ATO Crack Down on Family Trust Distributions

Article By Saul Segal | | Accounting, Business, Wealth, Farm Services

The ATO has been trying to crackdown on the use of trusts for many years and has recently released the following draft ruling, guideline and taxpayer alert relating to trust distributions that have associated reimbursement agreements:

  1. Draft Taxation Ruling (TR 2022/D1) – this deals with the ATO’s views on when section 100A will apply;
  2. Draft Practical Compliance Guideline (PCG 2022/D1) – this sets out the sorts of arrangements which the ATO would dedicate compliance resources to concerning section 100A; and
  3. Taxpayer Alert (TA 2022/1) - that applies section 100A immediately where parents benefit from trust entitlements to children over 18 years of age.

These could have major implications on how your family trust, if you have one, distributes income, together with the amount of tax your family will pay.

What is Section 100A?

Broadly, section 100A is an income tax anti-avoidance provision that may apply when a trust beneficiary is made presently entitled to (i.e. distributed) a share of income of the trust estate that arose out of, or in connection with, a reimbursement agreement, being an arrangement:

  1. Involving a benefit being provided to another person;
  2. Intended to have the result of reducing someone’s tax liability; and
  3. Entered into outside the course of ordinary family or commercial dealing.

When the rule applies, the trustee (and not the beneficiary) is liable to pay tax on the income at the top marginal tax rate (currently 47% including Medicare Levy).

What is a Reimbursement Agreement?

A ‘reimbursement agreement’ involves trust distributions to low taxed family members or family companies where the benefit of the distribution is diverted away from the beneficiary to another family member who would otherwise pay a higher rate of tax if it was distributed directly to them as illustrated in the below diagram:

Can Section 100A Apply to Parents Who Benefit from Trust Entitlements Made to Children Over 18 Years of Age?

For many years, it has been common practice by business owners and investors who use Family (Discretionary) Trusts to look to spread trust income across family member beneficiaries.  Trust distributions are often made to adult children for asset protection and estate planning purposes.

Sometimes, the adult children in a family may have lower tax rates than their parents, so the overall tax rate % for the family group is lower as a result of the spread of these trust distributions.

Under the new Taxpayer Alert, the ATO is reviewing the above trust arrangements only when the parents enjoy the economic benefit of trust income appointed to their adult children.

This may typically involve family trust arrangements where the parent’s adult children are made presently entitled to trust income, but the income is used to meet the expenses of the parents. The entitlements are then ‘satisfied’ by the children directing that the amounts be paid to their parents or applied against any beneficiary loans owned by the parents (i.e. gifting).

Under the arrangement, the parties may try to argue the children are required to repay their parents for their share of family costs or for expenses incurred in relation to their upbringing (e.g. private school fees and uniform costs, or their share of family holidays). However, the ATO is concerned taxpayers are entering into these arrangements to access tax-free thresholds and lower marginal tax rates of family members, rather than ordinary family dealings.

In these arrangements the ATO plans to, for tax purposes, invalidate the trust distribution and tax the trustee of the trust at 47% on the amount of the distribution, and they may charge penalties on this as well.

However, in example 3 of the Taxpayer alert, the ATO states that section 100A will not apply where the adult children’s current year expenses are paid directly by the trust. For example, the payment of university tuition fees or rent/board of the adult children.

Final Words

The changes not only affect distributions to adult children, but also distributions to extended family members such as to parents, parents-in-law, daughter & son-in laws, nieces and nephews whereby they are not actually receiving the benefit of the income they have been distributed.

It is important to stress that the draft ruling, guideline and taxpayer alert is only the ATO’s interpretation of the law. This means that it is not binding on taxpayers to comply with the above views, but merely a guideline to determine whether or not the ATO may take a closer look at your situation.

There is a significant amount to play out with all of this, and no doubt there will be a great deal of debate, and most likely Case Law in future, about what is “ordinary family dealings”.

Next Steps

Going forward, it is more important than ever for Trustees to keep contemporaneous records, to support the following:

  • Beneficiaries receiving actual cash comprising of their trust distribution(s);
  • Expenses of beneficiaries being paid directly out of the trust’s bank account and allocated to relevant beneficiaries' loan accounts, as opposed to, for example, a parent paying expenses for an adult child out of a personal bank account;
  • Making it very clear that the beneficiaries are under no obligation to pay anyone else their entitlements; and
  • Beneficiaries being aware that if any amounts are subsequently gifted back to their parents/the trustee (including by cash transfers), evidence such as a Deed of Gift should be prepared as it may be critical to establish the timing of the reimbursement agreement in the event of an ATO review/audit.

If you have concerns about how the new draft ruling, guideline and taxpayer alert relating to trust distributions that might be subject to a reimbursement agreement, our specialised team is able to help.

You can contact us on (08) 94275200, or by emailing your usual contact at Munro's, or emailing digital@munros.com.au.

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