In 1979, s.100A was introduced into the Income Tax Assessment Act 1936 (‘ITAA36’) by the then Treasurer, the Right Honourable Mr John Howard. It’s primary purpose as explained in it’s Explanatory Memorandum, was to prevent tax avoidance by trusts via the introduction of low tax or exempt from tax beneficiaries in such a way as to specifically reduce the total tax impost on the family group.
Decades later, the ATO has focused it’s attention on this section, forever changing the landscape of trust distributions to family members.
In February 2022 the ATO released 4 tax rulings (well, an Alert, a Ruling, a Fact sheet and a Determination, but who’s being picky?!) which redefined their interpretation and application of s.100A ITAA36 and thus preventing many distributions to family members. It’s one of the most significant developments for the taxation of trusts in over two decades.
In their defense, the view they have taken is not entirely incorrect, just highly aggressive and not necessarily in-line with the original intention of the legislation. That being said, the courts agree with them so all things being equal, their position is here to stay.
The key types of transactions where the ATO’s redefined interpretation is likely to impact are:
- applications of trust income by a trustee on behalf of a low-income adult beneficiary to meet expenses attributable to them;
- the retention of income in a trust appointed to a low-income beneficiary; and
- so called washing machine arrangements whereby income is appointed to a private company and then distributed back to the trustee by way of a franked dividend.
As a result of these ATO rulings:
- your options to spread your trust income across your family members may be vastly limited; and
- your family group overall tax payable will probably increase.
More so than at any other time, forward planning to determine distributions is going to be imperative as the fundamental principal of these changes is that any distributions cannot be “paper only”. The cash needs to physically be moved before 30 June 2022.
ATO “ATTACK” ON TRUSTS
For many years, it has been common practice by all business owners and investors who use Family (Discretionary) Trusts to look to spread trust income across family member beneficiaries. In many trusts, distributions are often made to adult children for asset protection and estate planning purposes.
Sometimes, the adult children in a family may have lower tax rates than their parents, so the overall tax rate % for the family group is lower as a result of the spread of these trust distributions.
However, on 23 February 2022 the ATO issued Taxpayer Alert TA 2022/1 ”Parents benefitting from the trust entitlements of their children over 18 years of age” and it’s a game changer.
It states that the ATO believes parents who make trust distributions to their adult children and then arrange for their children to give the distribution back to them are only doing this to reduce tax. The ATO plans to invalidate the trust distribution and tax the trustee of the trust at 47% on the amount of the distribution, and they may charge penalties on this as well.
The ATO have stated that they can go back as far as the 2015 tax year to review trust distributions. And just to make sure accountants are singing from the same hymn sheet as them, any accountant seen to be advising clients to undertake any such arrangement as done previously will likely be prosecuted under the Promotor Penalty Regime. This is so even for distributions made before their change in application.
This is a significant change for trust distributuions and is going to impact not only the 2022 and future financial years, but the close out of 2021 where trusts have not yet finalised their work.
Should you be concerned? Absolutely. The ATO have signalled that they intend to review every trust distribution both historically and in the future in order to ensure it has been undertaken in-line with the revised view. What is not yet clear, is whether there will be any kind of amnesty for trusts voluntarily revising their tax returns to amend distributions to stay within the limits off the new view.
So what do you need to be doing?
Firstly: plan for the end of FY22. Speak to your tax advisor and undertake the tax planning they no doubt have been hounding you to do.
Secondly: if you haven’t finalised FY21 yet, do so applying the new rules. Better to be safe than sorry.
Thirdly: if you are trading through a trust, discuss with your advisor whether this is still the best type of structure for you. Perhaps the time has come to undertake some restructuring.