Tax Ruling 2022/4 (Final Ruling) has been released following a period of consultation with industry on its draft version (Draft Ruling). It also incorporates developments in the case law through decisions that were handed down since the Draft Ruling was published. The Final Ruling sets out how the ATO will administer section 100A of the Income Tax Assessment Act 1936 (Act) on reimbursement agreements.
In substance the Final Ruling is consistent with its draft version, which we have summarised in an earlier article. However, the Final Ruling offers new examples and detail on the Commissioner’s view of the statutory elements making up section 100A, including cultural factors that weigh towards and against the ordinary dealing exception and consequences for the beneficiary across other tax provisions.Tax and Revenue Team, Maddocks
The ATO’s Final Ruling provides guidance on the application of section 100A including the ‘ordinary dealing’ exception.
Section 100A can be applied by the Commissioner of Taxation (Commissioner) if the following four basic requirements are satisfied:
Such agreements were historically known as ‘trust stripping’ arrangements however the Commissioner’s current approach to 100A arguably broadens its application beyond ‘trust stripping’.
Where section 100A applies, the beneficiary’s present entitlement to the income of the trust estate is ’switched off’ such that they are deemed not to be presently entitled to that income which results in the trustee being taxed on the taxable net income of the trust relating to that trust income at the top marginal rate.
In Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation  FCA 1619 (Guardian), which is referred to in the Final Ruling, the Federal Court found that the existence of a relevant ‘reimbursement agreement’ could not be established on the facts. The Commissioner contended that the agreement consisted of the nomination and appointment of income to a corporate beneficiary, return of franked dividends to the trustee and distribution to a non-resident individual had the effect of capping tax income at a corporate rate. However, the Court found that the requisite ‘agreement, arrangement or understanding’ that each of those steps would be completed did not exist at the time the unpaid present entitlement (UPE) of the corporate beneficiary arose.
The Commissioner appealed the decision to the Full Federal Court which upheld reasoning of the first instance judge and dismissed the appeal with respect to the 100A issue. In doing so, the Full Court held that a mere expectation that an arrangement concerning the payment of a dividend could be entered into after creating the UPE is not sufficient to establish that a reimbursement agreement had been created at the time of the UPE.
As outlined in our earlier article, and as referred to above, the legislation requires 3 positive elements for a reimbursement agreement to be formed: connection between an entitlement and the arrangement, benefit to another and a tax reduction purpose.
The Final Ruling clarifies that an entitlement will be connected with an agreement where it arises either before or simultaneously with the agreement.
What about the tax reduction purpose requirement?
The Final Ruling provides that purpose can be demonstrated by the parties’ own evidence as well as the objective facts, circumstances and their financial consequences.
Reasoning from BBlood Enterprises Pty Ltd v Commissioner of Taxation  FCA 1112 (BBlood) suggests that the purpose inquiry is arguably broader than the ordinary meaning of the words of the legislation suggest, with the broad reasoning in BBlood summarised in the Final Ruling at paras  to . For example, the BBlood decision includes comments by the judge that there is no requirement to identify precisely what would have occurred in the alternative but rather what is required is that there is only a purpose that a liability for tax be wholly or partially avoided. On the facts of that case, the judge ultimately held the taxpayer did not discharge its onus to establish there was no tax reduction purpose.
Notably, the BBlood case in on appeal and it will be of significant interest to advisers to see if the Full Federal Court upholds the trial judge’s reasoning in relation to the purpose requirement.
The Final Ruling emphasises the paramountcy of the ‘core test’ for ordinary dealing, which requires the dealing and the steps that comprise it to have the quality of achieving family and commercial objectives.
Supplementing these tests are factors that may weigh against a dealing being ‘ordinary’. While the Draft Ruling focused on whether the dealing has artificial or contrived features, the Final Ruling repeats the sentiment from Guardian that elements of artificiality point against an agreement being an ordinary family or commercial dealing but is not necessarily decisive. It adds two other features that will weigh against the exception. The first feature is that the arrangement suffers from over-complexity that lacks justification to achieve the alleged family or commercial objects. The second factor is where conduct of the arrangement is inconsistent with the legal and economic consequences of the beneficiary’s entitlement, for example where funds are lent to a third party with no intention of being repaid.
The ATO also reminds readers that tax effectiveness compared to alternatives is a common and permissible feature of commercial and family dealings.
While cultural factors are not mentioned at all in the Draft Ruling, the Final Ruling is descriptive about the influence cultural factors can have towards finding family objectives in a dealing. The Final Ruling defines the concept as follows:
"cultural factors refer to the distinct and observable ideas, customs or practices of people or certain groups within a society. The existence of a cultural factor which is not widely understood in the broader community can be demonstrated by evidence."
Three examples of cultural factors that tie into family objectives are referred to that could assist in informing the question whether a dealing is to achieve family or commercial objectives:
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Tax and Structuring Practice Group.
You can read earlier ClearLaw articles on a range of matters.
Discretionary Trust Distribution Minute
Discretionary Trusts - Deed of Variation (Excluding Foreign Persons)
Daniel is a Senior Associate in the Maddocks Tax & Revenue team.Daniel advises extensively in the following areas:
His advice covers both direct and indirect tax considerations.
Prior to joining Maddocks, Daniel worked at a Big Four Chartered Accounting Firm focusing on tax consulting for mergers and acquisitions.
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