Tax avoidance via trust distributions – ATO guidance on s100A reimbursement agreements
Draft Taxation Ruling TR 2022/D1 & Draft Practical Compliance Guideline PCG 2022/D1
S100A is an anti-avoidance provision within the tax legislation which targets trust distributions exhibiting the characteristics outlined below. It has not been widely used by the ATO to date but these rulings suggest it may have greater application to typical family groups.
For s100A to apply, the following conditions must exist:
(1) A Beneficiary is made presently entitled to the income of the trust ie. the trustee resolves to make a distribution to the beneficiary;
(2) A benefit is provided to someone other than the beneficiary which was made presently entitled;
(3) There is a purpose of reducing someone’s income tax liability; and
(4) The agreement does not fall within the ordinary family or commercial dealing exception. The transaction must be able to be explained as achieving regular “familial or commercial ends”, ie. merely having all parties to the arrangement as family members does not guarantee that the exception will apply.
If the ATO determines that s100A applies, the beneficiary is no longer considered entitled to the income, but instead the trustee is taxed at the top marginal tax rate of 47% on such income.
Situations where s100A could apply:
- Adult children are made presently entitled to trust income, but their entitlement is never paid or they gift/lend their entitlement to other family members;
- Adult children are made presently entitled to trust income, but their entitlement is offset against other amounts payable to the trust (see section below on the Taxpayer Alert);
- Non-resident/foreign beneficiaries are made presently entitled to trust income, but their entitlement is never or only partially paid;
- A beneficiary with significant tax losses is made presently entitled to trust income, but their entitlement is never or only partially paid;
- Beneficiary is never advised of their entitlement to trust income
Just because a beneficiary does not receive physical payment of their trust entitlement does not automatically mean s100A will apply. The trustee may instead choose to retain some of the funds for investment purposes or for working capital purposes where there is a business operating out of the trust. These situations should not trigger s100A. Such arrangements are considered “low-risk” in the ATO’s risk rating.
Draft Practical Compliance Guidelines PCG 2022/D1 sets out 4 different risk zones and provides scenarios and examples for each risk zone to guide taxpayers and advisors to assess their risk rating and how the ATO will treat the arrangement.
Worked Example – Based on Example 5 in the PCG – Green Zone
- Greater Trust holds a number of investment assets.
- Ms Great and Mr Better have two children, Hubert (aged 15) and Violet (aged 17).
- On 30 June 2023, the trustee of Greater Trust makes a determination to appoint 50% of the trust income to each of Ms Great and Mr Better. Funds representing the entitlement are paid to a bank account jointly held by Ms Great and Mr Better. The funds are subsequently used for purposes which benefit both of them and their children.
- The entitlements were used for joint family purposes and to benefit the beneficiaries’ dependent children. This is an example of an arrangement falling in the green zone so the ATO would accept it and not review it.
Worked Example – Based on Example 7 in the PCG – Red Zone
- Brown Trust’s beneficiaries include the members of the Brown Family. Brown Co is the trustee of Brown Trust, and Bronwyn Brown is the sole shareholder and director of the trustee.
- Bronwyn is the parent of three adult children; Sandra (aged 26), Simon (aged 21) and Sam (aged 19).
- During the 2022-23 income year, Sandra is self-employed and has a taxable income of $90,000. Simon and Sam live at home, study full-time and derive no income during the income year.
- During the 2022-23 income year, Brown Trust derives $240,000 in income. The Trust makes regular payments totalling $240,000 into Bronwyn’s bank account during the year to meet her personal living and household expenses. Those payments are recorded as a ‘beneficiary loan’ in the accounts of Brown Trust.
- On 30 June 2023, Brown Co resolves to make Simon and Sam each presently entitled to $120,000 of the Brown Trust income.
- Brown Co records their entitlements as being fully paid by applying them against the beneficiary loan owed by Bronwyn.
- The entitlements of Simon and Sam are applied in this manner because they each purportedly have an outstanding debt owed to Bronwyn in respect of education expenses and their share of the Brown household expenses that Bronwyn paid before they each turned 18.
- This arrangement meets the conditions in red zone, meaning the ATO is likely to review it.
The draft guidance is generally proposed to apply both before and after its date of issue. However, unless certain circumstances apply, the ATO will not review arrangements entered into before the 2014-15 income year.
ATO alert on parents benefiting from trust income of children aged over 18 years – Taxpayer Alert 2022/1
Taxpayer alerts are issued by the ATO where there are certain tax behaviours that they are looking to stamp out. In TA 2022/1 the ATO are proposing to review trust arrangements where parents enjoy the economic benefit of trust income appointed to their adult children ie. are over 18 years of age (Children). The ATO is concerned that taxpayers are entering into these arrangements to avoid tax on the income of the trust by utilising the lower marginal tax rates available to the Children.
This taxpayer alert is targeting a specific type of arrangement that s100A might apply to (in addition to some other anti-avoidance tax rules).
According to TA 2022/1 the arrangements may display all or most of the following features:
- The trustees of a discretionary trust (Trust), or the directors of a corporate trustee, are either one or two individuals who are the parents in a particular family (Parents)
- Income derived by the Trust is used during the year of derivation to meet the expenses of the Parents. These may be recorded as beneficiary loans made from the trustee to the Parents throughout the year.
- Children are presently entitled to a share of the income of the Trust
- The entitlements are for substantial amounts but do not generally result in the Children’s taxable income exceeding the threshold for the top marginal tax rate ($180,000)
- Amounts are not paid to the Children. Rather, at the actual or purported direction of the Children, the entitlements are satisfied by the amounts being either
- Paid to their Parents; or
- Applied against any beneficiary loans owed by the Parents
- The parties believe that the entitlements are paid or applied in this manner because:
- The Children are required to repay their Parents for expenses incurred in relation to their upbringing or while they were minors (for example, school fees, school uniform costs or their share of the family holidays). The ATO does not accept that adult children can be made liable to repay expenses incurred by their parents whilst they were a minor.
- The Children are required to pay or repay their Parents amounts to meet their share of family costs for the current year in excess of amounts it would reasonably be expected an adult child would contribute towards. The ATO accepts that adult children can apply some of their trust distribution towards board, car expenses or rent if living away from home that the parents may have paid for during the year.
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The above summary is intended to be general in nature and does not cover all issues raised in the ATO’s rulings. Should you believe that any of the above matters may be relevant to you or your Group’s particular circumstances, please discuss the specific details with your Slomoi Immerman Partners advisor. Liability limited by a scheme approved under Professional Standards Legislation.