The ATO’s recent release of draft ruling TR 2022/D1 Section 100A reimbursement arrangement, PCG 2022/D1 and TA 2022/1 is a significant development in the taxation of trusts.

Section 100A reimbursement agreements is an anti-avoidance provision broadly aimed at situations where the economic benefit or cash flowing from trust distributions is different from the person who has paid tax on the amount. The legislation has been around for some time, however this new ATO guidance sets out their concerns in this area which identify arrangements that have been common and accepted practice by trustees as being considered high risk.

 

The Draft ruling explains situations where section 100A is likely to apply and which would result in the trust being tax at 47% rate, rather than the tax rate of the beneficiary.

For 100A to apply there will be 4 requirements:

-Connection- there is a connection between the creation of a present entitlement to a share of income (ie the trust distribution of profit) and a ‘reimbursement agreement’.

-Benefits another – the payment of money or agreement must benefit someone other than the beneficiary of the distribution.

-Tax reduction purpose- the agreement was entered into for the purpose of reducing tax.

-Not excepted as ordinary family or commercial dealings – cannot explain the commercial or regular familiar reasoning.

 

There are some exceptions to section 100A, including where the income has been appointed to a minor or where the distribution relates to transactions that are in the ordinary course of a family or commercial dealing- however TA 2022/1 clearly warns taxpayers that the ATO will be reviewing trust arrangements where parents enjoy the economic benefit of trust income appointed to their children who are 18 years of age or older– an arrangement which was previously thought to be within the rules. The ATO has confirmed this is not the case, stating that just because something is common, doesn’t mean it is an ordinary family dealing.

 

The following ATO example shows a situation that has been common place for Trustees in the past, but will now attract attention and audit.

The trustee of the Blue Family Trust is Azure Pty Ltd. Trevor is the sole shareholder and controller of Azure Pty Ltd. The Blue Family Trust derives assessable income in excess of $400,000 a year. Trevor’s daughter, Simone, is a beneficiary of the trust. Simone has recently turned 18 years of age and works part-time. Simone expects to derive assessable income from her work of approximately $20,000 a year.

Before the end of the 2020-21 income year, Simone meets with her father and agrees that any distribution resolved to be made by the Trustee will, after the payment of tax, be paid to Trevor to reimburse him for part of the fees for secondary schooling and costs of other extracurricular activities since Simone was five years old. Records maintained by the family show that these expenses amounted to $315,000.

The Trustee resolves to distribute $160,000 to Simone and pays this amount into an account held in Trevor’s name. Trevor pays income tax on Simone’s behalf.

This arrangement raises the concerns that are mentioned in this Alert. Simone is purportedly made entitled to a trust distribution and this amount is used to reimburse her parents for expenses that they would ordinarily meet. The arrangement, which results in Trevor obtaining the economic benefit of the trust income without that income being subject to tax at the top marginal tax rate he would otherwise have paid, appears to be more readily explained by the tax outcomes achieved, rather than any familial objectives, The ATO believes that the expenses outlined are parental expenses and should not be considered part of a family arrangement.

 

This is a clear area of focus at the moment and based on the ATO’s strict interpretations this may mean that many family groups will end up paying more tax on income generated by family trusts in coming years.

The ATO has also advised that this change will be considered retrospectively, indicating they could review distributions back as far as 2015 financial year.

 

How Can Alto Help?

Alto can review your previous years trust distribution pattern and determine if your trust is at risk of ATO attention. We can also discuss your current year position and look at options for tax minimisation, that are within the ATO’s parameters.

 

Author: Donna Bruce