After our semi-serious opening statement on the Australian Taxation Office’s (ATO) recently released guidance on section 100A and unpaid present entitlements, this is one of a series of deep-dive articles on that guidance. These articles look at each of the ATO guidance products separately and then we discuss what the overall impact may be.

This article is on Draft Practical Compliance Guideline PCG 2022/D1 (Draft Guideline) that sets out the ATO’s proposed compliance approach to section 100A and reimbursement agreements. The compliance approach would apply prospectively and retrospectively.

The Draft Guideline (should be read in conjunction with Draft Taxation Ruling TR 2022/D1 (Draft Ruling) that was released at the same time as the Draft Guideline and we discussed here).

Recap

Section 100A of the Income Tax Assessment Act 1936 was inserted in the tax legislation in 1979 as an anti-avoidance provision to counter trust stripping arrangements (which enable income derived by trusts to escape tax).

Despite being an anti-avoidance provision, the courts have held that section 100A can apply to other transactions that have similar characteristics to a trust stripping arrangement. For example, engineering distributions to a loss-making trust.

The Draft Ruling sets out the ATO’s draft views on when section 100A may apply and should be read in conjunction with the Draft Guideline.

What is the Draft Guideline?

The Draft Guideline “sets out a practical administration approach to assist taxpayers in complying with” section 100A.

The Draft Guideline is not law, nor does the Draft Guideline replace, alter, or affect the ATO's interpretation of the law. However, once finalised the ATO says that “provided you follow [the finalised Guideline] in good faith, the Commissioner will administer the law in accordance with” that approach.

The risk matrix

In what has become a feature of ATO Practical Compliance Guidelines, the Draft Guideline includes a risk matrix to allow taxpayers to self-assess the perceived section 100A risk associated with their arrangements. The matrix includes four zones:

The ATO expects taxpayers to self-assess their current arrangements to determine whether they fall within the White, Green, Blue, or Red zones. Apart from the obvious (why blue not amber) the risk matrix raises the question of how the ATO will determine what zone a taxpayer’s arrangements fall in as there is no scoring and / or numbering system aligned to the matrix as compared to in other recently released guidelines such as PCG 2021/4 that concerns the allocation of professional firm profits. 

When looking at the examples (see below) in the Draft Guideline of the types of arrangements that fall within the four zones, apart from conducting a review or an audit, how is the ATO to know what Zone the arrangements fall within to conduct compliance activity? All the examples include features that should / would be known to taxpayers but not to the ATO from the mere lodgment of returns.

The examples

The Draft Guideline includes eleven examples that illustrate the application of the different risk zones:

• White zone: example 1

• Green zone: examples 2 to 6

• Blue zone: no examples

• Red zone: examples 7 to 11

Apart from Example 1 (White zone) the Examples in the Draft Guidelines illustrate the following scenarios:

All the Examples, while simplified, include multiple features. In terms of drawing definitive conclusions from the Examples, the Draft Guideline uses phrases such as “all of”, “one or more”, and “any of” “the following features”.

There would be danger in saying that an arrangement does not fall within Example X in the Red zone because the arrangement does not have “all of” the features in Example X as the arrangement could have “any of” the features in another Red zone example.

What are the Blue zone arrangements?

As discussed, the Draft Guideline says that Blue zone (medium risk) arrangements do not fall within the White zone, Green zone, or Red zone. Duh!

While the Draft Guideline does not include Examples on Blue Zone arrangements, the Draft Guideline says that Blue arrangements may include “one or more” of the following features:

• The beneficiary makes a gift of their trust entitlement or an associated amount receivable from the trust (for example, if the unpaid present entitlement was converted into a loan).

• The beneficiary disclaims their entitlement or forgives or releases the trustee from its obligation to pay their trust entitlement or an associated amount receivable from the trust.

• The income of the trust estate is less than the net income because of the trustee exercising a power, or the deed being amended, to affect the quantum of income of the trust estate.

• A beneficiary's trust entitlement is satisfied by payments that are sourced from that beneficiary, or a beneficiary's trust entitlement has been made subject to a loan agreement and the repayments of that loan are sourced from payments or loans from that beneficiary. Examples include:

  • where a dividend payable by a corporate beneficiary to the trustee is set-off against the amount payable by the trust

  • where the trustee issues units in the trust to the beneficiary and the amount owed for the units is set-off against the amount payable by the trust, or

  • where the trustee is made entitled to income of another trust that is made up of franked distributions paid by the beneficiary.

• The arrangement involves one or more features that may be explicable by a tax avoidance purpose.

What does the Draft Guideline mean?

The ATO says that when finalised, the compliance approach will apply prospectively and retrospectively. However, for trust entitlements conferred before 1 July 2022, the ATO will stand by any administrative position reflected in Trust taxation - reimbursement agreement, first published on its website in July 2014, to the extent it is more favourable to the taxpayer's circumstances than in the finalised Guideline.

While taxpayers may feel relieved for pre-1 July 2022 arrangements, the (very) generalised positions in the 2014 guidance may not be a sword during an audit and may, at best, be a (poor) shield.

The ATO says that the Draft Guideline (once finalised) will not replace, alter, or affect the operation of the law in any way (see above). That is true. However, if the finalised Guideline causes behaviour to change because many taxpayers do not want to be in the ‘Red zone’, or perhaps ‘Blue zone’, with increased risk of ATO compliance activity, the effect may be that the finalised Guideline becomes the ‘lore’ with respect to section 100A.

Taxpayers that continue post-1 July 2022 with the same arrangements as in the past that are now in the Blue or Red zones may discover that they are on a highway to hell with respect to ATO compliance activity. We note that setting off a dividend payable by a corporate beneficiary to a trustee against an amount payable to the corporate beneficiary by the trustee, is a Blue zone feature.

Sladen Legal’s tax team regularly advises on section 100A. If you have any questions about what the ATO views may mean for you and your arrangements, 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

Rob Warnock
Principal Lawyer
T +61 3 5226 8512 | M +61 419 892 115
E: rwarnock@sladen.com.au

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