Background of Section 100A.
Discretionary Trusts (or family trusts, where distributions
are at the discretion of the trustee) are a key part of the structure of many
businesses, thanks to their flexibility in income distribution, including
distributions to members outside of the direct family group.
However, this flexibility also brings risk of ATO scrutiny if it falls outside of what the ATO consider ‘ordinary family and commercial dealings’. The ATO has recently made its position clear on the related legislation, Section 100A, and what is considered to be ordinary family or commercial dealings.
What is Section 100A?
Section 100A of the Tax Act was introduced in 1979 to deal with reimbursement agreements and Trust Stripping arrangements, where the taxpayer made entitled to the trust income is not the beneficiary of the income. Crucially, unlike other anti-avoidance provision Section 100A has no time limit on any audits, allowing the ATO to target distributions made years ago.
What are ‘ordinary family and commercial dealings’?
Unfortunately, the definition of ‘ordinary family or commercial dealings’ has been vague and uncertain ever since the legislation was introduced. Until recently there has been little judicial rulings relating to this issue, so while has released its position there is not enough evidence to be able to confidently determine a courts perspective.
Two practices the ATO have particularly targeted in the recently released approach to S100A are:
Unpaid Distributions to Low Income Individuals
Where income is distributed to low-income individuals, and then the after-tax amount is gifted or loaned indefinitely back to the parents or controllers of the trust. This arrangement is of particular concern when:
1. The money is gifted back to reimburse parents for school fees. These expenses are considered a wholly parental responsibility and should be paid for by the parents.
2. The distribution is repaid to the parents through excessive board, above commercial rates
3. The distribution remaining unpaid in the trust with no genuine intention of paying the amount.
Bucket company arrangements
Where income is distributed to a ‘bucket company’ with a tax rate of 25-30%, rather than the controllers at the top margin rate of 47%. This arrangement is of particular concern when:
1. Income is distributed to a company, however the cash loaned to the controllers for private expenses, or
2. Where the shares in the company are owned by another or the same trust. (This is commonly referred to as a washing machine arrangement, where there can be an endless cycle of distributions to the company and dividends back to a trust.)
Whilst majority of distribution arrangements would comply with the ATO’s views, it is important to ensure that your financial arrangements are structured effectively to avoid ATO scrutiny, as it’s always better to avoid a fight then to win a fight.
If you have any questions in relation to your trust arrangements, reach out to a UBTA manager.