ATO Guidance targeting reimbursement agreements and trust distributions
ATO Guidance targeting reimbursement agreements and trust distributions
The Australian Taxation Office (ATO) has recently issued draft guidance, which sets out the ATO’s new compliance approach, in relation to trust distributions and “reimbursement agreements”.
The ATO focus is on trust distributions made to beneficiaries to achieve a tax advantage where the funds relating to the distributions are not paid out to a beneficiary or are in some way reimbursed by the beneficiary back to the trustee or other parties.
The legislation that this guidance is based on (ie. section 100A of Income Tax Assessment Act 1936) was introduced over 40 years ago with the intention to counter tax avoidance arrangements where a specially introduced low tax (or tax exempt) beneficiary was made presently entitled to income of a trust estate in such a way that the trustee was relieved of any tax liability on the income.
What arrangements may be impacted by this guidance?
Broadly, this guidance will apply to circumstances where:
- a beneficiary has become presently entitled to trust income, but it has been agreed that another person will benefit from that income; and
- that agreement is made with the purpose that some person will pay less or no income tax as a result; and
- the agreement was entered into outside the course of ‘ordinary family or commercial dealings’.
When applied by the ATO, this guidance can deem the trustee (rather than the beneficiary presently entitled to a trust distribution) liable for the tax payable at the top marginal tax rate.
Importantly, there are exclusions from the scope of section 100A where an agreement was not entered into or carried out for a purpose of reducing that person’s income tax liability, and where an arrangement is considered to be an ‘ordinary family or commercial dealing’.
What are the implications when this guidance applies?
The purpose of the guidance is to provide the ATO’s view about each element of these arrangements and give taxpayers an indication of what circumstances this anti-avoidance legislation may be applied to.
The ATO’s new guidance is set to invalidate many commonly made trust distributions, including distributions to adult children, grandparents and even bucket companies. It will challenge some traditional family trust distribution strategies and will impact the required thinking around trustee resolutions as early as 30 June 2022.
What arrangements are at risk?
The concept of a “reimbursement agreement” is so broad that many common arrangements involving trust distributions are exposed to its application.
Consideration is always given to whether a reimbursement agreement exists triggering section 100A whenever a trustee of a discretionary trust makes a distribution in any of the following circumstances:
- to an individual on a low tax rate;
- to a foreign resident where the net income of the trust includes foreign sourced income, or is otherwise subject to withholding tax in Australia;
- to an entity with tax losses;
- to a company of which the shareholder is the trustee with the result that the company has no option other than to distribute the income it receives back to the discretionary trust (typically via dividends).
Particular common transactions which now may be at risk include:
- applications of trust income by a trustee on behalf of lower marginal tax rate adult beneficiary to meet expenses attributable to them (for example, a trust distribution to an adult child to then repay their parents for university fees or holiday expenses);
- Trustee entitlements gifted to a trustee, where a beneficiary being made presently entitled to trust income for a particular year but then deciding to gift their entitlement back to the trustee (or some other person);
- gifts from parents to a child, where the lower marginal tax rate parents are repeatedly gifting trust entitlements to higher marginal tax rate children in lieu of the trustee distributing to the adult children directly, and ultimately less tax is payable;
- non-commercial loans between family members, where the lower marginal tax rate parents are repeatedly loaning trust entitlements to higher marginal tax rate children in lieu of the trustee distributing to the children directly; and
- so called ‘washing machine arrangements’ where a trustee of a discretionary trust owns the shares in a private company and, year on year, income is appointed to the private company and then distributed back to the trustee by way of a franked dividend.
These examples are not intended to be exhaustive and are by no means the only factual circumstances to which the ATO considers that section 100A could apply.
It is important to note that the underlying legislation (in section 100A) has been in place for over 40 years and the ATO has accepted some (or all) of these examples as being acceptable family arrangements to date.
The ATO is releasing this new compliance guidance to warn that the ATO now intends to take a closer look at certain trust arrangements (like the non-exhaustive examples listed above), and if the exemptions do not apply, then the ATO is likely to ask further questions or commence a review.
What are the next steps?
While the guidance is still in draft form, and subject to further consultation by accounting and legal industry bodies, the approach has been closely considered by the ATO over many years and we anticipate that much of the content of the guidance will likely remain in the final versions.
We must state that there is no doubt the ATO has a keen focus on many Australian trusts and their historical pattern of trust distributions in its ongoing concerns of perceived income splitting, particular involving family arrangements.
We will continue to watch how the guidance develops and keep you informed of further developments.
Please do not hesitate to contact your Lowe Lippmann Relationship Partner if you wish to discuss any of these matters further.
