This week, we wrap up our series on section 100A. We provide a recap of our series and consider the section 100A tax risk in the context of two case studies.
Recap of the series
Section 100A is a very live tax risk, as it is current law and can apply whenever the Commissioner is able to identify a distribution of trust income arising out of or in connection with a “reimbursement agreement”. The Commissioner has also indicated that the draft taxation ruling on section 100A is expected to be released in 2022. If section 100A applies, income tax can be imposed on the trustee at the top marginal tax rate (currently 47% including the Medicare levy).
In our series on section 100A, we considered the following primary defences to section 100A:
- present entitlement to income;
- legal disability of the beneficiary;
- lack of an “agreement” for the purposes of a “reimbursement agreement”; and
- the agreement being entered into in the course of “ordinary family or commercial dealing”.
We also provided tips in preparing for these primary defences, including:
- locating and reviewing the trust deed;
- reviewing historical distributions of trust income;
- gathering evidence to show that the provision of benefits to a person other than the beneficiary was the result of unilateral acts;
- gathering evidence on what constitute as an “ordinary family or commercial dealing”; and
- preparing contemporaneous evidence, including drafting fulsome resolutions relating to distributions of trust income.
Case Study A
John is elderly and requires full time physical care. He has legal capacity. He is the principal beneficiary of his family trust, the John Family Trust, which holds a portfolio of ASX-listed shares. John’s daughter, Susan, is the current trustee of the trust. Both John and Susan are Australian tax residents. In the current income year, Susan as trustee resolves to distribute all of the income of the trust, comprising of fully-franked dividend income, to John. John is informed of his right to demand payment of his entitlements but he does not exercise the right. He tells Susan to use the funds to pay for his caring expenses and to apply the remaining balance as she sees fit. Susan applies the balance to pay for her children’s school fees and a family holiday. Susan knew that distributing all of the income to herself instead of John would result in higher income tax, as she has more taxable income than John.
How can section 100A apply?
There is a beneficiary who is not under a legal disability and has present entitlement to trust income, being John. Some of the benefits to the trust income were provided to a person other than the beneficiary, being Susan. Further, Susan would have paid a higher amount of income tax if the distribution was made to her instead of John. On this basis, there is a “reimbursement agreement” if there was an agreement between John and Susan for the trust income to be distributed to John and for the benefits of the income to be used by Susan, unless the agreement was entered into in the course of an ordinary family or commercial dealing.
Was there an “agreement” to provide the benefits of the dividend income to Susan? In our view, this is a key question. Was the direction for the trust income to be used by Susan a unilateral act of John’s or an agreement with Susan? What evidence exists to show that the act was a unilateral decision of John’s? It would be helpful if there was a contemporaneous statement from John explaining that his direction to the trustee was a unilateral act and the reasons for his direction, which are backed-up as being consistent with prior conduct (e.g. John as the father has always provided financial assistance to Susan from time to time as part of taking care his family).
Case Study B
John is a foreign tax resident. He lives in the UK. He has legal capacity. He is the principal beneficiary of the John Family Trust, which holds a portfolio of ASX-listed shares. John’s daughter, Susan, is the current trustee of the trust. She is an Australian tax resident. In the current income year, Susan as trustee resolves to distribute all of the income of the trust, comprising of fully-franked dividend income, to John. John is informed of his right to demand payment of his entitlements. John is aware that Susan has been saving up money to buy a larger home in Sydney. He agrees with Susan that the dividend income will be distributed to him but he will lend the amount to Susan on interest-free terms to assist Susan in buying a larger home in Sydney. Both Susan and John knew that distributing all of the income to Susan instead of John would result in higher income tax, as Susan is on the highest marginal tax rate.
How can section 100A apply?
There is a beneficiary who is not under a legal disability and has present entitlement to trust income, being John. The benefit to the trust income was provided to a person other than the beneficiary, being Susan. Further, Susan would have paid a higher amount of income tax if the distribution was made to her instead of John due to John’s non-residency tax status. Given that John and Susan had agreed on the distribution and use of the trust income, there is an “agreement” for the provision of the trust income to someone other than the beneficiary.
On the basis that there is an “agreement” for the provision of the trust income to someone other than the beneficiary, the key question will be whether the agreement was entered into in the course of an ordinary family or commercial dealing. What evidence exists to show the ordinary family or commercial dealings between John and Susan? Is it usual for John to help Susan and/or his family by providing interest free loans? How many times has John helped Susan and/or his family in this manner? Would a reasonable person, having an understanding of John and Susan’s relationship, consider the current loan to be a usual ordinary family dealing between them? If John has in the past provided a number of interest-free loans to Susan and/or his other children from trust income distributed to him, appropriate evidence can include loan agreements for all of the previous interest-free loans, bank statements and correspondences between John and his children. Contemporaneous statements from John on his reasons in providing the interest-free loan can also assist.
How can we help?
We can help you in identifying and assessing the section 100A tax risk for your clients. We can also help you in preparing for defences to identified section 100A tax risk, including collating and/or documenting evidence on previous and/or proposed transactions such as drafting trustee resolutions, reviewing transaction documents and putting together self-serving evidence.
The Commissioner has indicated that the draft taxation ruling on section 100A will be released in 2022. The ruling is to be applied immediately by the ATO audit teams. Rather than waiting for the draft taxation ruling to be released in 2022, now is the time to act and prepare. As we close off 2021, section 100A should be on your priority list for review with your clients to finish 2021 or as priority in 2022. You should determine who has section 100A risks and put in place a plan to deal with it.
Contact us for a confidential discussion.