The ATO has published its final position on how it will implement some integrity regulations governing trust distributions, moving the goalposts for trusts giving to adult children, corporate beneficiaries, and businesses that have suffered losses. As a result of the ATO’s more assertive tactics, many family units will have to pay greater taxes.
Section 100A
Section 100A of the tax code is an integrity rule that applies when a trust’s revenue is directed in favour of a beneficiary but the financial gain from the distribution is given to another person or business. A “reimbursement arrangement” must be in effect at the moment the beneficiary is appointed to receive the income, or earlier, for section 100A to be applicable. These requirements do not apply to distributions to beneficiaries who are minors or who have other legal disabilities.
If section 100A applies to trust distributions, the trustee will typically be taxed on the income at penalty rates rather than the beneficiary at their individual marginal tax rates.
Notwithstanding the fact that section 100A has been in existence since 1979, the ATO has received virtually little guidance regarding its implementation. This is no longer the case, and according to the ATO’s most recent guidelines, a variety of trust distribution-related circumstances may now be in jeopardy.
The following conditions must be met in order for section 100A to be applicable:
– 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 currently entitled to the trust income; and
– One or more of the agreement’s parties must have the intention of reducing a person’s tax liability for a given income year.
High risk areas of Section 100A
Up until recently, many people relied on section 100A’s exclusions, which prevent the rules from being applied when a distribution is made to a beneficiary who is legally incapable (such as a minor) or when the arrangement is a part of an ordinary family or business transaction (the “ordinary dealing” exception). The ordinary trading exception is now the subject of discussion.
Let’s say, for illustration purposes, that a college student who is over 18 and has no other income sources has been granted the right to $100,000 in trust income. The student consents to compensate their parents for expenses made when the student was a minor by paying the money (minus any tax they must pay to the ATO). If the student’s marginal tax rate is lower than that of the parents’, this arrangement is probably high risk because the parents are getting the true benefit of the income.
Circular distribution-related scenarios worry the ATO as well. This might happen, for instance, when a trust pays out money to a business it owns. The trust then distributes some or all of the dividends back to the corporation after the company pays the trust dividends. so forth. According to the ATO, these agreements pose a high risk under section 100A.
Scenarios identified as high risk by the ATO include:
– The beneficiary is a firm or trust with losses and the beneficiary is not a member of the same family as the trust making the distribution. These are common cases that the ATO has recognised as high risk.
– A business or trust that is entitled to trust distributions gives the trustee the money (i.e., circular arrangements).
– Where the market value of the units is less than the subscription price or the trustee is able to do this without the beneficiary’s approval, the trustee of the trust (or a related trust) issues the beneficiary units and deducts the amount payable for the units from the entitlement.
What should I do next?
It is crucial to make sure that all trust distribution arrangements are examined in light of the ATO’s recommendations if you have a discretionary trust in order to assess the level of risk involved. Also, it is crucial to make sure that the right paperwork is in place to show how the money from trust distributions is being spent or put to use for the benefit of the beneficiaries.
The ATO’s new approach is applicable to claims both before and after the publication of the new guidance, but for claims made prior to 1 July 2022, the ATO will typically not pursue them if they fall under the new guidance’s definition of low risk or are in accordance with its earlier guidance on trust reimbursement agreements.
To get advice on your trust distribution arrangements get in touch with the team at MB Accounting & Business Services. We are a team of accountants based in Ormeau on the Gold Coast and can help you to navigate your tax.