Section 100A and discretionary trust reimbursement agreements:
Family Trusts are discretionary trusts that have the ability to choose to whom their income goes provided you meet the right conditions from a trust deed and tax perspective.
Generally, they exist as a holder of property, business assets or as the vehicle for holdings in other trusts or companies (to name a few examples) on behalf of others, usually a family group, for their benefit.
They distribute the income of those holdings every year, with that distribution being required to be declared by June 30 of each year.
The general advantage of trusts is having the ability to distribute income in the most tax effective manner given the circumstances of beneficiaries, the tax law of the day, and when the distribution is declared.
If however the Trustee of the Family Trust does not make the necessary declarations on time, or does them in a manner that is contrary to the regulations, they are at risk of being imposed a tax rate of 47% on the income deemed to be subject to the breach (if not all trust income).
One of the provisions that impacts trust distributions is Section 100A of the Income Tax Assessment Act 1936, which allows the commissioner to impose a tax of up to 47% on the Trustee if the trust is in breach, namely if the trust distribution in a discretionary forms part of a reimbursement agreement.
Reimbursement agreements occur when:
- a beneficiary is made presently entitled to trust income (via a declaration above);
- the beneficiary does not receive any cash distributions;
- instead someone else other than the beneficiary receives the benefit of the income (which could be through a payment or offset of money, including a loan, transfer of property, provision of services or provision of other benefits); and lastly
- the beneficiary pays lower income tax than the person receiving the benefits.
Typically, a risk occurs where a family trust distributes income to adult children and that child does not receive the benefit of that distribution (i.e. does not receive any funds) and instead, the trust retains the income or the funds go elsewhere.
The ATO is conducting a review process and can, if possible, impose this rule for current and prior years on any review.
A good example from the ATO website on reimbursements is set out below (Current as at the date of this article): The ABC Trust’s beneficiaries include the members of the ABC Family. David is the sole trustee of the ABC Trust. David and his wife Rani have two children, Jenny (aged 22) and Paul (aged 19), who live with them in the family home. David and Rani have an existing mortgage on the home.
Jenny and Paul are both full-time students and during the 2020-21 income year, they each earned approximately $12,000 from casual employment.
During the 2020-21 income year, the ABC Trust derives income of $720,000 (the trust’s net income is also $720,000).
A resolution of the trustee of the ABC Trust dated 30 June 2021 shows both Jenny and Paul are each presently entitled to $160,000 of the income of the ABC Trust, with David and Rani each presently entitled to $200,000.
Jenny and Paul are not paid any amounts. Instead, David transfers an amount equal to their entitlements to the mortgage offset account that he and Rani maintain.
Jenny and Paul’s entitlements are recorded as having been fully paid in the accounts of the ABC Trust. David pays Jenny and Paul’s tax liabilities in relation to their entitlements from his personal funds.
David has taken these actions as Jenny and Paul have agreed that their entitlements from the ABC Trust will be managed by David for the benefit of all family members. David has determined that those entitlements should be applied to reduce the debt on the family home.
This arrangement raises the concerns mentioned in this Alert. By entering into this arrangement, the purported $160,000 entitlements of both Jenny and Paul are not subject to the top marginal tax rate.
David has not managed the entitlements for the benefit of all members of the family. The arrangement has the result that the post-tax amounts of Jenny and Paul’s entitlements have been diverted to meet their parent’s individual liabilities in circumstances where their parents would have been able to meet them.
David and Rani receive the same economic benefit from that income as if it had been appointed to them directly, but without the amounts being included in their assessable income and subject to tax at a higher marginal tax rate.
The arrangement involving the making of the trust distributions and use of those amounts appears to be motivated by the tax outcome achieved rather than ordinary familial objectives.
Please note that, this ruling may apply to anyone taking advantage of other people tax positions via similar arrangements and agreement (i.e. via trusts).
To ensure the above trust is not impacted by Section 100A, a number of defence items would need to be covered on any review by the ATO.
If you believe that your trust maybe affected by section 100A or may engage in a reimbursement agreement, then contact your tax accountant at Simaco Partners as we can explore one of the defences that may apply to your situation or take steps to ensure your risk of contravening Section 100A are minimised.
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