Earlier this year, the Australian Tax Office (ATO) released a package of draft advice and guidance products focusing on trust entitlements arising out of reimbursement agreements and unpaid present entitlements (UPEs) of trust beneficiaries. That’s section 100A (s. 100A) for those who like to get technical.
The reason for the release was for the ATO to communicate their revised guidance as to how the law is to be applied when it comes to s.100A for public consultation and feedback. It has definitely attracted a lot of interest and generated a high volume of community interest.
What is the guidance targeting?
Essentially, the guidance package is a revision of the 2014 guidance and focuses on instances where trust income has been distributed to adult children in order to take advantage of lower marginal tax rates, and then the actual benefit of the income is obtained by someone else, perhaps another beneficiary of the trust, such as a parent, or the trustee of the trust.
It is important to note that not every trust distribution to adult children is being called into question here. The ATO recognises that most trust distributions and transactions are “above board” and will not be reviewed as part of the current guidance, rather it is intended to identify and investigate those transactions and agreements that are misusing the tax benefits in relation to trust income distribution.
In a recent statement, ATO Deputy Commissioner Louise Clarke clarified that “The ATO’s position is that if the beneficiary of the trust gets the benefit, 100A has no role to play. The ATO is not concerned about ordinary family trusts where the relevant family members benefit from the distributions”.
Similarly, Ms Clarke also noted that the ATO is not concerned when profits from the family business are distributed to members of the family who work in the management of the business and then that family member chooses to reinvest the profits in the business.
What does it mean for my trust?
While the application of s.100A is quite technical, it generally applies when:
- a beneficiary is made presently entitled to trust income
- there was an arrangement that another person is set to benefit from that trust income – this is called a ‘reimbursement agreement’
- a purpose of the arrangement was someone paying less tax
- the arrangement was not an ‘ordinary family or commercial dealing’.
The main determining factor is where there appears no other clear purpose for the transaction other than tax benefit.
As part of its guidance package, the ATO has defined colour coded zones to highlight where their attention will be focused.
Green zone – Items in the green zone, are considered “OK” and will not require further investigation. These types of arrangements include ordinary family or commercial dealings such as where family members have mixed finances (eg. joint bank accounts), gift from parent to adult child, retention of funds by trustee for use as working capital or acquisition of investment asset, arm’s length dealings.
Blue zone – Arrangements in the blue zone will usually require “further investigation”. Where there is a retention of funds by the trustee that does not fall into the green zone – beneficiary makes a gift of their trust entitlement, disclaims the entitlement or forgives or releases the trustee from the obligation to pay the entitlement – or other arrangements that don’t clearly fall into the green or red zone, the ATO will look closer at the details of the arrangement.
Red zone – The ATOs primary focus at this time is events and arrangements that fall into the red zone. In the instances where a beneficiary has lent or gifted entitlements to another party or other arrangements subject to Taxpayer Alert TA 2022/1, washing machine arrangements are in place, inappropriate use of losses have occurred, and other similar circumstances, the ATO will be investigating in line with their recent guidance.
While the above zones set out some general types of arrangements to be reviewed, the critical factor here is in regards to triggering the application of s.100A. There may be instances flagged for review in the blue or red zone that do not trigger s.100A and therefore do not need to be investigated.
The test for whether s.100A applies relies on whether there was a reimbursement agreement at the time the beneficiary was made presently entitled to the trust income.
What has the ATO said?
The draft guidance sets out the ATO’s preliminary but considered views on the interpretation of the relevant law, as well as guidance on how the ATO will administer the ATO view as expressed in the draft products. They have included explanations of proposed transitional arrangements to support clients to adjust their tax affairs to comply with the draft guidance once it is finalised.
Ms Clarke went on to say “the ATO is aware that the guidance – which has been long requested by the tax adviser community – has unsettled some in that community because it calls into question some practices which have been relatively longstanding”.
“The vast majority of small businesses operating through a trust are not operating in a way that will attract section 100A. A distribution to an adult child who has a low marginal tax rate will not attract section 100A where they simply receive or enjoy the benefit of their distribution”.
Ms Clarke went on to say that “The ATO does not make law. We have not changed section 100A; 100A remains as it always has been. What we have done is publish what is at this stage draft guidance for consultation as to how we think the law applies”
The ATO will not be pursuing taxpayers that entered into arrangements between 1 July 2014 and 30 June 2022 where, in good faith, they concluded that section 100A did not apply to them based on the previous 2014 guidance.
“I want to reassure the community – we won’t have a retrospective element. We stand by our 2014 guidance for this interim period,” Ms Clarke said.
What do I need to do?
In light of the new ATO guidance package in relation to trust distribution to adult children, it is important to seek professional advice in order to accurately review the current risk level of your trust activities in regards to s.100A. Pending the outcome of that review, it may be necessary to then identify the best options for dealing with any existing or historical risks, and of course take any necessary actions and be sure to be aware of the new guidance with regards to any future trust distribution dealings.
The team of accountants and tax lawyers at The Quinn Group can help to review your trust distribution agreements and transactions to ensure that you are operating within the rules of the law and minimising your risk of s.100A. Contact us on (02) 9223 9166 or submit an online enquiry to schedule an appointment and discuss your individual trust account situation.