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The new draft section 100A ruling is here! What do trustees and advisors need to know?

Draft Tax Ruling 2022/D1 (Ruling) has been released which sets out how the ATO will administer section 100A of the Income Tax Assessment Act 1936 on reimbursement agreements.

The Ruling expands on the ATO's interpretation of the three requirements of section 100A and the "ordinary dealings" exception. Broadly a reimbursement agreement relating to a trust arrangement will not be considered to be an "ordinary dealing" if it has certain "contrived features".

Ari Armstrong, Maddocks Lawyers

Section 100A and the new Ruling

To understand the background behind section 100A, please refer to our earlier article on this topic which was published before the Ruling was released.

Currently, the Ruling is in draft and the Commissioner of Taxation (Commissioner) is inviting comment from industry. It is not anticipated that there will be material changes to the Ruling as a result of public comment, and the Commissioner may in fact use this process as an opportunity to see where the arguments will arise in any live audit.

The ruling is primarily concerned with 'reimbursement agreements' which are defined as an arrangement whereby someone other than a presently entitled beneficiary actually benefits from that trust income and at least one party enters into the agreement for purposes that include getting a tax benefit.

What does section 100A say, and how does it work?

Section 100A operates to alter the general rule of taxing presently entitled beneficiaries, and can operate to assess the trustee on the taxable income of the trust at the top marginal rate even where there would ordinarily otherwise be a presently entitled beneficiary of trust income.

It is an anti-avoidance measure which broadly applies where a beneficiary's entitlement arises out of a reimbursement agreement. In such a circumstance, 100A applies such that the presently entitled beneficiary in question is deemed to not be, and was never, entitled to the trust's income and therefore assesses the trustee instead.

So, what does the Ruling add to what we already know about section 100A?

The Ruling sets out the Commissioner's view on the three requirements which are contained in the legislation, being:

  1. that the beneficiary's present entitlement is connected with, or as a result of, a reimbursement agreement (Connection Requirement);
  2. that the reimbursement agreement provides some benefit to a person or persons other than the beneficiary (Benefit to Another Requirement); and
  3. that the agreement was entered into so that a person is liable for less income tax than would have been if the agreement had not been entered into (Tax Reduction Purpose Requirement).

The Ruling also sets out the Commissioner's view on the 'ordinary dealings' exception.

Interestingly, the person receiving the tax benefit need not even be a party to the agreement nor even understand the agreement for the Benefit to Another Requirement and Tax Reduction Purpose Requirement to be satisfied. This would seemingly capture agreements where minors or uninvolved spouses receive tax benefits as a result of an agreement. The Benefit to Another Requirement can also be satisfied by a presently entitled beneficiary not calling on their benefit, resulting in the trustee obtaining a benefit.

For the Tax Reduction Purpose Requirement to be made out, the agreement's sole, dominant or continuing purpose must be that one or more parties pays less tax than otherwise would be payable. This includes deferring tax to later income years.

The Ruling also states that reimbursement agreements includes agreement and understandings that are informal, express or implied. There is no requirement for the agreement to be enforceable in the Courts, and it can involve a plan or a series of steps. We note that testamentary trusts are included in this regime.

What happens if these requirements are made out?

Where section 100A does apply, the beneficiary is deemed not to be, and never to have been, presently entitled to the relevant trust income. The trustee would instead be taxed at the top marginal rate.

'Ordinary dealings' exception

Given how wide the three requirements are cast, it seems likely that the main way of contesting a trust arrangement being categorised as a 'reimbursement agreement' is by contending that the exception applies, as was the case in Guardian AIT Pty Ltd ATF Australian InvestmentTrust v Commissioner of Taxation [2021] FCA 1619 (Guardian). In this regard, the Ruling seems to attempt to set tight parameters around what the ATO considers to be "ordinary".

The Ruling states that an essential feature of the ordinary dealings exception, is that a trust arrangement must be capable of explanation by familial and/or commercial objects. Somewhat puzzlingly, the Ruling states that:

"a dealing is not an ordinary family or commercial dealing merely because it is commonplace or involves no artificiality."

This position may prove to become untenable for the ATO, as the terms 'commonplace' and 'ordinary' tend to be used interchangeably. Furthermore, it is unclear how tax planning activities will be treated by the ATO as activities such as deferring tax and maximising deductions tend to be seen as common ways to "grow wealth" of family group.

Other relevant factors the ATO will consider includes conduct or circumstances inconsistent with the beneficiaries' entitlement such as where it is unlikely that beneficiaries will ultimately receive their trust entitlements.

The Guardian Decision

The Guardian decision was a major blow to the ATO. In his judgement, Justice Logan found for the taxpayer, stating that "risk minimisation" was actually found to be an ordinary family dealing and that the reimbursement agreement must be in place prior to the present entitlement arising. Crucially, Justice Logan also stated that a connection based on legal or factual hypotheticals is not enough to satisfy the Connection Requirement or Tax Reduction Purpose Requirement.

The Guardian decision is currently on appeal to the High Court of Australia.

PCG 2022/D1 and TA 2022/1

Together with the Ruling, Practical Compliance Guideline PCG 2022/D1 gives guidelines on what the ATO's compliance approach will be and divides where the ATO's compliance enforcement resources will be deployed in 4 "zones". PCG 2022/D1 sets out the ATO's compliance approach in relation to beneficiary entitlements conferred on or after 1 July 2022.

Generally, arrangements entered in prior to 1 July 2014 will attract the least amount of compliance resources and will be in the "white zone". The next zone, the green zone, applies to arrangements where the ATO will not dedicate compliance resources, such as where there have been distributions to a spouse's joint bank account or where funds are only retained for working capital or for a Division 7A loan agreement.

The blue zone applies to arrangements which do not fit into any other zone, such as where there has been a retention of funds which is not for those green zone purposes and includes features such as gifts, loans back to the trustee and disclaimers or forgiveness of entitlements. The red zone is reserved for arrangements with an obvious and apparent motivation of sheltering net income from higher tax, with contrived elements to enable an entity to benefit from the distribution.

Whilst these "zones" are guidelines designed to give comfort to taxpayers, they are not strictly binding on the ATO.

Tax Payer Alert TA 2022/1 puts taxpayers on notice that the ATO is particularly concerned with arrangements to avoid tax by distributing to persons with a lower tax rate, where the benefit is enjoyed by the parents. A benefit includes children paying for expenses ordinarily met by parents, or where the children's entitlement is applied for the benefit of the parents.

It is essential to consider the risk of 100A when trustees are distributing funds and are making any type of transfer of trust property or dealing with stakeholders in their capacity as trustee of their trust.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Revenue Practice Group.

More Cleardocs information on related topics

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Lawyer in Profile

Julian Smith
Julian Smith
Partner
PH: 61 3 9258 3734

Julian Smith is a partner in the Maddocks Commercial team.

Julian advises extensively in the following areas:

  • trusts law;
  • self managed super funds;
  • business and company sales and acquisitions; and
  • financial services law.

Julian advises clients ranging from public companies servicing the wholesale financial services market to high net worth individuals and their advisers.

Julian has been with Maddocks since undertaking articles in 2001.