ATO issues rulings that may significantly impact trust distribution strategies

On 22 February 2022, the ATO released several rulings that will no doubt impact the way in which trusts seek to distribute income to their beneficiaries.  Several of the rulings issued are in draft form and are subject to ongoing consultation.  However, the content of the rulings provide a clear understanding of the ATO’s thoughts on the use of trusts for tax planning strategies.

The rulings are summarised below:

TA 2022/1 – Parents benefitting from the trust entitlements of their children over 18 years of age

TA 2022/1 is a taxpayer alert.  The ATO generally issues taxpayer alerts in relation to particular transactions that they view as aggressive and potentially subject to the application of the anti-avoidance rules contained in the income tax legislation (which can result in significant penalties being imposed).

In TA 2022/1, the ATO focus on arrangements whereby trusts purport to distribute income to the adult children of the controllers of the trust but where the economic benefits of the distribution (i.e. the underlying cash) is paid to the parents of the adult children.  In the circumstances outlined, the ATO state in TA 2022/1 that they will seek to apply anti-avoidance provisions contained in the tax legislation to assess the trustee of the trust (i.e. instead of the adult child) at the top marginal tax rate.

Examples identified in TA 2022/1 that the ATO outlines they have concerns with:

Example 1 – A discretionary trust controlled by the parents declares distributions to a child over the age of 18 on a low marginal tax rate.  The financial accounts for the discretionary trust record the distribution as having been paid but the underlying cash is instead directed to repay the mortgage of parents.  In example 1, the ATO conclude that the adult children never received the economic benefit of the distribution and that the distribution would appear to be motivated by a tax outcome.

Example 2 – A discretionary trust controlled by the parents declares distributions to a child over the age of 18 on a low marginal tax rate.   The financial accounts for the discretionary trust record the distribution as having been paid but the underlying cash is directed to the parents purportedly in consideration for previously funding school fees and other costs associated with raising their child.  In example 2, the ATO conclude that the adult child never received the economic benefit of the distribution, that it is unreasonable for parents to seek reimbursements of expenses paid to raise their children and that the distribution would appear to be motivated by a tax outcome.

An example identified in TA 2022/1 that the ATO believe represents an acceptable arrangement is as follows:

Example 3 – During a financial year, a child over the age of 18 on a low marginal tax rate obtains loans from her parents and her grandparents to fund her university fees and her rent.  The discretionary trust controlled by the parents declares distributions to their child at the end of the year but the funds are directed to the parents and grandparents to repay the borrowings.  In example 3, the ATO conclude that it is reasonable for the child to obtain loans for legitimate expenses they have decided to incur and it is therefore reasonable to conclude that the entitlement owing by the trust to the child could be offset against the loans they owe.

Release of draft ruling TR 2022/D1 and draft practical compliance guide PCG 2022/D1

In conjunction with TA 2022/1, the ATO has issued a lengthy and somewhat contentious draft tax ruling and draft practical compliance guidelines relating to what are commonly referred to as “trust reimbursement agreements”.

By way of background, section 100A of the Income Tax Assessment Act 1936 is an anti-avoidance provision in the tax legislation that can apply where a trust makes a beneficiary presently entitled to the income of the trust but the underlying economic benefit of the distribution (i.e. the cash) is directed to a separate entity.

Where section 100A applies, the ATO has the power to assess the trust distribution to the trustee of the trust, rather than the beneficiary made presently entitled to the income, at the top marginal of tax.

In TR 2022/D1, the ATO has issued their draft views on the scope of section 100A.  PCG 2022/D1 seeks to outline a risk assessment framework to enable taxpayers to determine whether their arrangements are low risk (green zone), medium risk (blue zone) or high risk (red zone).

Based on the draft ruling and draft practical compliance guidelines, the ATO have taken a wide approach as to the type of arrangements that could attract the application of section 100A.  If the ruling is finalised in its current state, taxpayers may need to reconsider their distribution strategies going forward to ensure they do not fall into the ATO red zone scenarios.

At this point in time, the ruling and compliance guideline are both in draft and may be subject to change after industry consultation.

Concluding comments

Taxpayer Alert TA 2022/1 represents the ATO’s finalised views and it is reasonable to assume that the ATO will target taxpayers that enter into arrangements with their adult children where trust distributions are purportedly paid to the adult children but are in fact directed to their parents.

In comparison, TR 2022/D1 and PCG 2022/D1 are all draft ATO views which may be changed significantly before being finalised.

We will provide further updates as further information is released by the ATO. If you have any further questions relating to the above, please do not hesitate to contact your client services contact at Banks Group.

 

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