Gary Anders | October 2023
This article was current at the time of publication.
Make no mistake: the Australian Taxation Office (ATO) has an unambiguous, ongoing focus on family trusts distributions and the tax arrangements around them.
This is abundantly clear from the Taxpayer Alert TA 2022/1, in which the ATO advises it is actively reviewing family trust arrangements where parents benefit from the entitlements of children over 18 years.
The ATO is concerned about taxpayers who are specifically entering into arrangements to avoid tax on the net income of their trusts. Parents are doing so by using the lower marginal tax rate applying to their adult children in circumstances where the benefit from these arrangements is, in substance, enjoyed by them.
This includes arrangements where adult children are paying amounts for expenses that would ordinarily be met by their parents, where the adult children’s entitlements are otherwise being applied for the benefit of the parents either directly, or by the charging of excessive amounts, and/or there are elements of contrivance.
The ATO notes that from its review of these arrangements, the following consequences may arise:
- the purported entitlement of children to trust income may be a sham or otherwise ineffective for trust law purposes
- the arrangement may constitute a reimbursement agreement for the purposes of avoiding tax under section 100A of the Income Tax Assessment Act 1936 (ITAA 1936)
- subsections 95A(1) and 97(1) of the ITAA 1936 may apply to treat the parents as presently entitled where the means by which the trustee permits the use of the funds evidences the exercise of a discretion to pay or apply those amounts to the parents (notwithstanding that the appointments are recorded as “beneficiary loans”)
- the broader anti-tax avoidance provisions contained in Part IVA of the ITAA 1936 could apply
Furthermore, the ATO says that while its Tax Alert specifically considers arrangements involving the children of controlling individuals, it is also concerned about similar arrangements involving other family members of controlling individuals that would have lower marginal tax rates than those of the controlling individuals.
Trust distribution reimbursement agreements
That the ATO has a strong focus on family trust arrangements should come as no surprise to tax practitioners.
The regulator has already released Taxation Ruling TR 2022/4 dealing with unpaid present entitlements (UPEs) and the application of section 100A.
For section 100A to apply, there must be a “reimbursement agreement” and an individual pays less or no tax due to the reimbursement agreement. But an agreement, arrangement, or understanding cannot be considered a reimbursement agreement if it was entered into in the course of ordinary family or commercial dealings.
TR 2022/4 includes two recent Federal Court rulings where it was found two trusts had used complex trust structures and arrangements in order to avoid tax – Guardian AIT Pty Ltd and BBlood Enterprises Pty Ltd.
In the Guardian case, trust income was distributed to a corporate beneficiary, returned as a franked dividend to the trustee (the sole shareholder) in the following year and then distributed to a non-resident individual.
The court held that the Part IVA general anti-avoidance rules applied in the second year that occurred but not the first.
In the BBlood case, the trustee of a trust received proceeds in excess of A$10 million from a buy-back of shares in a company it controlled. Because of amendments to the trust deed made shortly before the buyback was conducted, these proceeds were excluded from the definition of trust income. The court held that section 100A be applied.
Another recent case concerning the Owies family trust has also attracted widespread attention. The Victorian Supreme Court of Appeal found that the trustees of the discretionary trust had breached their fiduciary duties in 2015, 2016 and 2018 by not giving “real and genuine consideration” to all the trust’s beneficiaries.
As a result, every annual trustee distribution made from 2015 to 2019 was ruled to be voidable and the trustee of the trust was replaced with an independent third party for future years.
White, green and red compliance zones
The ATO’s accompanying Practical Compliance Guideline (PCG 2022/2) sets out when it will apply its compliance resources to review arrangements where section 100A may apply.
Its compliance approach has been broken down into three zones: white (arrangements entered into in income years that ended prior to 1 July 2014), green (distributions to individuals who are members of a family) and red (arrangements deemed to be high risk).
The ATO will not dedicate compliance resources to consider the application of section 100A for white and green zone arrangements, subject to specific exceptions.
The ATO says red zone arrangements will attract its attention and it will conduct further analysis on the facts and circumstances of the arrangement as a matter of priority.
Tax practitioner steps
It’s important for tax practitioners to be fully across the ATO’s areas of focus in relation to family trust distributions and tax arrangements, including TR 2022/4 and PCG 2022/2.
The ATO advises there are currently s100A cases at the AAT and more cases are likely to arise in future, leaving tax practitioners and other advisers potentially exposed to negligence claims by clients.
Megan Bishop, partner at legal firm Holding Redlich, says tax practitioners should stop any client trust arrangements that are in the ATO’s red zone and consider whether to make a voluntary disclosure.
“In the taxpayer alert TA 2022/1 the ATO says put all the detail in, but the trust case law says the more information you give the more open your trust distributions are to challenge by your beneficiaries,” she says.
“If they’re challenged by your beneficiaries the distributions can be found to be invalid. Judgement calls therefore need to be made.
“When it’s time to make trust distributions, don’t just do what you’ve done in the past. Reconsider whether what you’ve done in the past remains appropriate going forward. That’s not just for this year. You need to reconsider it every year.
“Having regard to the Owies case, I would say consider whether you ought to be implementing a process to contact at least some of the beneficiaries of the trust to understand what their needs are or implementing processes to formally exclude others from the beneficiary class.”
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