Distributions from discretionary trusts are under increasing scrutiny from the ATO. This article highlights some recent s.100A developments and practical ways of managing the s.100A risk.
The ATO Activity
Over recent months there has been a flurry of activity dealing with section 100A (“s.100A”) of the Income Tax Assessment Act 1936 “ITAA1936”. On 8 December 2022, ATO released their guidance documents on s100A. TR 2022/4 and PCG 2022/2 were released, and took into consideration submissions and comments arising from the consultation on their draft release. Accordingly, the ATO also released compendium documents detailing their responses to the submissions and comments.
Court Ruling
In addition to the ATO activity, the Full Federal Court handed down its decision on one of two cases dealing with s100A. Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust (2023) FCAFC 3 (“Guardian”) was handed down on 24 January 2023.
What does all of it mean in practical terms?
S100A has been available to the ATO for many years as part of its armoury against certain trusts’ activities. Many believe that it should only be applied in an anti – avoidance type scenario.
Basically, four elements must exist for the provision to apply.
- A beneficiary must have been made presently entitled to trust income in connection with a reimbursement agreement, (“the connection” requirement);
- the agreement must provide for the payment of money, or transfer of property, or provision of services, or other benefits for a person other than that beneficiary, (the “benefit to another” requirement);
- a purpose of one or more parties to the agreement must be that a person would pay less income tax, (“the tax purpose” requirement);
- The ordinary commercial or family dealing exception does not apply.
Critically, the agreement must exist at the time that the present entitlement arises. In Guardian, the Full Federal Court found that this element of the four basic requirements was not present in the facts as found.
As a matter of practical guidance, the ATO will not apply compliance resources to arrangements prior to 1 July 2014.
When trustees are making their decisions regarding distributions of trust income, it will be crucial to understand fully the implications of that decision. It was commonly thought, that if a presently entitled beneficiary was physically paid their entitlement, then s100A would have no application. It is now clear, that the ATO may look beyond such simple circumstances, and look to what that beneficiary did with the money. How that money is dealt with, may amount to a “benefit to another” and thus create a potential s100A scenario.
For example, if a company is made presently entitled to trust income and receives its entitlement in cash, but subsequently loans that money back to the trustee or to some other entity, the ATO may determine that the “benefit to another” requirement has been met. If the other three basic requirements are met, there may be a s 100A issue to manage.
While the Commissioner was unsuccessful in his appeal in Guardian, it was essentially decided on the facts. It is expected that the ATO will be very keen to explore the circumstances surrounding the trustee decisions regarding why distributions to certain beneficiaries were made. It is our experience and understanding that the reasons why a trustee decides which beneficiaries are to become entitled to distributions of trust income is rarely (if ever) documented. The trustee resolves or determines where the trust income will be distributed, but how such decisions were arrived at, is rarely expressed.
It may also become necessary for trustees to understand what a presently entitled beneficiary is going to do with their entitlement. Will a trustee now need to be aware of what a beneficiary intends to do with their entitlement to understand any risk of a s100A situation.
The ATO’s PCG 2022/2 does provide some arrangements that would not require devoting compliance resources to, referred to as Green Zone or low risk arrangements. For example, where a trust retains funds for working capital, or places funds on loan on commercial terms. Understanding when arrangements fall into this green zone (paragraph 32 of PCG 2022/2) will be crucial to avoid potential ATO scrutiny. Arrangements that do not fall into the green zone will be high risk and in the red zone and attract ATO attention and may lead to compliance reviews.
It will imperative that trustees and their advisors are aware of the full implications that their decisions in distributing trust income to beneficiaries are understood in the light of these recent s100A developments.
TR 2022/4 provides specific examples of what the ATO will deem low risk and what the ATO will deem high risk
In summary if a trustee is made presently entitled to a profit distribution the cash must follow the distribution within 2 years of becoming presently entitled
If the ATO deems that S100A applies to the transaction then the ATO will deem that the beneficiary was never presently entitled and the trustee will be assessed on the distribution at 47%
This is a game changer and it is imperative that you understand these new updated rules when deciding on annual trust distributions to adult beneficiaries.
Please contact your usual Quantiphy advisor if you would like to discuss this tax ruling in more detail or have any questions.
