ATO Scrutiny of Family Trust Arrangements

In December 2022 the Australian Taxation Office (ATO) finalised a tax ruling relating to trust arrangements that may be caught by anti-avoidance tax laws. 
The final ruling does not differ significantly from the draft ruling issued earlier in 2022 and can apply both prospectively and retrospectively.

If you are the trustee of a trust you should keep reading.

Broadly, the anti-avoidance rule in s100A targets arrangements where a beneficiary is made presently entitled to trust income, but, under a “reimbursement agreement”, the economic benefit of that distribution is received by another person. In simpler terms, Section 100A targets arrangements where a trust distributes income to one party (usually recorded only in accounting and tax records), but the cash or other benefits of the distribution flow to another party. 

Distributions that are captured under s100A are disregarded for taxation purposes, making the trustee of the trust liable for tax at the highest marginal tax rate.

The legislation in s100A does not apply to arrangements that constitute an ‘ordinary family or commercial dealing’.  The ruling, TR 2022/4 and accompanying practical guidance PCG 2022/2 provide the ATO’s view on what arrangements fall under the exemption for ordinary family or commercial dealings. The PCG also sets out a risk assessment framework that allows the trustees of trusts and their advisors to assess the level of risk regarding their trust distribution arrangements. The framework is broken up in white, green and red zones and outlines how the ATO will respond to trust distribution arrangements considered to be in each of those zones (the green zone is for low-risk arrangements for which the ATO does not intend to undertake reviews).

Ordinary Family or Commercial Dealing

For your trust’s distributions to be considered an ‘ordinary family or commercial dealing’, the transactions between your trust, your family members and their associated entities must be explainable as achieving family or commercial objectives.

Examples of ordinary family or commercial dealings that fall within the ATO’s green-zone and should not attract ATO scrutiny include:

• A family trust distributes income equally between spouses who themselves have a shared financial responsibility of the family unit and ultimately enjoy the shared benefits of the distribution from the trust.
• A family trust distributes to beneficiaries who are controllers or responsible for the management of the trust when funds are retained by the trust for working capital or reinvestment.
• A family trust makes a distribution to a low-income adult child of the trustee and the funds underlying the present entitlement are paid to the adult child or set aside to be held by the trustee upon a separate trust for the sole benefit of the child, and the adult child is at liberty to call for the trust entitlement at any time.  

In instances where a family trust does distribute income to an adult child, the finalised compliance guideline indicates the ATO:

• expects the funds to have been paid to the adult child, or otherwise applied directly for the benefit of the adult child, within 2 years of the distribution for the arrangement to remain in the green-zone; and
• considers that if the adult child gifts the distribution back to the trustee or to their parents, or loans the funds on interest-free terms for an undefined period to the trustee or another entity, the arrangement may require further ATO examination.

In the finalised ruling, the ATO has stated that the core test to determine whether the arrangement is an ordinary family or commercial dealing is to consider all relevant circumstances, including what is sought to be achieved and whether the arrangement will achieve those objectives. Arrangements that are overly complex, artificial or contrived will attract a higher risk rating and are more likely to be reviewed by the ATO. Additional steps in the arrangement that cannot be explained to have other objectives, such as tax minimisation, will not be exempt from anti-avoidance laws due to being a family or commercial dealing.

ATO Compliance

Accompanying the tax ruling is a practical compliance guideline which goes into depth about what is, and what is not, an ordinary family commercial dealing.

If any arrangement has one or more of the following features, it will fall out of the ATO’s green-zone and may attract the ATO’s scrutiny as to whether s100A will apply:

• Gifts of funds by the beneficiary to another person or entity
• Amendments to the trust deed or the trustee exercising discretion to define trust income in a particular way that result in the beneficiary’s actual trust entitlement being less than the taxable amount of the distribution
• Distributions to loss companies or trusts in certain circumstances where the company or trust that receives the distribution is unable to repay existing or future liabilities
• Beneficiary’s entitlement is used by the trustee as payment for units issued by the trustee or a related trust
• Distributions to private companies that use that distribution to fund a distribution to a non-resident

This list is not exhaustive and if your arrangement has any of these features, the ATO will be expecting to see contemporaneous documentation to explain why the arrangement was undertaken in a particular way.

Complementing these rulings is an ATO Taxpayer Alert, which discusses beneficiaries who are adult children of the controllers of a trust. Arrangements where an adult child receives a substantial distribution but does not receive an actual economic benefit will attract the ATO’s attention for audit.

Even if s100A does not apply, trustees must also keep in mind the general anti-avoidance provisions in Part IVA if the arrangement is done with the sole or dominant purposes of obtaining a tax benefit.

What, if any, Actions Should Trustees of Trusts be Taking?

Making sure you get trust distributions right is in important step each year as part of your obligations as a trustee. A distribution that is caught by the s100A anti-avoidance rules will void the distribution completely, meaning that the trustee may be liable for income tax at the top marginal tax rate.

While trustees have always had to exercise due care in resolving how trust income is to be distributed, this recent guidance from the ATO may give rise to new considerations for trustees when they come to distribute trust income for the years ending on or after 30 June 2023.

Please contact your usual PVW Partners advisor should you have any questions in relation to the ATO’s guidance and how it may have application to your trust and its income distributions (past or future).