The ATO has been looking at issues associated with Trust Distributions for some time.

On 23 February 2022, the ATO released new draft guidance materials on the application and operation of section 100A and Division 7A of the Income Tax Assessment Act 1936.

Background

Section 100A is an anti-avoidance provision of the Tax Act which has been around since 1979. It was introduced at that time to target fairly specific arrangements, however the ATO is now seeking to expand its interpretation of this section and in the process invalidate many trust distributions. Worse still, it is proposing to back-date the ruling to encompass trust distributions outside of the normal amendment period (four years for most trusts).

The Government originally introduced section 100A because it was concerned about avoidance arrangements where a beneficiary was made presently entitled to income of a trust leaving the trustee relieved of any tax liability on the income, but also where the beneficiary did not pay tax. This may be, for example, because the beneficiary’s income is exempt from income tax or there is another trust with sufficient deductible losses to absorb its share of income as a beneficiary of the first trust.

So what is the Issue?

It is common for trust beneficiaries to be made presently entitled to trust income.

Sometimes (though much less commonly), a beneficiary's present entitlement to a share of trust income arises out of, or in connection with, an arrangement:

• Involving a benefit being provided to another person,
• Intended to have the result of reducing someone's tax liability, or
• Entered into outside the course of ordinary family or commercial dealing.

In these cases, section 100A generally applies to make the trustee, rather than the presently entitled beneficiary, liable to tax at the top marginal rate.

The draft guidance material provides the Commissioner's view about these arrangements and the four basic requirements for section 100A to apply, being:

• 'Connection requirement' - for section 100A to apply, broadly stated there must be a present entitlement, or deemed present entitlement, of a beneficiary (other than a beneficiary under a legal disability) to a share of trust income, which has arisen out of, in connection with or as a result of a reimbursement agreement (being an agreement, understanding or arrangement that has the three qualities described in the following dot points).

• 'Benefit to another requirement' - 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 requirement' - 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.

• 'Ordinary dealing exception' - the agreement must not be one that has been entered into in the course of 'ordinary family or commercial dealing'.
  
  

Importantly in the last dot point, section 100A doesn’t apply to “ordinary family or commercial dealings” (OFOCD). This concept has been commonly used to validate trust distributions to beneficiaries within a family group for many years. But the ATO has taken the position that a number of arrangements that are common in a family setting, are artificial or contrived and thus outside the OFOCD exception.

The ATO are also concerned about certain other arrangements including:

• Where distributions are made to adult children but it is not intended that the children will receive the income and as such the distribution is predicated on avoiding tax. 

• Distributions to corporate or bucket companies and how Division 7A impacts on such distributions.

What is the ATO Proposing?

In issuing the draft guidance the ATO sets out a risk assessment framework to determine the allocation of ATO compliance resources. The framework contains four risk zones that determine the ATOʼs compliance approach, ranging from no compliance resources being allocated, to the ATO conducting further analysis on the facts and circumstances of an arrangement as a matter of priority, which may proceed to audit.

The ATO explains that:

• They generally won’t allocate compliance resources to arrangements entered into before 1 July 2014 (noting there are some exceptions); and

• Taxpayers can rely on existing ATO web guidance if this is more favourable to their circumstances than the outcome under the PCG for arrangements entered into before 1 July 2022.

Where to From Here?

It is important to note that the guidance materials issued by the ATO are still in draft and as such can, and probably will change following a consultative period.

There is a case on appeal to the Full Federal Court (the Guardian case) which depending upon the outcome may also have an impact on the ATO’s final position. 

The issues that will be of most interest for most “vanilla flavoured” trusts will be around the “ordinary family or commercial dealing” and how the ATO will assess the risk zone which will determine the likelihood of audit activity.

We will be keeping an eye on the outcomes and certainly be considering the effect of final rulings on our client’s circumstances, both historical and future. If you want to read more about the ATO’s stance, here is a link to their guidance:

https://www.ato.gov.au/General/Trusts/In-detail/Trust-entitlements---draft-guidance/

Please contact us if you would like to discuss your personal circumstances.