Recent ATO guidelines on Section 100A

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What is Section 100A (S.100A)?

Section 100A, also known as S.100A, of the Income Tax Assessment Act 1936 is an anti-avoidance rule in Australian tax law. This pertains to a ‘reimbursement agreement’ in which one person benefits from a trust while another is considered entitled to income and assessed. Its purpose is to prevent income shifting within trusts for tax avoidance. If Section 100A is applicable, the beneficiary’s entitlement is ignored, and the trustee is taxed at the top marginal rate on the beneficiary’s share of the trust’s taxable income. In cases where S.100A is applicable, the beneficiary’s entitlement is nullified, and the trustee becomes liable for assessment on the beneficiary’s portion of the trust’s taxable income, subject to the highest marginal tax rate.

Applications of Section 100A (S.100A)

Section 100A (S.100A) comes into effect when specific conditions are met, often stemming from arrangements that extend beyond standard family or commercial transactions. In these instances, a beneficiary may hold present entitlement to trust income, yet the income’s benefits remain elusive. The central objective of such arrangements typically revolves around the reduction of an individual’s tax liability. The trigger for S.100A hinges on the convergence of these key conditions:

Connected present entitlement

The entitlement must be intricately linked to an agreement, arrangement, or understanding.

Benefit to another party

A benefit, whether in the form of trust property transfer, monetary payment or loan, or provision of services, must be conferred upon someone other than the entitled beneficiary.

Tax reduction purpose

At least one party involved must possess the intent to curtail or defer income tax obligations.

Significantly, S.100A is not confined to specific trust types; it applies broadly to trusts, including discretionary trusts, fixed trusts, and unit trusts. The distinction lies in the election of a ‘family trust,’ which involves a trust controlled by a ‘family group’ and is a subject unto itself.

Section 100A exemptions in family trusts

Section 100A presents notable exceptions, especially concerning family trust distribution tax and structures. It is important to recognise that certain criteria can prevent Section 100A from coming into play, allowing distributions to proceed without invoking this provision. These exceptions are pivotal for family trusts as they strive to protect assets, optimise tax efficiency, and maintain compliance.

These substantial exclusions include specific scenarios:

Beneficiaries with legal disabilities

Section 100A does not apply when distributions target beneficiaries with legal disabilities, like minors or those in bankruptcy. In such cases, trustees evaluate these distributions to ensure compliance and protection.

Absence of tax reduction intent

Section 100A excludes agreements lacking a ‘tax reduction purpose.’ This purpose ensures that individuals involved do not receive reduced or zero income tax compared to the standard amount.

Trustee beneficiary dynamics

If a beneficiary has ‘trustee beneficiary’ status and a distribution flows to another trust with certain conditions, Section 100A may not apply. Careful evaluation of these distributions is crucial, especially in complex family trust structures.

Ordinary family or commercial transactions

Section 100A(13) excludes agreements arising from ‘routine family or commercial dealings.’ In such cases, the section remains inactive, acknowledging standard practices.

These exceptions empower family trusts to navigate tax complexities while safeguarding family interests, effectively managing assets, and minimising tax obligations within legal bounds.

Table titled 'Section 100A Exemptions' with four exemption criteria and their descriptions.

Implications of the application of S.100A to a distribution

When Section 100A is employed with regard to a distribution from a family trust, it triggers specific tax ramifications:

The beneficiary is retroactively considered to have never possessed a current entitlement to the trust income.
If the beneficiary’s entitlement was predicated on income receipt or allocation, that income is treated as though it was never disbursed or assigned.

This results in an obligation for the trustee to pay tax at a rate of 47%, encompassing the highest marginal tax rate and Medicare levy, on the beneficiary’s portion of the trust’s net taxable income.

The Australian Taxation Office (ATO) has the authority to retroactively invalidate trust distributions under Section 100A. Nevertheless, affected beneficiaries have the option to adjust their tax returns to recover previously paid taxes. These consequences are applicable universally, regardless of the existence of a default beneficiary clause in the trust deed or the nature of the trust income generated.

