By Kristy Binns and Karishma Mehta (RSM Australia)

On 8 December 2022, the Australian Taxation Office (ATO) clarified and confirmed its position on the application of section 100A of the Income Tax Assessment Act 1936 (ITAA 1936) with the release of Taxation Ruling TR 2022/4 and the Practical Compliance Guideline PCG 2022/2 (Section 100A reimbursement agreements - ATO compliance approach).

The guidance issued by the ATO under TR 2022/4 and PCG 2022/2 is comprehensive and details several commonly encountered situations with trust arrangements. The key message is that the ATO’s core compliance approach to s100A will depend on where on a trust arrangement sits on the ATO’s three-coloured risk framework. Each zone in this risk framework represents a risk rating and denotes the level of ATO engagement that can be expected by trustees for their trust arrangement.

Clients with discretionary trusts are therefore urged to contact their tax and legal advisors to assess their risk profile in accordance with this framework and take remedial action where required.

Following on from RSM’s Tax Insight on 04 March 2022, the ATO has now confirmed its position on the application of s100A with the issue of TR 2022/4 and PCG 2022/2.

The guidance offered by the ATO in these two key rulings takes a softer, more considered approach in comparison to previous draft rulings TR 2022/D1 and Draft PCG 2022/D1 which were issued in February 2022.

Nonetheless, TR 2022/4 and PCG 2022/2 will have a significant impact on the manner in which income of a trust is distributed to corporate beneficiaries and/or adult beneficiaries, given a risk framework will now be used to assess the level of ATO engagement that a trust arrangement will potentially attract. It is important to note that TR 2022/4 applies to trust arrangements both before and after its issue and should be read in conjunction with PCG 2022/2.

TR 2022/4 INCOME TAX: SECTION 100A REIMBURSEMENT AGREEMENTS

TR 2022/4 provides a succinct explanation of what the Commissioner’s view is on reimbursement agreements for the purpose of this anti-avoidance provision.

The ruling provides a clear, logical understanding of each of the 4 basic requirements which need to be met for this anti-avoidance provision to apply:

• “Connection requirement”: a present entitlement arising out of or in connection with a reimbursement agreement.
• “Benefit to another requirement”: a benefit to another other than the beneficiary.
• “Tax reduction purpose requirement”: the purpose of one or more parties to the agreement is to pay less tax for that income year.
• Non-application of the ordinary dealing exception: this exception is satisfied if an agreement is entered into in the course of ordinary family or commercial dealings, both of which take on their ordinary meaning.

Where s100A is applicable, a beneficiary’s present entitlement that has arisen from a reimbursement agreement will be deemed to essentially be invalid i.e., the beneficiary will be deemed not to be presently entitled to the relevant trust income in question. The consequence of this is that the trustee will be deemed to be presently entitled to the relevant trust income by virtue of s100A, albeit taxed at the top marginal tax rate.

It is particularly important to note the following points that have been highlighted in TR 2022/4:

• Specific Entitlements: s100A not only applies to income that is presently entitled but income that can also be specifically entitled to beneficiaries. This means that income that is often streamed (e.g., franked distributions, capital gains) will also be captured under the provision.
• Ordinary Dealing Exception: the ATO’s view on the ordinary dealing exception is quite narrow. It is not sufficient to look at each step in a series of connected transactions to satisfy this exception. Rather, the ATO is of the view that to be an “ordinary family or commercial dealing” the course of dealing as a whole will be considered for the agreement which was entered into.
• Unpaid Entitlements Held on Trust: by virtue of example 9 provided in Appendix 1 of the ruling, the ATO has made it clear that the ordinary family dealing exception will apply to a commonly encountered trust distribution arrangement. In cases where a distribution is made to an adult child beneficiary who is aware of their distribution and has agreed to the retention of this payment, the failure of the child beneficiary to call on the trustee for immediate payment of the UPE will be treated as an ordinary family dealing. This position holds given that the adult child beneficiary has the liberty to exercise their rights at will.

The ruling applies to arrangements both before and after its issue. However, it will not apply to the extent that it conflicts with the terms of settlement of a dispute agreed to before the issue of this ruling.

In summary, TR 2022/4 provides a concise and logical explanation of the Commissioner's view on s100A and also utilises several case law examples including the recent decisions from the Full Federal Court on Guardian AIT and BBlood Enterprises, to provide clients and tax practitioners with confidence on the applicability of s100A.

PCG 2022/2 SECTION 100A REIMBURSEMENT AGREEMENTS – ATO COMPLIANCE APPROACH

The Practical Compliance Guideline PCG 2022/2 sets out the Commissioner's compliance approach in dealing with s 100A and should be read in conjunction with TR 2022/4.

Whilst the TR 2022/4 focuses on the 4 basic requirements of s100A, the accompanying PCG 2022/2 outlines the ATO’s confirmed guidance on how it will assess trust arrangements for the potential application of s100A.

The ATO will be differentiating and managing risk for a range of trust arrangements based on which of the 3 zones a trust arrangement falls in:

1. White (low risk)– applied to pre-1 July 2004 arrangements.
2. Green (low risk) – covers several common familial scenarios including receipt of the entitlement within 2 years and the trustee's retention of funds and ordinary dealings.
3. Red – these are high-risk trust arrangements that include but are not limited to the circular flow of funds between a corporate beneficiary and trust which is a shareholder, as well as arrangements where entitlement to income has been ‘gifted’ back to the trustee (or a parent) or otherwise forgiven.

At this stage it is important to note two important differences between the previously drafted PCG 2022/D1 and the newly issued PCG 2022/2:

The number of zones in the risk framework has been reduced from 4 to 3 with the blue zone now removed.

The green zone has been expanded and is still considered to be low risk.

More practical examples have been included in the PCG to assist with understanding green and red zones.

The zoned risk framework outlined in PCG 2022/2 not only represents the ATO’s view on the risk factor a trust arrangement carries, but it also dictates whether the arrangement will attract a low, medium or high-risk compliance approach from the ATO. There are several examples set out in PCG 2022/2, however, the ATO’s consensus is that it will not dedicate compliance resources to white-zoned arrangements.

Green zone arrangements will not attract ATO scrutiny in terms of considering the applicability of s100A, rather resources will be deployed to confirm that the trust arrangement meets the green zone features.

Being high-risk, red zone arrangements will be the focus of the ATO’s scrutiny with a strong level of engagement and deployment of resources expected.

PCG 2022/2 will have application both before and after its date of issue, however, for entitlements arising before 1 July 2022 the Commissioner will uphold his position in Trust Taxation – reimbursement agreement, issued in July 2014, to the extent that it is more favourable to the taxpayers circumstances than PCG 2022/2.

Further information and support can be obtained through RSM here.

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

Related documents:

• Trust Distribution Minutes Library for 2021/22 - Multi-Use
• Trust Distribution Minutes Library for 2021/22 - Single-Use
• Company (ELodgement)

Related webinars:

• Webinar On Demand - Trust Distributions and Section 100A