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The ATO’s section 100A Christmas gifts

Morris Maroon ||

On 8 December 2022, the ATO released its finalised guidance on section 100A of the Income Tax Assessment Act, Taxation Ruling TR 2022/4 and Practical Compliance Guideline PCG 2022/2, together with an ATO media release and updated ATO web guidance—all just in time for Christmas.

Section 100A concerns the tax treatment of income distributions from family trusts. It is the hottest tax topic in 2022 for family trusts as, earlier in the year, the ATO released in draft form Taxation Determination TD 2022/D1, Taxation Ruling TR 2022/D1 and Practical Compliance Guideline PCG 2022/D1 together with Taxpayer Alert TA 2022/1, which concerns parents benefiting from trust distributions made to adult children. These materials describe the ATO’s intention of invoking a 40-year-old anti-avoidance measure to now attack trust distributions.

The draft guidance ‘unsettled’ taxpayers and advisers, as the ATO was going to attack what many had considered as regular tax planning relating to family trusts. Some called the position unfair (as the ATO technically has an unlimited amount of time to go back and review for section 100A risks but is choosing to review 2014 and onwards in most cases). Others called it the ‘end of family trusts’.

The bad news?

With the release of the finalised guidance, the ATO’s position of using section 100A to scrutinise family trust distributions is here to stay.  Section 100A will no doubt continue to be one of the hottest tax topics in 2023 as taxpayers and advisers now have no reason to delay their review for section 100A risks (if this process has not already started).

The good news?

The ATO’s finalised guidance takes into account consultation and feedback received from the industry and two recent Federal Court decisions, Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619 (Guardian) and BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112 (BBlood), both of which are currently on appeal.  The finalised guidance provides clearer and more comprehensive commentary, such as on the ordinary family or commercial dealing.  This will be welcomed by taxpayers and advisers.  However, the guidance only goes so far and there are already critics of the finalised guidance as section 100A problems are ultimately dependent on the particular facts in play.

More reading materials

If you’ve missed our earlier articles on section 100A, including a five-part series explaining the provisions in detail and potential defence strategies, you can find them as follows:

The rest of this article provides a recap on section 100A and what’s changed from the finalised ATO guidance.

What is section 100A?

Section 100A was introduced in 1979 as an anti-avoidance measure to target trust stripping arrangements. It allows the Commissioner to disregard trust distributions that form part of a ‘reimbursement agreement’ and instead impose tax on the trustee at the top marginal tax rate (currently 47% including the Medicare levy). A reimbursement agreement is broadly defined to include a 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 where it would result in any one or more person or entity in paying less income tax for any income year.

There are four basic requirements for section 100A to apply:

  1. ‘Connection requirement’ – there must be a beneficiary who is presently entitled to an amount of trust distribution, and this present entitlement must have arisen out of, as a result, or in connection with a reimbursement agreement;
  2. ‘Benefit to another requirement’ – the agreement must provide for the payment of money or transfer of property to, or provision or services or other benefits for, a person other than that beneficiary;
  3. ‘Tax reduction purpose requirement’ – a purpose of one or more of the parties to the agreement must be that a person would be liable to pay less income tax for a year of income; and
  4. ‘Ordinary family or commercial dealing exception’ – the agreement must not be one that has been entered into the course of ordinary family or commercial dealing.

In most cases, the key will be whether the ‘tax reduction purpose requirement’ is satisfied and/or whether the ‘ordinary family or commercial dealing exception’ can apply to the arrangement (which has an element of tax purpose).

Taxation Ruling TR 2022/4 – What’s ‘new’?

Ordinary family or commercial dealing exception

Thresholds of the exception

The Commissioner has provided further guidance on his view on when this exception may apply, having regard to the recent Federal Court decisions in Guardian and BBlood—noting that these decisions are currently on appeal. The Commissioner had lost in the decision in Guardian and had won in the decision in BBlood. The facts in these cases are included in ‘high-risk’ (or the ‘red zone’ zones) in PCG 2022/2.

