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Guardian AIT: section 100A – the end of the beginning?

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Winston Churchill famously said “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

The Federal Court decision in Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT [2021] FCA 1619 (Guardian AIT) concerning section 100A of the Income Tax Assessment Act 1936 is perhaps the “end of the beginning” of what may become increased clarity on the judicial and administrative approach to that section.

What is section 100A?

Very broadly, section 100A targets arrangements where a trustee makes a beneficiary presently entitled to income (the form), but another person benefits from that present entitlement (the substance). If section 100A applies, there is an unlimited amendment period and the trustee is assessed on the income at the top marginal rate.

The Explanatory Memorandum introducing section 100A in 1978 said the section was “to overcome certain tax avoidance arrangements designed to enable trading profits and other income derived by trusts to escape tax.” However, as Logan J said in Guardian AIT, to “begin with such subjects would apt to distract from a necessary starting point, which is the text of the relevant provision”.

Section 100A is broadly, but awkwardly, drafted.

For section 100A to apply, there must be a ‘reimbursement agreement’ and:

  • someone pays less or no tax due to the reimbursement agreement; and

  • an agreement, arrangement, or understanding cannot be a reimbursement agreement if the agreement, arrangement, or understanding was entered into in the course of ordinary family or commercial dealing.

Section 100A requires postulation of an alternative (counterfactual) to what happened. The effect of the counterfactual is that someone paid less tax because of the reimbursement agreement.  The taxpayer has the onus of showing that the counterfactual would not have occurred.

While section 100A has been a feature of the tax legislation for more than 40 years, there is limited judicial guidance on its application. However, despite the limited judicial guidance, since around 2010 section 100A has become a regular focus of audits of private groups by the Australian Taxation Office (ATO). The broad drafting of section 100A, coupled with an unlimited amendment period if the section applies, may be a reason for this.

The increased audit focus led in 2016 to a request to the ATO to publish guidance on its views on the application of section 100A. The ATO has said that guidance on the ‘ordinary family or commercial dealing’ exception to section 100A will be released in early 2022 (see below).

What was Guardian AIT about?

In Guardian AIT, Logan J of the Federal Court found for the taxpayer that section 100A did not apply to an arrangement where the trustee made a corporate beneficiary presently entitled to income of the trust and the corporate beneficiary, after paying tax on that income, paid a fully franked dividend back to the trust. Logan J also considered that Part IVA did not apply to the arrangement although this article only discusses section 100A.

More specifically, the facts in Guardian AIT were:

  • for the 2012 and 2013 income years:

    • the trustee made the corporate beneficiary (AITCS) presently entitled to income (recorded as an unpaid present entitlement (UPE));

    • AITCS paid its income tax liability by drawing on the UPE;

    • AITCS declared a fully franked dividend to its shareholder (the trustee) and AITCS and the trustee offset the amount that AITCS owed the trustee for the dividend against the UPE; and

    • the trustee resolved to distribute all the fully franked dividends it received to a non-resident beneficiary of the trust (no further Australian tax was paid by the non-resident beneficiary on the fully franked dividends).

  • In 2014, the trustee distributed income to AITCS and the AITCS and the trustee entered into a Division 7A loan agreement in relation to the UPE (after AITCS drew on the UPE to pay its tax). The trustee repaid the Division 7A loan in the 2016 income year

The taxpayer maintained that asset protection and risk minimisation were the reasons for the establishment and use of AITCS.

The ATO thought that the arrangement was a reimbursement agreement whereby on or before the trustee conveyed the present entitlements the trustee and foreign beneficiary reached an understanding that AITCS would be made presently entitled to the income and the foreign beneficiary would ultimately benefit from that income (and pay less tax).

Logan J disagreed that section 100A applied.

What did Logan J say about 100A?

Logan J made the following observations about section 100A:

  • a reimbursement agreement:

    • has to precede the present entitlement (see paragraph 129);

    • need not be legally enforceable (see paragraph 132); and

    • must provide for the payment of money, transfer of property or the provision of services or other benefits to a person other than the beneficiary (see paragraph 155);

  • a “hypothetical contingency” open in law but never considered is not enough to establish a reimbursement agreement (see paragraph 132);

  • the beneficiary presently entitled to the trust income need not be a party to the reimbursement agreement (see paragraph 135);

  • even if there is an agreement to confer a present entitlement but the agreement does not provide for “the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary …” then that agreement will not be a reimbursement agreement (see paragraph 155);

  • in determining a tax avoidance purpose as required by section 100A(8):

    • the court must determine what the income ‘would’ have been had the agreement not been entered into. ‘Would’ takes its ordinary English meaning and is a higher test of prediction than ‘might’ (see paragraph 160);

    • a fact is not “disqualified” from consideration merely by reason of the fact having been an element of the scheme which was in place (see paragraph 162); and

    • the test is an objective one and the onus of proof falls on the taxpayer but the onus can be discharged via proof with respect to what the prevailing circumstances were and what was in fact done in light of them by the taxpayer and its, her, or his associates (see paragraph 163).

  • with respect to the exclusion for ‘ordinary family or commercial dealing’:

    • the adjective “ordinary” is used in contradistinction to “extraordinary” and refers to a dealing which contains no element of artificiality (see paragraph 144);

    • the use of a corporate beneficiary does not necessarily bear the stamp of tax avoidance or is it “necessarily incompatible” with an ‘ordinary family or commercial dealing’ (see paragraph 152); and

    • use of a corporate beneficiary for risk minimisation may, depending on the circumstances, be an ‘ordinary family or commercial dealing’ (see paragraphs 151 and 152).

 What does Guardian AIT mean?

The taxpayer’s success in Guardian AIT was comprehensive. However, the taxpayer was assisted by strong contemporaneous documentation and witnesses that “offered honest, candid, consistent evidence” that “sat well with” the documentation. Therefore, while the decision in Guardian AIT will be welcomed by many advisors, drawing broad conclusions about corporate beneficiaries and section 100A based upon Guardian AIT may not be appropriate (particularly where the documentation is not to the standard in Guardian AIT).

The ATO has said that it will release guidance on the ‘ordinary family or commercial dealing’ element of section 100A in early 2022. Whether the ATO releases that guidance as planned is unknown. As is, as at the date of writing, whether the ATO will appeal Guardian AIT to the Full Federal Court.

However, we consider that it is likely that the ATO will appeal the Guardian AIT decision. If that happens then we consider that the ATO may wait until the finalisation of the appeal process before issuing the guidance. (We note that as at the date of writing the ATO website lists the release of the guidance as being in February 2022).

It is more than 13 years since the High Court considered section 100A in Raftland v FCT [2008] HCA 21. Since that time, the spectre of section 100A has become increasingly common in audits of private groups comprising trusts with corporate beneficiaries.

For this reason, the awkward drafting of section 100A, and the obscure nature of the ‘ordinary family or commercial dealing’ exception, the decision of Logan J in Guardian is welcomed. However, we think that the decision of Logan J is “not the end” but, perhaps, it may be the “end of the beginning” of renewed consideration by the courts of section 100A.

For more information please contact:

Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E nbrydges@sladen.com.au

Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327|  T +61 3 9611 0105
E: dsmedley@sladen.com.au

Edward Hennebry
Senior Associate
T +61 3 9611 0113 | M +61 405 847 261
E: ehennebry@sladen.com.au

Neil Brydges