Tax Alert: ATO Guidance Impacting Trust Distributions
Are you a trustee of a discretionary trust?
Last week the ATO issued a suite of draft public advice and guidance in relation to Section 100A reimbursement agreements and Division 7A of the Income Tax Assessment Act 1936.
The draft guidance in relation to Section 100A reimbursement agreements has been long-awaited.The draft guidance is a significant development and trustees may need to re-consider their approach to distributions as common family arrangements may no longer be acceptable to the ATO. Particularly where distributions are made to lower taxed individuals and companies but are unpaid and the trust income is used by other related higher taxed family members.
Section 100A reimbursement agreements
The ATO issued the following draft guidance in relation to Section 100A reimbursement agreements:
- Draft Taxation Ruling TR 2022/D1 Income tax: section 100A reimbursement agreements
- Draft Practical Compliance Guideline PCG 2022/D1 Section 100A reimbursement agreements – ATO compliance approach
- Taxpayer Alert TA 2022/1 — Parents benefitting from the trust entitlement of their children over 18 years of age
Section 100A is an anti-avoidance provision in the tax law that can impact the taxation of trust distributions.
The application of section 100A is complex. Broadly, section 100A can apply in the following situation:
- The trustee of a trust makes a beneficiary entitled to trust income (i.e. determines to distribute income to the beneficiary);
- Instead of paying the amount of the trust distribution to the beneficiary, someone else benefits from the income (e.g. because the trustee retains the income, or gives or lends the money to another person);
- The arrangement (the reimbursement agreement) is entered into for purposes that involve getting a tax benefit (e.g. the beneficiary pays less tax than if an amount was distributed to someone else who benefits from the trust income); and
- The arrangement is not entered into in the course of an ordinary family or commercial dealing.
If section 100A applies to a distribution, the trustee is liable for tax on the distribution at the top marginal tax rate including the medicare levy (47%) rather than the distribution being taxable to the beneficiary.
Draft Taxation Ruling TR 2022/D1 provides the ATO’s detailed views in relation to the application of section 100A including (importantly) what it considers to be covered under the exclusion for ‘ordinary family or commercial dealings’.
The ATO guidance notes that whether a particular agreement constitutes an ‘ordinary family or commercial dealing’ depends on all of the relevant facts. The ATO view is an agreement will not necessarily be considered ordinary family dealings merely because all of the entities involved are members of the same ‘family group’. Further, where an arrangement involves tax savings by distributing to a lower taxed beneficiary that is unlikely to receive the cash distribution this may indicate it is not an ordinary family or commercial arrangement.
The ATO includes a number of examples of arrangements that illustrate the principles in the Ruling including examples of what is and isn’t considered ordinary family or commercial dealings.
One area of concern to the ATO is distributions to low income adult children who don’t receive the cash distribution and, for example, gift their entitlements back to the trust or their parents. The ATO also issued a separate Taxpayer Alert TA 2022/1 in relation to this.
In TA 2022/1 the ATO indicates it is reviewing arrangements where parents enjoy the economic benefit of trust income distributed to adult children. They are concerned where income is distributed to children but the distribution is not paid and in substance it is the parents who benefit from the income. They are particularly concerned where the Trust distribution is satisfied by:
- A gift to the parents; or
- Offset against amounts that children are required to repay to their parents where this relates to expenses incurred prior to the child turning 18 or excessive contributions to the maintenance of the family above reasonable levels.
Proposed compliance approach
The ATO also separately provided details of their proposed ongoing compliance approach in relation to section 100A and distributions to beneficiaries in Draft Practical Compliance Guideline PCG 2022/D1.
PCG 2022/D1 provides guidance as to the level of risk of different arrangements and the expected ATO compliance approach as follows:
| Risk Zone | Risk | Description of arrangements | ATO compliance approach |
|---|---|---|---|
| White Zone | Low | - Arrangements entered into before 1 July 2014 (the ATO first published some limited web guidance on Section 100A in July 2014) | The ATO will generally not take any action. |
| Green Zone | Low | - Distribution to a beneficiary that benefits their spouse & dependants. - Beneficiary is individual or company and funds retained or used for working capital or investments (not for private use of an associate) | ATO will not take compliance action. |
| Blue Zone | Medium | - Arrangements that do not fall within the white, green or red zone | Less likely to be considered by the ATO but may be queried. |
| Red Zone | High | - Adult beneficiary / non-resident beneficiary but income gifted / loaned to parent/other party (or offset against expenses for beneficiary incurred before beneficiary turned 18) - Circular company dividend / trust distribution arrangements - Certain arrangements where a beneficiary is issued units in the trust to satisfy the distribution entitlement - Certain arrangements where the beneficiaries’ share of taxable income is significantly more than the beneficiary's distribution entitlement - Certain arrangements where the beneficiary has tax losses (and does not receive the economic benefit of the income distribution) - Arrangements subject to a Taxpayer Alert (e.g. Taxpayer Alert TA 2022/1) | These will attract ATO attention who will conduct further analysis and may lead to audit. |
Date of Effect
The new ATO Section 100A reimbursement agreement guidance is intended to apply both before and after the date of issue.
However, the ATO has indicated that for distributions prior to 1 July 2022 that they will stand by any administrative position reflected in the previous (albeit limited) guidance provided on their website in July 2014.
Updated views on UPEs and Division 7A
As part of the suite of draft rulings and guidance the ATO also released Draft Taxation Determination TD 2022/D1: Division 7A: When will an unpaid present entitlement or amount held on sub-trust become the provision of ‘financial accommodation’?
In this Draft Taxation Determination the ATO provides their updated views in relation to the application of Division 7A to unpaid trust distributions to private company beneficiaries (unpaid present entitlements or UPEs).
The ATO had previously provided their views on this issue and administrative approach in Taxation Ruling TR 2010/3 and Law Administration Practice Statement PS LA 2010/4, both of which will be withdrawn with effect from 1 July 2022 for trust distributions arising from that time.
The revised ATO view is relatively simple. They consider that a company UPE will be treated as a loan from the company to the trust for Division 7A purposes. Broadly, the UPE will be considered a loan at the following times:
- For a distribution of a fixed amount – at the time of the distribution.
- For a distribution of a percentage of income (or amount that needs to be calculated) – when the amount is determined after year-end.
To avoid a deemed dividend arising under Division 7A, a UPE will generally need to be paid or subject to a complying Division 7A loan.
The revised view only applies for distributions after 30 June 2022. The key changes after 30 June 2022 are:
- The timing of when a UPE may be considered as giving rise to a Division 7A loan – particularly for distributions of fixed amounts the loan will arise in the current year rather than after year-end.
- The sub-trust arrangements allowed by the ATO under PS LA 2010/4 will no longer apply.
Key takeaways and actions
The ATO has invited comments on the draft rulings and guidelines.
While the final rulings and guidelines may be refined, we do not expect the ATO’s general views to change significantly. It will be important for taxpayers with family trust structures to note three key takeaways:
- Historical tax planning distribution strategies with family trusts may no longer be accepted by the Tax Office (e.g. certain arrangements where trust distributions are made to adult children);
- Current and prior trust distribution strategies and practices should now be reviewed and trustees should consider the ATO’s views when planning their current 2022 financial year distributions;
- There are changes to the treatment of UPEs for corporate beneficiaries but only applicable from the 2023 financial year.
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Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.
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