On the ‘ordinary family or commercial dealing exception’, at a high-level:

  • Whether this exception applies will be a question of fact.
  • The test is an objective one, looking into the perspective of those persons whose purposes are relevant to the operation of section 100A. These persons are not necessarily limited to the beneficiary and the trustee.
  • In the draft ruling, the Commissioner had explained the essential feature of an ordinary family or commercial dealing is that it is ordinary. Acts undertaken in the course of ordinary family or commercial dealing are capable of explanation by the familial and/or commercial objects they are apt to achieve. This has now been removed.
  • Rather, the Commissioner notes that an ordinary family or commercial dealing is a dealing explained by the family or commercial objectives it will achieve. If the objective of a dealing can be explained as the payment of less tax to maximise group wealth, rather than a family or commercial objective, it is not an ordinary family or commercial dealing.
  • It is the ‘whole’ dealing (including the transaction, set of transactions or other actions) that must have the quality of an ‘ordinary family or commercial dealing’. It is not sufficient that each step in a series of connected transaction is capable of being described as ‘ordinary’.
  • The test is to consider all relevant circumstances, including: (i) the objective(s) (i.e. is there one or more sensible family or commercial objective(s) that is sought to be achieved); and (ii) whether the steps that comprise of the dealing will likely achieve those objectives.
  • This can also call into question:
  • the historical behaviour of the parties (i.e. is the arrangement something that is ‘regular’ or normal for the parties); and
  • whether the dealing is artificial or contrived; overly complex; contain steps that are not needed to achieve the family or commercial objectives; or contain steps that might be explained instead by objectives different to those said to be achieved.

Cultural factors

In a welcome addition, the Commissioner has acknowledged the relevance of cultural factors and its influence in respect of the ordinary family or commercial dealing exception.  The final ruling includes the following additional examples on when cultural factors can be relevant:

  1. Cultural practice of gifting – the example considers a cultural practice of grandparents gifting money or goods to younger members of the family during festive seasons;
  2. Cultural practice of supporting older relatives – the example considers a cultural practice of supporting older relatives, including providing for shelter needs and living arrangements (i.e. a beneficiary directing that its entitlements are paid to a relative to cover mortgage repayments); and
  3. Cultural practice of not accepting entitlements – the example considers a cultural practice of not accepting entitlements for religious reasons (i.e. a beneficiary not calling for their entitlement for this reason).

Whilst these examples are a welcome addition, in practice, there can be much more complex arrangements that will call into question the extent that cultural factors can be relevant in the ordinary family or commercial dealing exception.

Tax reduction purpose requirement

What purpose?

It is important to understand that section 100A can be invoked where there is merely a purpose of reducing tax by one of the parties to the arrangement, noting the following:

  • the person whose tax liability is to be reduced or eliminated need not necessarily be a party to the reimbursement agreement;
  • an intended reduction in a person’s tax liability need not actually be achieved;
  • the tax reduction purpose does not need to be the sole or dominant purpose (which is the test used in Part IVA (general tax anti-avoidance). Rather, all that is needed is for one of the parties to the arrangement to have a purpose of avoiding tax.  A purpose to defer tax to a later year is sufficient.

Purpose may be determined by reference to the parties’ own evidence as to their purposes for entering into the agreement and to the objective facts and circumstances including the financial, taxation and other consequences of the transaction entered into.

Whose purpose?  My advisers?!

Controversially—the purpose of an adviser (e.g. a tax adviser) can be attributed to the taxpayer in determining whether a tax reduction purpose exists.  This is based on the Federal Court decision in BBlood.  In that case, the purpose of the accountant and lawyers were taken into consideration by the Court.

Where the adviser is a party to the agreement, the purpose of the adviser will be directly relevant.

A taxpayer who acts in accordance with their advisers’ advice may be imputed with the purpose of the adviser.  This will be very contentious for clients who are not sophisticated (e.g. mums and dads) and simply act on the advice of their professional advisers to implement any part of an arrangement—a purpose of which is to minimise tax.

