In February 2022, the Australian Taxation Office (ATO) released a draft ruling (TR 2022/D1) and accompanying guidance (PCG 2022/D1) on how they intend to tax distributions by trusts where the beneficiary made entitled to the trust income is different to those who enjoy the benefits of that income.
By applying Section 100A the income distribution to a beneficiary is ignored, instead the trustee is taxed at the top marginal rate. Further, there is no time limit for the ATO to apply this section, meaning the trustee is forever at risk of the ATO applying the law retrospectively.
What is Section 100A and how will it be applied
Section 100Aof the tax law has existed since 1979, however it has not previously been applied broadly by the ATO due to it requiring four things, which include;
- The beneficiary must be entitled to a share of the trust income
- The benefit of the trust income is to a person other than the beneficiary
- The tax paid on the income by the beneficiary is lower than others would have paid. This is usually due to the beneficiary being a company, non-resident or low income earner.
- The distribution should not be excluded because of ‘ordinary family and commercial dealings.’
The accompanying guidance sets out four ‘risk zones’ that will determine the ATO’s response – these zones are white, green, blue and red.
White Zone
White zone is aimed at pre- 1 July 2014 arrangements.
The ATO will only look into these zones if it is part of an ongoing investigation for an arrangement that continued after this date, or the trust and beneficiaries failed to lodge tax returns by 1 July 2017.
Green Zone
Green zone arrangements are considered low risk arrangements and are unlikely to be reviewed by the ATO, if the arrangements are properly documented.
For example, the ATO has suggested if a trust applies income to an individual where the funds are paid into a joint bank account, that the individual holds with their spouse, then this would be considered a low-risk scenario. Another example is when a parent pays the deposit of their adult child’s mortgage using their trust distribution and it is a once-off arrangement.
Blue Zone
Blue zone arrangements may be reviewed by the ATO but section 100A will not be automatically applied to these arrangements. The ATO will need to be satisfied that the arrangement is not subject to Section 100A.
This zone is essentially the default zone and covers arrangements that do not f
all within one of the other three risk zones. This zone is likely to include scenarios where funds are retained by the trustee, however the arrangement does not fall within the scope of the specific scenarios covered in the green zone.
Red Zone
Red zone arrangements will be reviewed in detail by the ATO. The ATO consider these arrangements are designed deliberately to reduce tax, or where an individual or entity other than the beneficiary is benefiting. Arrangements that are high on the ATO’s list to review include where an adult child’s entitlement to trust income is paid to the parent or other caregivers to reimburse them for expenses incurred before the child turned 18. An example of this is school fees for private schools or where a loan is provided by the trust to the adult child for expenses they incurred before they turned 18 and the entitlement is used to pay off the loan.
Trust distributions for 30 June 2022
The ATO’s draft interpretation could pose risks to trustees for 2022 distributions which do not comply with their interpretation. Trustees who have previously made distributions to adult children where there was no payment to them, could hold risk going forward. There is also uncertainty other arrangements could also be caught, such as interest-free loans to associates where the trust loans to corporate beneficiaries.
Trustees will need to carefully consider who to distribute their income to and how they distribute it for the year ending 30 June 2022. As part of your year end tax planning and preparation of the 2022 trust distributions, we recommend contacting our office to discuss these implications.