Section 100A can also have an impact on capital gains or franked dividends allocated to beneficiaries, potentially necessitating a reallocation of income. In such cases, the trustee may face additional assessments under Section 99A.

While Section 100A has implications for tax matters, it does not nullify trust distributions in terms of trust law. This distinction can give rise to legal and practical challenges, including complexities in accounting, for both the trust and its beneficiaries.

For example, a family member beneficiary has already received a trust distribution and tax has been remitted. If the ATO subsequently deems the distribution invalid, the trustee is generally liable for tax at the highest rate on the beneficiary’s share of income. While beneficiaries can pursue tax refunds, trust law often does not compel them to return received amounts. This raises questions about managing the trustee’s tax liability and the dynamics of family trust operations.

Finalised Australian Taxation Office (ATO) compliance guidelines

The Australian Taxation Office (ATO) introduced PCG 2022/D1 on 23 February 2022, outlining its initial strategy for Section 100A compliance in family trusts and businesses. These initial guidelines sparked controversy and criticism due to their content.

A few months later, on 8 December 2022, following extensive consultations over several months, the ATO unveiled the final Section 100A compliance guidelines, along with a compendium addressing feedback from the initial guidelines.

PCG 2022/2 is an improvement over PCG 2022/D1, including additional exempted scenarios from ATO compliance scrutiny under Section 100A. However, as we’ll discuss shortly, certain concerns remain for trustees, particularly regarding trust distributions involving adult children of discretionary trust controllers. This underscores the need for tax-efficient trust structures, benefiting future generations and safeguarding family assets while optimising tax in family trust distributions.

The ATO’s S.100A Compliance Guidelines provide a structured approach, focusing on trust distributions in family trusts and businesses. They help taxpayers assess the “S.100A risk” associated with their trust distributions.

The ATO employs a defined risk framework to categorise trust distributions based on their risk profiles, as outlined below.

Green zone = Low risk

Within the low-risk “green zone,” trust distributions come with a degree of confidence. The ATO typically does not prioritise compliance efforts related to these distributions under Section 100A, except to verify that they align with the taxpayer’s unique situation. Trustees are encouraged to maintain proper documentation to demonstrate their adherence to the criteria associated with the green zone.

Red zone = High risk

Trust distributions falling into the “red zone” immediately draw the attention of the ATO, signaling potential high-risk elements that could lead to an audit. While the guidelines don’t explicitly address distributions outside the green or red zones, the ATO provides principles for evaluating the likelihood of allocating compliance resources:

Extending benefits to individuals beyond the current beneficiary, especially in cases involving an adult child.
Involving complex or contrived provisions, such as commercial dealing.
Offering opportunities for more direct benefit provision to as many beneficiaries as possible.
Resulting in significantly reduced tax payments compared to more straightforward methods, potentially affecting the trust’s assessable income and the tax rate applied to the trust’s beneficiaries.

Trust arrangements situated outside the green or red zones are not automatically classified as high-risk for Section 100A. The ATO may engage with taxpayers to understand these arrangements, assess Section 100A applicability, and promote documentation for potential exemptions. Alternatively, trustees can explore adjustments to align their arrangements with the criteria of the green zone.

Importantly, these guidelines encompass considerations related to family trusts, family members, and businesses, taking into account potential tax advantages and underscoring the significance of tax-efficient trust structures. They have both retroactive and prospective applicability. Additionally, transitional relief provisions apply to trust distribution arrangements involving income years ending before July 1, 2014 (the “WHITE zone”), with partial relief available for trust distributions made before July 1, 2022.

These guidelines serve as a valuable resource for understanding the ATO’s approach to Section 100A compliance within the realm of discretionary trusts, ensuring effective management of trust distributions, optimising the tax landscape, and considering the implications for Australian residents and the trust’s beneficiaries.

Table summarizing Section 100A Compliance Risk Zones with descriptions.

Next Step is to Contact TMS Financials

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Disclaimer

This outline is for general information only and not as legal, tax or accounting advice. It may not be accurate, complete or current. It is not official and not from a government institution. Always consult a qualified professional for specific advice tailored to your unique circumstances.

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Recent ATO guidelines: Section 100A and Family Trust Distributions