Practical Compliance Guideline PCG 2022/2 – What’s ‘new’?

In the draft guideline, the ATO had provided guidance on when they consider arrangements will be OK (green zone), not OK (red zone) or require further investigation (blue zone) for section 100A purposes.

Additional ‘green zone’ scenarios & exclusions

The green zone has been expanded to include the following scenarios:

  • beneficiary’s entitlement received and used by the beneficiary;
  • retention of funds by the trustee;
  • individual beneficiary and retention of funds by the trustee; and
  • company or trust beneficiary and retention of funds by the trustee.

The Commissioner has also expanded its list of exclusion from the green zone if the arrangement features any one of the following.  It will be prudent for taxpayers to review this list:

  • the beneficiary is a loss company or loss trust that uses its trust entitlement to fund a distribution to its members and that distribution compromises the ability of the beneficiary to repay its existing or future liabilities;
  • the beneficiary is a private company that uses its trust entitlement to fund a distribution that is made directly or indirectly to a non-resident;
  • the beneficiary is a private company or trust that uses its trust entitlement to fund a distribution that is made directly or indirectly to the trustee that made the beneficiary presently entitled to income;
  • the trustee has not notified the beneficiary of their entitlement to trust income by the earlier of the trustee’s due date and actual date of lodgment:
  • where the beneficiary that is presently entitled to trust income in a year is required to lodge a tax return for that year, either the:
  • beneficiary has not lodged, or
  • the beneficiary has understated or omitted in that tax return their share of the trust net income, trust capital gains or franked dividends received from the trust;
  • the beneficiary uses the trust entitlement to pay excessive consideration where the parties are not dealing at arm’s length.

Removal of the ‘blue zone’

The ‘blue zone’ that had straddled between the ‘green zone’ and the ‘red zone’ has been removed.  This is welcomed as it only added to confusion.  If a taxpayer intends to swim between the flags set by the ATO, then the key is to have an arrangement that falls into the ‘white zone’ (arrangements that ended before 1 July 2014) or ‘green zone’ (generally, where the ordinary family or commercial dealing exception applies), and steer clear of the ‘red zone’ (high risk arrangements).

Record keeping

Trustees are directed to prepare and keep good records that explain the transactions that have happened.

As good practice, the ATO considers that the following records should be kept wherever possible:

  • the trust deed (including amendments), trustee resolutions and contact details of the trustee and former trustees
  • notes, contemporaneous documents and records of discussions or meetings explaining the transactions that have happened or calculations that have been made
  • details of how the beneficiary was notified of their present entitlement to trust income
  • details of how the present entitlement to trust income was satisfied and, where practical, used by the beneficiary
  • details of how the trustee utilised the underlying funds; for example, to satisfy the trustee retention of funds or the trustee working capital condition; and
  • copies of loan agreements and records showing how the loan repayments were satisfied from time to time.

Whilst family arrangements are typically conducted with a greater level of informality, the trustee or registered tax agent should maintain contemporaneous records to demonstrate the objectives an arrangement was intended to achieve and how it would achieve them. This can be in the form of a file note of meeting between the trustee and registered tax agent.

What should you do now?

Section 100A is not new law. It is existing law and has been in force for the last 4 decades.  The ATO’s finalised guidance merely cements a position about using existing law to scrutinise family trust distributions that involve an element of tax minimisation.

With the finalised guidance, the ATO’s proposal of arming itself with section 100A is here to stay.  It is also important to note that section 100A can have broad application—broader than Part IVA—and is generally fact dependent.

It is prudent for taxpayers and tax advisers to assess their historical section 100A risks.  This should be undertaken with priority in 2023, if the process has not already started.

Any section 100A defence plan must also consider enlivening the ordinary family or commercial dealing exception.

If you require assistance or have any questions, please contact Coleman Greig’s Taxation team.

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