ATO draft guidance causes concern for Trusts - ‘common’ trust arrangements may no longer be considered ‘ordinary’ (or acceptable)

These documents were all released on the same day, and are intended to be read together, including:

• Draft Taxation Ruling TR 2022/D1 Income tax: section 100A reimbursement agreements (‘TR 2022/D1’)
• Practical Compliance Guideline PCG 2022/D1 Section 100A reimbursement agreements - ATO compliance approach (‘PCG 2022/D1’)
• Taxpayer Alert TA 2022/1 Parents benefitting from the trust entitlements of their children over 18 years of age (‘TA 2022/1’)

Many trustees may be unfamiliar with section 100A or think that it should have no application to their circumstances (on the basis that they have never entered into a ‘reimbursement agreement’), or have done so as part of an ordinary family dealing.  Unfortunately, these documents need to be on the top of the ‘must read’ list of anyone with a trust.

A brief background on section 100A

Section 100A is an anti-avoidance section that has been around since 1979 and was introduced to combat “trust stripping” arrangements that had the effect of enabling income derived by trusts to escape tax.   The ATO view just published is that section 100A is not limited to ‘traditional’ trust stripping arrangements and can apply more broadly.

When can section 100A apply?

TR 2022/D1 outlines the Commissioner of Taxation’s (‘Commissioner’) view of arrangements subject to section 100A. Relevantly, the Commissioner states that the four basic requirements that must be satisfied for section 100A to apply are as follows:

1. The connection requirement: broadly, there must be a present entitlement of a beneficiary to a share of trust income which has arisen out or, in connection with, or as a result of a reimbursement agreement (a reimbursement agreement is an agreement, understanding or arrangement that has the three below qualities).
2. The benefits to another requirement: the ‘agreement’ must provide for money, property, services, or other benefits, to be provided to a person other than the beneficiary with the present entitlement. This requirement does not actually require any actual reimbursement.
3. The tax reduction purpose requirement: one or more of the parties to the agreement must have had a tax reduction purpose (i.e. the purpose of a person being liable to pay less tax than they otherwise would have had to). Relevantly, the tax reduction purpose does not need to be the sole or dominant purpose of the agreement. It only needs to be one of the purposes of the agreement and the purpose of an adviser can be imputed to parties to the agreement. 
4. The ordinary dealing exception: the agreement is not one that was entered into in the course of an ordinary family or commercial dealing. Relevantly a dealing is not an ordinary family or commercial dealing merely because it is commonplace or involves no artificiality.

In broad terms, section 100A can potentially apply to arrangements where a beneficiary is made presently entitled to the income of the trust, but under an ‘arrangement’ (with a tax reduction purpose), the benefits of that entitlement are received by others.

What is an ordinary dealing?

The Commissioner has provided some commentary and examples in its guidance regarding what it considers to be ordinary dealings for the purposes of section 100A. Relevantly, in TR 2022/D1, the Commissioner has stated that a dealing “is ordinary where a person can examine the acts and predicate that they can be explained by the familial and/or commercial objects they are apt to achieve without further explanation”.

One key takeaway from the guidance is that the Commissioner’s stance is that a dealing will not be ordinary just because it is commonplace or because there is no artificiality.

Further, another important takeaway for taxpayers and their advisers is that the Commissioner’s position appears to be that not all dealings between family members will qualify as an ordinary family dealing for the purposes of section 100A.

For example, an agreement between parent and child that the child’s after-tax distribution will be paid to parent to reimburse him for certain costs incurred by them on behalf of the child prior to the child turning 18 was highlighted in both PCG 2022/D1 and TA 2022/1 as an example of situations the Commissioner is concerned the ordinary dealing exception may not be available and, therefore, section 100A could apply.

Other examples provided of situations where the ordinary dealing exception may not be available include:

• distributions being made to adult children where the adult child gifts their trust entitlement to their parents;
• distributions being made to adult children where the adult child gifts their trust entitlement back to the trust;
• franked distributions are paid to non-residents who then agree to lend their entitlements to a resident on interest-free terms.

When is this all effective from?

Section 100A has an unlimited amendment period.  Given how long section 100A has been around, this could result in substantial tax liabilities for taxpayers. 

TR 2022/D1 states that when the final ruling is issued, it is intended to apply to arrangements both before and after its issue.

PCG 2022/D1 outlines what the Commissioner’s compliance approach towards arrangements to which section 100A could apply – in other words, it outlines when the Commissioner is more likely to ‘dedicate compliance resources to consider the application of section 100A’ to certain arrangements.

In this PCG, the Commissioner outlines different risk categories of arrangements and how likely it is that the Commissioner will seek to analyse the arrangements, including that generally arrangements entered into prior to 1 July 2014 will fall into a ‘white zone’ (subject to a number of exclusions), whereby the Commissioner will not dedicate new compliance resources to consider the application of section 100A to these arrangements.

While this might sound somewhat helpful and reassuring, taxpayers and practitioners should note that the comments in PCG 2022/D1 only advise the basis on which the ATO will allocate compliance resources – there is nothing in PCG 2022/D1 which stops the ATO from applying section 100A to a ‘white’ or ‘green’ (the other low risk category) arrangement if it is otherwise found.

As a final note, it is worth highlighting that section 100A was recently considered by the Federal Court in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619. This case was found in favour of the taxpayer (i.e. the judge found that section 100A did not apply to their circumstances).  The case is being appealed by the Commissioner and has largely been ignored in the draft guidance.

Further comments and next steps

The release of the various section 100A guidelines highlights that this is an area of focus for the Commissioner. In particular, in light of the comments made by the Commissioner in the guidance, many situations that historically were considered to be ordinary family dealings (and fairly common in practice) are likely to need to be reconsidered.

While the guidance is currently in draft, it does not appear likely at this stage that the Commissioner will dramatically change his opinion between now and the issue of the final advice.

Trustees need to review their former arrangements to determine if they may be caught by the new ATO approach and how to deal with that.   Further, more detailed planning will be needed for trust distributions in the future.

If you would like more information on 100A and its potential impacts, please contact your usual Mazars advisor or our experts via the form below or on:

Author: Jennifer Ferguson

Published date: 14/3/22

All rights reserved. This publication in whole or in part may not be reproduced, distributed or used in any manner whatsoever without the express prior and written consent of Mazars, except for the use of brief quotations in the press, in social media or in another communication tool, as long as Mazars and the source of the publication are duly mentioned. In all cases, Mazars’ intellectual property rights are protected and the Mazars Group shall not be liable for any use of this publication by third parties, either with or without Mazars’ prior authorisation. Also please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice. Content is accurate as at the date published.