Will my trust distributions to a beneficiary be scrutinised by the ATO? The ATO’s current view on trust distributions under section 100A of the Income Tax Assessment Act 1936.
As the end of the 2022 – 2023 financial year draws upon us, trustees and accountants alike will be preoccupied with the question in respect of trust distributions to beneficiaries and how best to navigate the recent guidance implemented by the ATO in light of some recent decisions in the Australian Courts.
What is Section 100A of the ITAA 1936?
Section 100A of the Income Tax Assessment Act 1936 (ITAA 1936) is at its core an anti – avoidance provision which deals with trust distributions to beneficiaries in respect of what are known as reimbursement agreements.
Arrangements covered under this anti – avoidance provision are where:
- a beneficiary of a trust has become presently entitled to the trust’s income where an agreement has been reached whereby the actual benefit will be transferred onto another person, instead of the beneficiary; and
- the reimbursement agreement was entered into by at least one of the parties, with the purpose of reducing or deferring a party’s tax liability.
A simple example of this may be where parents distribute trust income to an adult child on paper but retain the benefits of the income themselves.
If s 100A of the ITAA 1936 is deemed to apply, then the beneficiary’s entitlement to the trust distribution will be disregarded. Consequently, the net income which would have been assessed to the beneficiary, may be assessed in the trustee’s hands at the highest marginal tax rate.
Ordinary family or commercial dealing
That said, like in all areas of law, there are always exceptions, and if it can be proved that the arrangement was entered into throughout the course of an ‘ordinary family or commercial dealing’ then it is not considered to be a reimbursement agreement under s 100A.
Whilst at first blush the concept may seem simple, the Commissioner has taken a strong position as to what will not fall within the exception as has been seen in recent court decisions.
On 8 December 2022, the ATO finalised its guidance notes which were first drafted in February 2022, with respect to the Commissioner’s interpretation of s 100A of the ITAA 1936 and the exception.
The Ruling seeks to simplify and remove the ambiguity of certain terminology and phrases within section 100A of the ITAA 1936 and provide clarification in respect of the basic requirements associated with Section 100A and the ordinary dealing exception test.
When testing whether an agreement is an ‘ordinary dealing’, the Commissioner will look at the entirety of the dealing, and various transactions to ensure that the test is met. It is not sufficient that each step in a series of connected transactions is capable of being described as ‘ordinary’.
Critically, if the objective of a dealing can properly be explained as the payment of less tax to maximise group wealth, rather than a family or commercial objective, the Commissioner considers the exception will not apply.
The Guideline focus on three key zones for characterising arrangements under s 100A of ITAA 1936.
If an arrangement falls within the white or green zone it may be considered low risk, whereas if it falls within the red zone the ATO may deem it to be high risk and will dedicate additional resources to investigating it.
However, the level of uncertainty becomes difficult for those arrangements which do not clearly fall within one of the three zones, and these arrangements should be judged on a case–by–case basis with s 100A factors being at the forefront of the trustee’s mind.
The zones are as follows:
Description of Zone
|Arrangement in this zone will not be subject to ATO compliance in respect of income years which ended before 1 July 2014.
However, we note that there are caveats to this zone which include:
Arrangements in this zone will not be determined to require further investigations, other than those to confirm the arrangements comply with the following scenarios:
The Guideline further outlines 10 green zone examples and sets out 11 arrangements which will not comply with this zone.
Arrangements in this zone will be considered high risk and attract the attention of the ATO. The ATO will dedicate resources and conduct an in-depth investigation to determine whether the trust distributions are in breach of s 100A of the ITAA 1936. These arrangements may include where:
There are six scenarios which satisfy this zone:
The Guideline sets out five red zone examples which, in the Commissioner’s perspective, clearly fall foul of s100A of the ITAA 1936.
Recent court decisions
The Ruling and Guideline were published prior to the recent decision of Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation  FCAFC 3 (Guardian)
Guardian is an example of a structure where a corporate beneficiary was created to receive the entitlement of a trust. The Full Federal Court found it did not give effect to a reimbursement agreement under s 100A.
In this case the Full Federal Court made clear that for s 100A to apply, the ‘reimbursement agreement’ must exist at or prior to the time a beneficiary becomes presently entitled to net income of a trust.
Whilst the Full Federal Court considered that s 100A did not apply, it did however find that the arrangements in one income year fell foul of the general anti-avoidance provisions contained in Part IVA of the ITAA 1936.
The Commissioner has not yet released a decision impact statement on Guardian.
If you want to read further into the decision in Guardian, we have provided a link to the case here.
Conversely, in BBlood Enterprises Pty Ltd v Commissioner of Taxation  FCA 1112 (BBlood), it was considered that the arrangement satisfied the requirements to be a reimbursement agreement and was not in the nature of ‘an ordinary family or commercial dealing’.
In BBlood the trustee of a trust received proceeds in excess of $10 million from a buy-back of shares in a company it controlled. Amendments made to the trust deed shortly before the buy back, had the effect of excluding those proceeds from the definition of trust income. The trustee resolved to make a newly formed corporate beneficiary presently entitled to trust income, being approximately $300,000 received from related entities. The effect of the arrangement, was that the corporate beneficiary was liable to tax on the taxable income of the trust including the buy-back dividend of $10 million. As the share buy-back dividend was fully franked, the corporate beneficiary paid no further tax on it. For trust law purposes, the proceeds were retained in the trust as capital and used by the group.
If you want to read further into the decision in BBlood, we have provided a link to the case here.
BBlood has been appealed by the taxpayer and is due to be heard in March 2023 and the outcome, may have a significant impact on the legal landscape in respect of the application on s 100A and provide further clarification on areas of uncertainty for trustees, accountants, practitioners and the ATO alike.
We will provide an update to our clients in respect of the BBlood appeal and any changes to the Commissioner’s view following the Court’s decision.
Key takeaways from the above cases, Ruling and Guideline demonstrate that:
- prudent record-keeping is essential to accurately demonstrate the basis for trustee’s resolutions to distribute income or capital, both to satiate any disgruntled beneficiary and satisfy the Commissioner;
- each factual matrix is determined on a case-by-case basis and the Commissioner’s view is continually evolving;
- it is necessary to consider an arrangement as a whole and not individual steps; and
- the utmost care should be taken where a person other than the presently entitled beneficiary receives a benefit from an arrangement.
Seeking early advice into the current position and practical approach which the ATO may adopt in respect of s 100A for individuals, trustees or business who operate through a trust may prevent potential or protracted investigation by the ATO.
Should you wish to obtain further guidance with respect to your obligations and whether an arrangement may ‘fall foul’ of the ATO’s views, please contact our tax and wealth management principals, Kale Rigano on +61 8 8210 1207 or firstname.lastname@example.org and Marissa Mackie on +61 8 8217 1361 or email@example.com.