Section 100A is an integrity rule in the tax legislation aimed at situations where income of a trust is appointed in favour of a beneficiary, but the economic benefit of that distribution is actually provided to another individual or entity. Where trust distributions are 'caught' by s100A, this will generally result in the trustee of the trust being taxed at penalty rates rather than the beneficiary being taxed at their usually lower, marginal rate.
In the past section 100A has rarely been invoked by the ATO except in situations where obvious and deliberate tax avoidance was suspected. Further, there are some important exceptions to s100A such as where income is appointed to minor beneficiaries and where the arrangement is part of an ordinary family or commercial dealing. Much of the ATO's draft rulings/guidance focuses on whether these arrangements form part of an 'ordinary family or commercial dealing' with the ATO seemingly looking to express a very broad view of when s100A is likely to apply and a very narrow view of when the 'ordinary family or commercial dealing' exception is likely to apply. Specifically, the ATO's view is that the exception will not apply merely because all parties to the arrangement are family members.
What is acceptable and what is problematic?
The ATO guidance defines four risk zones into which arrangements are likely to fall, the white zone, green zone, blue zone and red zone.
The white zone refers to arrangements entered into prior to 1 July 2014. The ATO will not look into these arrangements unless already part of an ongoing investigation.
The green zone arrangements are low risk and are unlikely to be reviewed by the ATO. For example, where a trust appoints income to an individual, but the funds are paid to a jointly held bank account that individual holds with their spouse. This will ordinarily be viewed as a low risk or green zone scenario.
Blue zone arrangements may be reviewed by the ATO. The blue zone applies to all arrangements that don't ordinarily fall within one of the other risk zones. Section 100A does not automatically apply in the blue zone, it does however mean that the ATO will need to be satisfied that the arrangement is not subject to s100A. One such scenario is likely to be where distributed funds are retained by the trustee, but the arrangement does not fall within the green zone.
Red zone arrangements will be reviewed by the ATO in detail. These arrangements are such that the ATO believes they were entered into to deliberately reduce tax, or where an individual or entity other than the beneficiary is benefitting. One particular area of focus here is where the trustee makes an adult child entitled to trust income, but that income is paid to the parent to 're-imburse' the parent for expenses incurred prior to the child turning 18 (such as school fees, board, food, etc) under the guise of the 'ordinary family dealing' carve out.
One further red zone arrangement likely to impact some taxpayers involves arrangements where the presently entitled beneficiary has losses. A distribution in such a scenario will be classified as a red zone arrangement specifically where the below applies:
Where a beneficiaries taxable is income is less than the trust net income included in the beneficiaries income, or the beneficiaries net capital gain is less than the beneficiaries share of net trust capital gains and each of the following applies:
- a reasonable person would conclude that the beneficiary was made entitled so the beneficiaries deductions or capital losses could be used against the trust net income (including trust net capital gains).
- the economic benefit associated with that trust net income is utilised by the trustee or an entity other than the beneficiary
Who is likely to be impacted?
The ATO guidance primarily focuses on distributions made to adult children, corporate beneficiaries and entities with losses. These type of arrangements, depending on how they are structured and documented, will potentially carry a significant amount of risk.
It is worth noting here that distributions to beneficiaries who are under a legal disability (i.e. minors) are excluded from these rules.
The end of distributions to kids and grandparents?
Distributions to adult children and grandparents on low or no income has been a commonly used tax planning strategy in recent times. Whilst such arrangements are not necessarily outlawed as a result of this new guidance, they will certainly be subject to a higher level of ATO scrutiny. If such distributions genuinely take place, and can be readily explained, with documentation, as fitting with an ordinary family dealing, then the exclusion can still apply.
For example, if an adult child who lives at home receives a $10,000 distribution from their parents family trust, and the child then forwards that distribution to their parents to cover board and running costs, this may withstand scrutiny under s100A with proper documentation.
Conversely, a distribution to that same adult child of $180,000 which then makes its way back to the parents, would be far less likely to be viewed as an ordinary family dealing.
The draft guidance as it is written now, can be applied retrospectively. For those with discretionary trusts, particularly those where distributions would previously fallen into or will fall into the blue or red zones, it is important to ensure all trust distribution arrangements are reviewed to determine the level of risk.
Documentation around trust distributions will also become increasingly more important, particularly to demonstrate how funds relating to trust distributions are being used or applied for the benefit of beneficiaries.