The ATO seems to have maintained a position for a long time, that it much prefers the dealings of individuals or corporate entities, to trusts, where the ultimate taxable benefits can be more readily manoeuvred and difficult to follow. 

Section 100A of the Income Tax Assessment Act 1936, was initially introduced back in 1979, by the then Federal Treasurer, John Howard.

It was designed as an anti-avoidance measure seeking to stop dividend stripping arrangements and tax avoidance by Discretionary Trusts through the distribution of profits to low-tax or tax-exempt beneficiaries and then having those funds pass back to a taxable entity / individual, via a “reimbursement agreement”.

These “reimbursement agreements were implement to ensure minimal or zero tax would be paid by the actual recipient, who ultimately had the enjoyment and use of the funds, because the funds were now altered into a tax-free form through the choice of beneficiary.

 

What happens if s100A applies?

Where s100A can be shown to apply, the original beneficiary is deemed to have never been presently entitled to a share of the trust income. The distribution is effectively unwound, and the trustee is assessed at the top marginal tax rate for individuals.

 

If it has been around for so long, why are we talking about it now?

There have been a number of cases brought by the ATO over the years, seeking to utilise s100A to impose a tax liability on an entity/individual, who in their eyes has been the ultimate recipient of the Trust funds, had it not been for the use of the low or no tax beneficiary, and the ‘reimbursement agreement’ to pass on those funds.

A recent case where the ATO attempted to show that a trust had breached the requirements of s100A is Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCT1619.

The scenario in this case involved  a “washing machine” arrangement whereby the trust distributed to a corporate beneficiary, of which it was a shareholder, the company paid tax in that Year 1, and pays a fully franked dividend out to its Trust shareholder in Year 2, which the Trust again distributes in Year 3.  This arrangement can go on in perpetuity, with the beneficiary company never actually receiving the funds and no imposition of Division 7A Loan Arrangements to the actual recipient of the funds from the Trust.

This case was found in favour of the taxpayer and then affirmed by the Full Federal Court due to the arrangement being held to be an “Ordinary Family Dealing” and that no “reimbursement agreement” was in place.

The court did however partially allow the ATO appeal on Part IVA regarding the dominant purpose to provide a tax benefit to the taxpayer.

In December 2022, The Australian Taxation Office (ATO) finalised its guidance in relation to reimbursement agreements where s100A may apply.  The final ATO Tax Ruling TR 2022/4 and the Practical Compliance Guide PCG2022/2, seek to provide details about their interpretation of the legislation and areas where they will and will not apply audit resources, as well as their view on reimbursement agreements and what constitutes “Ordinary Family Dealings”.

Of particular focus at this time was consideration of agreements that made tax distributions to adult children, but where they never physically received any payment of funds from the trust.

ATO Deputy Commissioner Louise Clarke said the guidance has been developed to support trustees and their advisors, who have been requesting clearer guidance to help them manage their tax obligations.  Ms Clarke noted that the vast majority of small businesses operating through a trust will not be affected, clarifying ‘A distribution to an adult child who has a low marginal tax rate will not attract section 100A where they simply receive or otherwise enjoy the benefit of their distribution’.

 

Classification of Arrangements

In these releases, the ATO has provided guidance, however there remains a lot of uncertainty surrounding the actual definitions and interpretations – which allows the legislation to be quite broad and all encompassing, despite the ATO’s assurances.

The ATO guidance has adopted a “traffic light” approach to the risk assessment of various trust arrangements.

• White Zone (no risk) – no ATO compliance action on matters arising prior to 2014

 

• Green Zone (low risk) –  low risk and unlikely for the ATO to devote compliance resources

This would include situations where

• • Trusts physically pay the presently entitled beneficiaries the funds distributed to them in the Trust accounts (the PCG considers a 2 year time frame reasonable) and the funds are applied to the beneficiary, spouse or dependents with no “gifting” back.
  • The Trustee retains the presently entitled funds in excess of 2 years, but those funds are used as working capital, funding an asset it holds or on lent under commercial terms
  • Trusts distributions to a corporate entity, which has tax losses but uses the funds to satisfy commercial / business operational expenses

Note – Green Zones transactions that may draw attention :

• • • Undocumented arrangements and undertakings
    • Unpaid distribution converted to a loan or subsequently gifted
    • Unpaid distribution to a corporate beneficiary paid out as a franked dividend
    • Companies using trust entitlements to fund payments to non-residents
    • Beneficiary has not lodged and Income Tax Return

 

• Red Zone (higher risk)-  expectation that the ATO will be dedicating compliance resources to arrangements with these characteristics
  • Any arrangement, agreement, meeting of the minds that can be construed as a reimbursement agreement
  • Low rate tax individual adult beneficiaries being made presently entitled to trust income where the financial benefit is directed by way of a gift or loan to a high tax rate parent / relative
  • Scenarios where an individual adult beneficiary is presently entitled to a share of trust income, but instead of flowing those funds to the individual, the distribution amount is offset to a beneficiary account which has been accrued for earlier life expenditure when they were a minor
  • Distributions to loss trusts
  • Guardian style “washing machine” arrangements involving a corporate beneficiary

 

Part IVA

With the focus on s100A as a result of the ATO’s dealings with the Guardian Case, it is easy to lose focus on another piece of legislation that they have at their disposal for dealing with general anti-avoidance arrangements.

Part IVA may readily be utilised to attack discretionary trust distributions, based on the substance of the transactions and the reasoning for them.

This provision has some advantages for the ATO in that the requirement to substantiate a tax avoidance purpose is more clearly defined and has been utilised historically to good effect.

So, whilst we need to be aware of ticking the legislative boxes to not fall foul of s100A, there is always a background requirement to not make those arrangements so specific, that they could be caught as having a dominant purpose of tax avoidance.

 

How Can Alto Help?

If you need assistance with understanding if your trust distributions could be caught under s100A or Part IVA please contact the Alto Team

 

Author: Steve Payne