Tax Files: Trust reimbursement

Trust reimbursement arrangements

STEPHEN HEATH, PARTNER, WALLMANS LAWYERS

The issue of the tax effectiveness of certain discretionary trust distributions has been a major focal point for the Australian Taxation Office (ATO) for quite some time. In many respects, the ATO perceives discretionary distributions to be akin to tax avoidance.

This has now culminated in the ATO issuing Taxation Ruling TR2022/D1 and Practical Compliance Guide PCG2022/D1 on 24 February 2022. These rulings have been issued as drafts and represent the Commissioner of Taxation’s preliminary view of the operation of section 100A Income Tax Assessment Act 1936 (Cth). Public consultation on the drafts closed on 8 April 2022.

In the writer’s experience most tax professionals have never had much cause to consider the application of section 100A to the annual exercise of determining the distribution of trust income. On occasion some more sophisticated and seasoned advisers have found reason to mention the potential application of section 100A to some arrangements, though usually without great conviction.

The reason for this, perhaps quite rightly, is that section 100A was only introduced into the tax legislation in 1978 to deal with blatant trust stripping arrangements. Gone are the halycon days of the tax avoidance industry, given free reign by the Barwick High Court. This has given rise to conjecture about the appropriate way to interpret tax legislation. The view, once upon a time, will of course have been that the revenue statute should be interpreted in favour of the King.

The ATO view now being espoused proceeds on the basis that, notwithstanding section 100A having originally had a specific purpose, if the words can be made to adapt and fit to other circumstances then there is no reason for the provision not be applied to that end.

What is Section 100A about?

Section 100A is open to being applied where: 1. A present entitlement of a beneficiary of a trust has arisen in connection with a ‘reimbursement arrangement’.

The term ‘present entitlement’ often gives rise to confusion. In simple terms a present entitlement arises when a trustee appoints income of the trust at year end to a beneficiary of the trust but does not pay the income to the beneficiary. This appears on the trust balance sheet as an unpaid present entitlement of the beneficiary and should not be confused with a loan.

A sui juris beneficiary, as of right, can demand payment as against the trustee at any time. 2. A ‘reimbursement arrangement’ exists where: a. there is the provision of a benefit to a person other than the presently entitled beneficiary; b. the purpose of any one or more of the parties to the arrangement is to reduce the overall incidence of tax; and c. the arrangement must be other than in the course of ordinary family or commercial dealings.

The meaning of course of ordinary family or commercial dealing is undefined and unclear and accordingly, it is not inconceivable that the Courts would resort to the historical context in which section 100A came into being to provide guidance. That may prove to be an impediment to the ATO given the attitude that section 100A can be applied in circumstances not originally intended.

Significantly, an application of section 100A is not subject to time limits and will result in the subject income being taxed to the trustee at the top personal marginal rate (47%) as distinct from the beneficiary’s tax rate at the margin (usually a lower rate).

What is the ATO view?

In PCG2022/D1 the ATO from an administrative viewpoint divides various trust distribution arrangements into white zone, green zone, blue zone and red zone arrangements. This is something of a fiction and has no basis by reference to the wording of the provision. In short, the objective for taxpayers is to stay out of the red zone! The PCG contains 11 factual examples which describe what ‘arrangements’ might fit into what ‘zones’. In the writer’s view the potential offered by this methodology is diminished by examples which are either simplistic and where the answer is self-evident or refer to manifestly aggressive tax planning.

Several generalisations can be made which are of some assistance:

Arrangements entered into before 1 July 2014 fall into the ‘white zone’ and are unlikely to attract attention from the ATO. • Likewise a case of ‘trustee retention of funds’ is unlikely to attract the ATO’s