Family trust distributions – what accountants need to consider

This article was current at the time of publication.

The Australian Taxation Office recently released a draft suite of public advice and guidance relating to family trust distributions and tax arrangements.

Specifically, the guidance package aims to make clear the ATO’s position on:

• reimbursement agreements in section 100A of the Income Tax Assessment Act 1936 (ITAA 1936), including the exception for ordinary family or commercial dealings, as well as identifying arrangements of concern
• when an unpaid present entitlement (UPE) or an amount on sub-trust will result in a form of “financial accommodation” and be subject to Division 7A
• arrangements where adult children who have relatively low tax rates are made entitled to trust income, in circumstances where their parents retain control over and enjoy the economic benefits of that income

Draft Taxation Ruling TR 2022/D1, which, at time of writing, is open for consultation until 29 April, seeks to clarify the ATO’s stance relating to Section 100A trust reimbursement agreements.

 “Very broadly put, the draft ruling explains that these rules may apply where the benefit of income of a trust is enjoyed by one person, while the tax is borne by another lower-taxed entity,” according to an ATO spokesperson.

“Importantly, and as made clear in our advice, these rules will only apply where this ‘diversion’ is for the purpose of avoiding tax and is not just part of an ordinary family or commercial dealing.”

The ATO also published an accompanying Draft Practical Compliance Guideline (PCG 2022/D1) setting out when it will apply its compliance resources to review arrangements where trust specific anti-tax avoidance rules contained in section 100A may apply.

Scope of the ATO guidance

While draft ruling TR 2022/D1 reflects the ATO’s view “of how these [trust] rules have always operated”, the effect of the draft practical compliance guideline is that in most cases it will not go back and apply them to arrangements carried out before 1 July 2014.

However, the ATO says it will look at “exceptional circumstances”, such as where there has been fraud or evasion.

“This introduces a practical limitation on the Commissioner,” the ATO says. 

“‘Indefinite scrutiny’ has always been available since these rules were first introduced over 40 years ago, but the position put in the PCG gives taxpayers confidence as to where the Commissioner stands.

“As part of our section 100A public guidance package, we also released a taxpayer alert conveying our concerns about certain arrangements involving adult children of controllers of discretionary trusts.

“Under these arrangements the adult children are made beneficially entitled to trust income but it is not intended that they retain any benefit of that income, and the arrangements are predicated on avoiding tax.

“Some people are concerned this is an attack on an ordinary family dealing. But they can be assured we have no concerns if the money is actually intended to go to those adult children. We are only talking about deliberate arrangements designed to avoid tax.”

While the ATO’s draft ruling on section 100A has both prospective and retrospective application, the PCG states that compliance resources will not be directed to certain arrangements, including particular arrangements entered into in current and prior income years. 

Separately, the draft determination TD 2022/D1 covers potential tax consequences when entitlements of a private company beneficiary, which has been retained by the trust, will be “financial accommodation” and thus treated as a loan from the company to the trust. 

It is proposed to apply to trust entitlements arising on or after 1 July 2022.

Diverging from trust law

Damien Bourke, a partner of legal firm Holding Redlich, says the ATO’s view in the guidance around “ordinary family and commercial dealings” in Section 100A may not be what most of us would consider this to mean. 

Bourke notes that it also appears at odds with the interpretation of this concept by the Federal Court in Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT [2021] FCA 1619. Unpacking the commissioner’s interpretation of the phrase in the ruling Bourke comments – “it doesn’t seem to have much legal foundation”.  

“Moreover, its application depends on whether a relevant agreement existed at the time the trust beneficiary was made entitled to the trust income,” he says. 

“If there was a distribution made, and there was a later release of an unpaid present entitlement, which is considered a blue zone offence, then unless it was originally part of the arrangement or understanding before the present entitlement came about, it still won’t fall foul of 100A.

“On unpaid entitlements, there’s nothing to be found in trust law that has any requirement like what the ATO is suggesting,” Bourke says.

“All that the rulings are doing is trying to compel accountants to make voluntary disclosures and putting anybody who’s not paying the top tax rate into the red basket.”

Peter Mogg, director of Moggs Accounting + Advisory, adds that accountants have advised clients according to common understanding of the laws and the ATO interpretation of them for many years.

He says rulings could have significant flow on effects should taxpayers decide to restructure their affairs to a more suitable entity, including capital gains tax, stamp duty and other unintentional costs.

Contrary to the ATO’s view that most small businesses operating through a trust will not be affected by this public advice and guidance, Mogg says all trusts and distributions made since 2015, including the actual payment of funds, will need to be reviewed.

“While I don’t disagree with the intent of the new rulings, if the ATO wants to implement these rulings, then in fairness to the taxation profession and taxpayers, the rules should be prospective and commence from 1 July 2022, so that clients can be advised of the correct treatment of the current laws and interpretations in advance.”

Steps for practitioners 

The ATO notes that feedback from its consultation process will help it to refine its administrative approaches.

It has several speaking engagements and webinars scheduled in April with various professional bodies and firms to support practitioners in understanding its package, including its practical application.

Bourke says that “given the legal position and the apparent disregard to the Guardian decision, it’s disappointing that the Commissioner has raised the prospect of practitioners being referred to the Tax Practitioners Board”.

“I think that tax agents should probably start looking at the distributions made by their clients and documenting things which have been paid by the trust, and where the benefit of the unpaid present entitlement has been received by the beneficiary,” he says.

“What I’ve been telling practitioners is that they need to make sure they get visibility over where the risks are in their firm, that all of those unpaid present entitlements [UPEs] that are on the books are isolated in the entity’s accounts, and they’re shown in the equity part of the accounts, not as liabilities of the trust.”

Bourke says payment of UPEs is an option, but not all trusts will have the financial capacity and may need to use a 109N complying loan to allow for a longer time frame for payment.

Another option may be to send a communication to the trust’s beneficiaries stating there is a UPE in their favour and they are entitled to call on it at any time.

Need to know more?

Hear directly from the ATO on the recent draft guidance on section 100A and Division 7A at CPA Australia public practice events at Lorne, VIC, Hunter Valley, NSW and in Adelaide.