The ATO has released its final position on how it will apply some integrity rules dealing with trust distributions – changing the goal posts for trusts distributing to adult children, corporate beneficiaries, and entities with losses. As a result, many family groups will pay higher taxes because of the ATO’s more aggressive approach.
For reference, please refer to our past article on the issue: Guidance for trust distributions – the ATO cracks down.
The current ATO guidance - for section 100A to apply:
- The present entitlement (a person or an entity is or becomes entitled to income from the trust) must relate to a reimbursement agreement;
- The agreement must provide for a benefit to be provided to a person other than the beneficiary who is presently entitled to the trust income; and
- A purpose of one or more of the parties to the agreement must be that a person would be liable to pay less income tax for a year of income.
High risk areas for Section 100A
‘Ordinary dealing’ in the spotlight
Until recently many people have relied on the exclusions to section 100A which prevent the rules applying when the distribution is to a beneficiary who is under a legal disability (e.g., a minor) or where the arrangement is part of an ordinary family or commercial dealing (the ‘ordinary dealing’ exception). It is the ordinary dealing exception that is currently in the spotlight.
For example, let’s assume that a university student who is over 18 and has no other sources of income is made presently entitled to $100,000 of trust income. The student agrees to pay the funds (less tax they need to pay to the ATO) to their parents to reimburse them for costs that were incurred when the student was a minor. This situation is likely to be considered high risk if the student is on a lower marginal tax rate than the parents because the parents are receiving the real benefit of the income.
Circular distributions also a cause for concern
The ATO is also concerned with scenarios involving circular distributions. For example, this could occur when a trust distributes income to a company that is owned by the trust. The company then pays dividends back to the trust, which distributes some (or all) of the dividends back to the company. And so on. The ATO views these arrangements as high risk from a section 100A perspective.
Common scenarios identified as high risk by the ATO
- The beneficiary is a company or trust with losses and the beneficiary is not part of the same family group as the trust making the distribution.
- A company or trust which is entitled to distributions from the trust returns the funds to the trustee (i.e., circular arrangements).
- The beneficiary is issued units by the trustee of the trust (or a related trust) with the amount owed for the units being set-off against the entitlement and where the market value of the units is less than the subscription price or the trustee is able to do this without the consent of the beneficiary.
- Adult children are made presently entitled to income, but the funds are paid to a parent in relation to expenses incurred before the beneficiary turned 18.
How can Walsh Accountants help?
If you have a discretionary trust, it will be important to ensure that all trust distribution arrangements are reviewed to determine the level of risk associated with the arrangements. It is also vital to ensure that appropriate documentation is in place to demonstrate how funds relating to trust distributions are being used or applied for the benefit of the beneficiaries.
Review and planning for trust distributions is a process we routinely carry out throughout our tax planning process. If you’re interested in conducting a review of your current situation as well as discovering opportunities to minimise the amount of tax you have to pay, our team is happy to help. Contact us today for a discussion based on your personal circumstances.
The ATO’s new approach applies to entitlements before and after the publication of the new guidance but for entitlements arising before 1 July 2022, the ATO will not generally pursue these if they are either low risk under the new guidance, or if they comply with the ATO’s previous guidance on trust reimbursement agreements.
