On 23 February 2022, the ATO released its long-awaited draft ruling and guidance on the application of anti-avoidance measures relating to trust distributions, and the related flow of funds. Operators of family trusts have been put on notice to ensure trust distributions to family members are genuinely payable to those family members in order to be considered effective.
Assuming it is finalised in its present form, the ruling will change the way that many family trusts determine their distributions, particularly in a situation where there are adult children or other low-income beneficiaries. Any distributions not actually available to those beneficiaries will be attacked by the ruling.
The long-anticipated ruling sets out the ATO’s views on section 100A of the Income Tax Assessment Act 1936. Section 100A was introduced in its current form more than 30 years ago by the then Treasurer, John Howard. With its long history, Section 100A was introduced to counteract tax avoidance arrangements entered into by trustees whereby income is distributed to beneficiaries with no or low tax obligations.
For s100A to apply, distributions must arise from “reimbursement agreements” between parties, entered into with the purpose of reducing tax liabilities. However, an arrangement will not be a reimbursement arrangement where it is considered an “ordinary family or commercial dealing”. Exactly what constitutes an ordinary family or commercial dealing has long been a grey area.
What’s in the draft ruling?
As expected, the ATO has reinforced that what constitutes an ordinary family or commercial dealing will depend on the facts of the case. However, in order to be an ordinary family or commercial dealing, the acts undertaken must be capable of explanation by the familial or commercial objects they are designed to achieve.
Note that the ATO will not consider an arrangement to be an ordinary family or commercial dealing just because it is commonplace, or undertaken between family members.
We have expanded on some of the key “high-risk” examples in the draft ruling and Practical Compliance Guideline below.
i) Adult children beneficiaries
The ATO sees mischief where adult children with low marginal tax rates are made presently entitled to trust income, and there is a history of the entitlement not being paid to the child. Additional factors that would trigger s100A (and would not be considered ordinary family dealings) include where the cash that represents the child’s trust entitlement is loaned or gifted to his/her parents, or is applied to repay his/her parents for costs incurred by the parents when the child was a minor. The same logic can be applied to distributions to other family members, such as parents, siblings or in-laws.
ii) Beneficiaries with losses
The ATO has indicated that they are likely to apply audit resources to situations where beneficiaries with tax losses are made presently entitled to trust income, and the cash representing the entitlement does not flow to the beneficiaries.
The views espoused by the ATO represent a significant shift in the previously accepted norms, and trustees may need to adopt different approaches or obtain further advice in the future.