The Australian Taxation Office (ATO) is actively targeting trusts and how trusts distribute income to beneficiaries. For those with discretionary trusts it is important to ensure that all trust distribution arrangements are reviewed considering the ATO’s latest guidance to determine the level of risk associated with the arrangements.
It is also vital to ensure that appropriate documentation is in place to demonstrate how funds relating to trust distributions are being used or applied for the benefit of beneficiaries.
The ATO has released a package of new guidance material that directly targets how trusts distribute income. Many family groups will pay higher taxes (now and potentially retrospectively) because of the ATO’s more aggressive approach.
The ATO’s updated guidance focuses primarily on distributions made to:
- Adult children
- Corporate beneficiaries, and
- Entities with losses
Distributions to beneficiaries who are under a legal disability (e.g., children under 18) are excluded from these rules.
Family trust beneficiaries at risk | Section 100A
The tax legislation contains an integrity rule, section 100A, which is aimed at situations where income of a trust is appointed in favour of a beneficiary, but the economic benefit of the distribution is provided to another individual or entity. If trust distributions are caught by section 100A, then this generally results in the trustee being taxed at penalty rates rather than the beneficiary being taxed at their own marginal tax rates.
The latest guidance suggests that the ATO will be looking to apply section 100A to some arrangements that are commonly used for tax planning purposes by family groups. The result is a much smaller boundary on what is acceptable to the ATO which means that some family trusts are at risk of higher tax liabilities and penalties.
Section 100A has been around since 1979 but to date, has rarely been invoked by the ATO except where there is obvious and deliberate tax avoidance at play. However, the ATO’s latest guidance suggests that the ATO is now willing to use section 100A to attack a wider range of scenarios.
There are some important exceptions to section 100A, including where income is appointed to minor beneficiaries or where the arrangement is part of an ordinary family or commercial dealing. Much of the ATO’s recent guidance focuses on whether arrangements form part of an ordinary family or commercial dealing. The ATO notes that this exclusion won’t necessarily apply simply because arrangements are commonplace or they involve members of a family group. For example, the ATO suggests that section 100A could apply to some situations where a child gifts money that is attributable to a family trust distribution to their parents.
Adult children
High on the ATO’s list for the “red zone” are arrangements where an adult child’s entitlement to trust income is paid to a parent or other caregiver to reimburse them for expenses incurred before the adult child turned 18. For example, school fees at a private school. Or, where a loan (debit balance account) is provided by the trust to the adult child for expenses they incurred before they were 18 and the entitlement is used to pay off the loan. These arrangements will be looked at closely and if the ATO determines that section 100A applies, tax will be applied at the top marginal rate to the relevant amount and this could apply across multiple income years.
A number of clients have requested a strategic review of their business and structure to ensure that they are in the best possible position in the future. Let us know if you would like us to explore the options with you.
If you have any questions about the issues outlined in this update, or if you have any concerns, please call the office.
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