The ATO has recently released a Draft Ruling TR 2022/D1 and Taxpayer Alert TA 2022/1 directly targeting Family Trust distributions made to adult children.
In the Alert, the ATO have advised they are currently reviewing trust arrangements where Trust income is distributed to adult children (more than likely at a lower marginal tax rate), while the parents have still enjoyed the benefit of the trust income.
The ATO are concerned these types of arrangement fall under the Scope of Section 100A ‘Reimbursement Agreements’.
What is Section 100A?
Section 100A of the Income Tax Assessment Act 1936 is an anti-avoidance provision, which was introduced to deal with ‘trust stripping’ arrangements.
Section 100A will apply in circumstances where a beneficiary’s present entitlement to a share of trust income arises out of, or in connection with, an arrangement:
- Involving a benefit being provided to another person
- Intended to have the result of reducing someone’s tax liability, and
- Entered into outside the course of ordinary family or commercial dealing
When Section 100A applies, it will be the Trustee, rather than the presently entitled beneficiary, liable for tax at the top marginal rate.
What Arrangements are the ATO looking at?
The subject of the ATO focus is arrangements containing the following features:
- The trustees of a discretionary trust, or the directors of a corporate trustee, are either one or two individuals who are the parents in a particular family
- The Trustee (being the parents) make a decision to distribute the Trust income to the adult children on lower marginal tax rates
- The income is used during the year to meet the expenses of the parents
- The parties contend that the children are not paid the money because:
- The Children are required to repay their Parents for expenses incurred in relation to their upbringing or while they were minors (e.g. school fees, school uniform costs or their share of the family holidays)
- The Children are required to pay or repay their Parents amounts to meet their share of family costs for the current year in excess of amounts it would reasonably be expected an adult child would meet for their personal living expenses while they remain at home or otherwise supported to some extent by their Parents (those amounts being, for example, a reasonable rate for their board, lodgings or rent if living away from home, or car expenses), or
- There is an agreement that the Parents will manage the pooled family members’ entitlements from the Trust for the benefit of the family members.
- There is no expectation or understanding that the Children’s income they derive from sources other than the Trust distributions will be used to either repay their Parents for expenses incurred when they were a minor or pay more than their reasonable share of the household expenditure or be placed in a pool to be managed by the Parents for the benefit of the family members.
What are the ATO Concerns?
The ATO are concerned that taxpayers are entering into these arrangements to avoid tax on the net income of the trust by utilising the lower marginal tax rate of the children in circumstances where the benefit from these arrangements is, in substance, enjoyed by the Parents as:
- The Children are paying amounts for expenses that would ordinarily be met by their Parents, or
- The Children’s entitlements are otherwise being applied for the benefit of the Parents either directly, or by the charging of excessive amounts, and/or
- There are elements of contrivance
While the Taxpayer Alert specially considers arrangements involving the children of controlling individuals (The Trustees), the ATO have advised they are also concerned about similar arrangements involving other family members that would have a lower marginal tax rate than those of the controlling individuals).
How far back are the ATO looking?
They ATO has issued a Practice Compliance Guideline detailing their compliance approach and categorizing examples and the likely audit risk between the green, blue & red zones.
The ATO have indicated that in most cases it will not look back to the 2014 and earlier years unless it is outside the green zone.
|Risk Zone||Description and compliance approach||Examples|
|White Zone – Low Risk||The white zone applies to arrangements entered into in income years that ended prior to 1 July 2014. The ATO will not dedicate new compliance resources to consider the application of section 100A to arrangement in the green zone.|
|Green Zone – Low Risk||The ATO will not dedicate compliance resources to consider the application of section 100A to arrangements in the green zone.||Mixed finances of family members – trust distributes income to spouse A. Spouse A & spouse B have a joint bank account. Trust income is paid into joint income. This is considered an ordinary family dealing. A trust is established under a Will. Income is distributed to a minor however that income is reinvested back into the Trust until the minor reaches a certain age. This is considered an ordinary family dealing. Assistance with university fees for adult child – Trust distributes income to adult child which is used to pay tuition fees (note this is not the same as school fees for a minor and trust income applied in this way would fall inside the red zone).|
|Blue Zone – Medium Risk||Arrangements in the blue zone may still be subject to review by the ATO but are less likely to attract attention than arrangements in the red zone. The ATO may contact taxpayers to understand and resolve any areas of difference including whether section 100A applies to their arrangement.||Arrangements that do not fall within the while, green or red zone will fall within the blue zone. Arrangements include retention of funds by trustee whereby: The beneficiary makes a gift of their trust entitlement. The beneficiary forgives their entitlement or releases the trustee from its obligation to pay the entitlement.|
|Red Zone – High Risk||The ATO will conduct further analysis on the facts and circumstances of your arrangement as a matter of priority. If further analysis confirms the facts and circumstances of your arrangement are high risk, the ATO may proceed to audit where appropriate.||A taxpayer lends or gifts their entitlement to another party (e.g. parent distributing to adult child but using funds themselves). Round robin of funds – Trust distributes income to a company in year 1. Company declares a dividend in year 2. Trust distributes that dividend back to the company in year 2. This cycle continues to be repeated.|
It will be important to identify the level of risk of section 100A applying to your Trust arrangements based on your individual circumstances for both present and historical distributions.
We will be discussing this matter further with our clients during tax planning sessions and when considering Trust resolutions for the year ending 30th June 2022.
If you have any queries or would like to discuss further as to how this relates to your personal circumstances, please don’t hesitate to contact our office on 07 3831 1055.