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 Taxation Ruling TR 2022/D1 (Draft Ruling).
The Draft Ruling is the clearest public indication to how the ATO interprets section 100A of the Income Tax Assessment Act 1936.
The Draft Ruling (which should be read in conjunction with Draft Practical Compliance Guideline PCG 2022/D1 that was released at the same time as the Draft Ruling) is a warning to taxpayers that many common transactions involving trusts may soon be open to indefinite ATO scrutiny (as section 100A has an unlimited period of review).
Introduction
Section 100A 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.
Many commentators have argued that the context and purpose of section 100A (as informed by its unlimited amendment period and the exclusion of ordinary family or commercial dealings) suggests that section 100A should be confined to contrived arrangements involving fraud, evasion, or shams. The ATO evidently disagrees.
What does the Draft Ruling say?
The Draft Ruling helpfully breaks down the 4 elements for section 100A to apply:
A connection requirement: there must be a present entitlement of a beneficiary to a share of trust income, which has arisen out of, in connection with or as a result of a “reimbursement agreement”. A reimbursement agreement is an agreement, understanding or arrangement that has the following three elements.
A benefit to another requirement: the “reimbursement agreement” must provide for the payment of money or transfer of property to, or provision of services or other benefits for, a person other than that beneficiary.
A tax reduction purpose requirement: one of the purposes of a party to the “reimbursement agreement” must be for reducing a liability to tax (it does not need to be the sole or dominant purpose).
An ordinary dealing exception – the agreement cannot be one entered into in the course of “ordinary family or commercial dealing.”
While the presence of the factors above is consistent with the case law, it is the last factor which continues to generate interpretative creativity (particularly in light of limited judicial guidance) and a divergence of views between the ATO and taxpayers.
The divergences are amplified in some of the examples in the Draft Ruling which highlight that simply because an arrangement involves a trust with family members does not preclude the application of section 100A. That is, just because family members are involved does not necessarily make the arrangement one entered into in the course of ordinary family dealing.
For instance, in Example 4, it is suggested that an adult child applying her trust entitlements to repay her parents for costs incurred on her maintenance and education when she was a minor may be indicative of tax avoidance rather than an action undertaken in the course of ordinary family dealing (a theme underpinned in Taxpayer Alert TA 2022/1 that was released at the same time as the Draft Ruling).
Likewise, in Example 5 and 6, family members entering into non-commercial and non-interest bearing loans may also be considered in some circumstances to be breaching section 100A if a tax avoidance purpose can be identified.
What does this mean for you?
The Draft Ruling, and the examples provided, indicate that the ATO will start to more closely scrutinise family dealings involving trusts and misalignments between those who are assessed to tax on a trust’s income, and those who enjoy the economic benefits of that income.
However, consistent with the case law and as acknowledged in the Draft Ruling, a reimbursement agreement must be in existence at the time when the “present entitlement” arises. It will therefore become more important than ever for taxpayers (in mitigating ATO scrutiny) to be able to substantiate that beneficiaries were made presently entitled before any agreement or understanding was reached with respect to the application of trust monies.
So despite the ATO’s push to closely review arrangements where adult children reimburse their parents for education and maintenance costs, it seems that section 100A may be difficult to apply if there was no such understanding before the child was made presently entitled. However, bear in mind that taxpayers have the onus of disproving any allegation that section 100A applies.
Where to from here?
If the Draft Ruling is finalised, it will apply retrospectively and prospectively (however, the ATO will apply its compliance resources in line with Draft PCG 2022/D1).
There may be some hope for taxpayers. It is, after all, a draft ruling. And furthermore, the Draft Ruling acknowledges the ongoing litigation of Guardian AIT (discussed here) which may prove significant to the ATO’s views as Example 9 of the Draft Ruling is very similar to the facts in that case.
But, in our view, the Draft Ruling (together with the associated PCG and Taxpayer Alert) reflects the growing trend of the ATO to apply section 100A more enthusiastically than in the past. What may once have been considered legitimate tax planning may now be in the eyes of the ATO be a form of tax avoidance.
Final thoughts
Since the introduction of section 100A in 1979, much has changed to the landscape of trusts.
For instance, we now have a comprehensive family trust election regime designed to facilitate the retention of monies within a family group and to reduce exposure to complex trust loss and qualified person rules (although the family group in the trust loss rules is not necessarily the same as family in section 100A).
Furthermore, what was ordinary in 1979 may not be ordinary in 2022 (do people still listen to disco music?)
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:
Edward Hennebry
Senior Associate
T +61 3 9611 0113 | M +61 405 847 261
E: ehennebry@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
Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au
Rob Warnock
Principal Lawyer
T +61 3 9611 0155 | M +61 419 892 115
E: rwarnock@sladen.com.au
