subject of a purported tax-free capital distribution to the controlling individuals. | Section 100A should apply. |
| 9 | A family trust owns all the shares in a company which is also a beneficiary of the trust. The company is made presently entitled to some or all the distributable income of the trust with the amount thereof paid to the company in the second year. The company pays a fully franked dividend to the trust in that second year. The company is made presently entitled to some or all the distributable income of the trust for that second year with the amount thereof paid to the company in the third year. | Section 100A should apply. |
Overview of the Draft PCG
The Draft PCG is a non-technical document outlining the risk rating for arrangements and whether the ATO are likely to seek to apply section 100A. The following table summarises those cases.
| Class | Outline | Compliance activity |
| Fact sheet | The ATO’s previous Fact Sheet which provided exceptions for certain distributions such as pre-2009 UPEs where the relevant funds are retained as working capital of the trust, sub-trust UPEs and loans to related entities where certain conditions were satisfied. | Will not generally be subject to new compliance activity. However, taxpayer needs to be on all fours with the Fact Sheet example. |
| White zone | Arrangements entered into in income years ended prior to 1 July 2014 where arrangements are not ongoing and all relevant tax returns were lodged prior to 1 July 2017. | Will not generally be subject to new compliance activity |
| Green Zone
(Case 1) |
Present entitlement to individuals with funds pooled with spouse or used for joint family purposes (similar to example 2 in TR 2022/D1). | Will not generally be subject to new compliance activity other than to confirm categorisation |
| Green Zone
(Case 2) |
Arrangements described as ordinary family or commercial dealings in TR 2022/D1. | |
| Green Zone
(Case 3) |
Present entitlement to individual or corporate beneficiary with funds retained in the trust and used as working capital in an active business, to acquire investment assets or lent out on Division 7A complying terms. | |
| Red Zone
(Case 1) |
Present entitlement to an individual who gifts or lends some or all their entitlement to another (in particular, a parent, caregiver or the trustee). | Will be the subject of compliance activity |
| Red Zone
(Case 2) |
Arrangements where distributable income is returned to the trust by the beneficiary in the form of assessable income (example 9 in TR 2022/D1 involving a corporate beneficiary owned by the trust). | |
| Red Zone
(Case 3) |
Arrangements involving the presently entitled beneficiary being issued units in the trust (or a related trust) with the amount owed for the units set-off against the beneficiary’s entitlement. | |
| Red Zone
(Case 4) |
Arrangements where the share of distributable income included in a beneficiary’s assessable income is significantly more than the beneficiary’s entitlement other than merely due to franking credits. | |
| Red Zone
(Case 5) |
Arrangements involving distributions of income to entities with tax losses. | |
| Red Zone
(Case 6) |
Arrangements subject to a Taxpayer Alert on section 100A. | |
| Blue Zone | Arrangements that do not fall within the white zone, green zone or the red zone are in the blue zone. | May be the subject of some compliance activity |
The Draft PCG includes an appendix with eleven further examples with their risk categorisation. These bear closer reading.
What arrangement does the Alert apply to?
The Alert addresses arrangements where a) an adult child is made presently entitled to an amount of distributable income (generally less than threshold for the maximum marginal income tax rate) and b) the child’s entitlement is applied to meet (or reimburse the parents for) the child’s share of the family’s living costs (including that child’s secondary school fees and other childhood extracurricular activity).
The ATO views these arrangements as being explained by the tax outcome achieved: being the use of the child’s tax-free threshold and lower marginal tax rates.
The Alert states that the ATO would have similar concerns in respect of arrangements involving other family members that would have lower marginal tax rates than the individuals who control the trust.
Based on comments in the PCG and the risk rating associated with the Alert under the PCG, there is a risk that the ATO may consider these arrangements from the 2014/15 and later income years.
Court cases
In December 2021, in a major upset for the ATO, the Federal Court upheld the taxpayer’s appeal against assessments issued in reliance on section 100A1;. This loss is noted in the Guidance as is the fact that the ATO have since lodged an appeal to the Full Federal Court.
We understand decisions in several other section 100A cases are pending. The outcome of these cases will be closely monitored to see whether or not they support the ATO’s views set out in the Guidance. Hopefully those decisions (and any subsequent appeals) will provide the clarity on the operation of section 100A that is sorely needed.
What are the next steps?
It is critical that clients consider their position and how the new ATO guidance will apply to their circumstances. Clients should contact their Pitcher Partners representative to review their situation and determine what action is required well before 30 June.
1 Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619.
