The ATO has announced a major crackdown on the taxation of family trusts. In a long-awaited draft ruling, the ATO has focused on common tax planning strategies involving distributions to companies and family members. This crackdown means that family groups will need to reconsider how they are using their family trust.
How will the crackdown operate?
The ATO is focusing its attention on a specific part of the tax law, known as section 100A. Where 100A applies, the trust distribution will be taxed to the trustee of the trust (at the top marginal rate, currently 47% including Medicare levy) rather than the beneficiary to whom it was purportedly to be taxed to (who would’ve paid considerably less tax than the trustee).
Broadly, section 100A can apply where:
- A beneficiary is presently entitled to a share of the income of a trust
- There is an agreement (whether formal or informal, written or unwritten) whereby a person other than the beneficiary will benefit from the amount, and
- A purpose of the agreement is that less income tax will be paid.
Section 100A does not apply if the agreement is entered into as part of an ‘ordinary family or commercial dealing’. It is this ‘ordinary family or commercial dealing’ aspect that the ATO is clamping down on. In particular, the ATO’s view is that the carve out does not operate merely because all parties to the arrangement are family members, or that the practices are widespread.
What type of distributions are problematic?
While a broad range of trust distributions could be caught by this draft ruling, some are more problematic than others. For example, a trust which distributes all its income to a husband and wife, who use that money to pay for their household expenses, is unlikely to be problematic.
However, if the trust is distributing to adult children, but the funds from that distribution actually end up in the hands of their parents, that is likely to be an issue.
This is one of the classic income splitting strategies. For example, adult children at university and earning no other income have the full benefit of the marginal tax rates.
A distribution to them of $180,000 could generate tax savings of around $30,000. Families may be attracted by the tax savings, but baulk at the idea of actually putting $180,000 in their teenager’s bank account. Strategies have evolved to manage that concern, and these are what the ATO is questioning.
Unpaid trust distributions to companies, or circular arrangements whereby a trust distributes to a company, which in turn pays a dividend back to the trust, which then distributes back to the company, are also a focus of the ATO crack down.
Is this the end of trust distributions to kids or grandparents?
Not necessarily, but such arrangements will be subject to much closer scrutiny in the future. If the distributions genuinely take place and the family or commercial basis for them can be readily explained, the situation may be more likely to fit within the ‘ordinary family or commercial dealing’ exclusion.
For example, if an adult child who lives at home with their parents receives a $10,000 distribution from their parents’ family trust, and the child forwards that distribution to their parents to cover board and car running costs, this may withstand scrutiny under 100A. However, a distribution to the adult child of $180,000 which finds its way to the parents would be far less likely to be readily explainable as an ‘ordinary family or commercial dealing’ in the absence of other more substantial reasons (such as the child using the distribution to make a repayment on a loan that the parents previously made to that child to enable them to purchase their first home).
The ATO makes specific mention of their view that a particular situation is not an ‘ordinary family or commercial dealing’ merely because it is common practice of the family or the community. Taxpayers cannot rely on their arrangement being ‘ordinary’ merely because ‘everyone else does it’.
Documentation and detailed reasoning for their actions will be crucial in any argument that the carve out should apply.
What should I do with my trust?
If you have a family trust, it is important to consider whether any of the new ATO views could be problematic for you. If your trust is distributing to a range of family members, or to companies, then you should review your situation in detail.
While some of the ATO view has been released in draft form, or is not proposed to apply until 1 July 2022, other parts of the ATO view are intended to apply retrospectively. Accordingly, considering the issues and addressing them well before 30 June 2022 will be important.
Trusts will continue to be an effective structure for managing family wealth, but the tax planning aspect will become more complex and tailored. Most family groups will need to revisit their tax planning in the lead up to 30 June 2022.
