Section 100A changes: trust distributions to the controllers of a discretionary trust
Section 100A (S.100A) operates as an anti-avoidance provision within the framework of the Income Tax Assessment Act 1936. Section 100A is designed to address situations where one person receives an economic benefit from a trust while another is made presently entitled to assessable income. This rule comes into play when the present entitlement is linked to an agreement, arrangement, or understanding, and there is an economic benefit provided to someone else, all with the purpose of reducing or deferring income tax.
If S.100A applies, the beneficiary's entitlement to trust income is disregarded, and the trustee is assessed on the beneficiary's share of the trust's taxable income at the highest marginal tax rate.
This provision is particularly relevant in scenarios involving discretionary trusts, where distributions are made to corporate beneficiaries or other non-resident beneficiaries. These scenarios often manifest through reimbursement agreements conducted outside the scope of ordinary family or commercial transactions.
To navigate the complexities of S.100A compliance, it's advisable for trustees to seek advice, especially when dealing with trust distribution resolutions and trust entitlements arising. Adherence to tax law and the careful consideration of net income, trust income, and the trust's net income are critical.
ATO's low-risk Green Zone scenarios
The Australian Taxation Office (ATO) has outlined various low-risk (green zone) scenarios under Section 100A (S.100A) compliance guidelines in the Income Tax Assessment Act. These scenarios relate to trust distributions benefiting an individual, often the controller of a trust, such as 'Mum and/or Dad' in a standard family trust scenario.
The green zone scenarios are categorised as follows:
Trust distributions exclusively benefiting specific family members
Trust distributions received and enjoyed by the presently entitled beneficiary within two years of entitlement arising
Trust distributions retained by the trustee
It's crucial to note all scenarios designated as green-zone operate under the assumption that none of the exclusions of the guidelines are applicable. This necessitates meeting various requirements, including notification and lodgment, among others.
The subsequent discussion centres on a standard family discretionary trust overseen by 'Mum and Dad,' established for the welfare of their family. This family includes: a minor child, an adult child, and grandparents.
Green Zone Scenario 1: Distributions that only benefit a certain family member
Under Section 100A of the Income Tax Assessment Act 1936, any entitlement a beneficiary derives from a reimbursement agreement is overlooked. Consequently, the net income, which would have been attributed to the beneficiary, is now assessed to the trustee at the top marginal tax rate.
The Practical Compliance Guideline sets out the ATO's compliance approach to trust distributions where section 100A may apply. It employs three color-coded zones to outline the ATO's compliance strategy for arrangements falling within these categories.
If an arrangement falls outside of an exclusion and aligns with the descriptions in the guideline's low-risk zones (the white zone and the green zone), the ATO will not allocate compliance resources to scrutinise the arrangement further, unless it's to verify the arrangement's adherence to the requirements of that specific zone.
Trust distributions earmarked for specific purposes maintain a low-risk status in terms of S.100A compliance, with the ATO committed to refraining from active application of this provision.
Tax advisory: exclusion is limited to the specified persons
The ATO cautions that the benefits which are described in the Green Zone Scenario 1, which involves ordinary family dealings, are restricted to the beneficiary, the beneficiary’s spouse, and their dependants. Any distribution extended to an individual or entity beyond the spouse or dependant of the beneficiary (such as an adult independent child, the trustee of the distributing trust, another trust or company, or a superannuation fund) would not fall under the exemption outlined in Green Zone Scenario 1.
It's crucial to note these limitations align with the ATO's guidance on ordinary family dealings and are part of a compliance approach to ensure transparency and fairness in trust distribution arrangements. The ATO aims to dedicate compliance resources judiciously, focusing on high-risk arrangements while providing practical compliance guidelines for those falling within the low-risk green zone.
For practical year-end tax planning and to optimise taxes, taxpayers are encouraged to consider the ordinary family or commercial dealing exclusion. However, it's advisable to seek further advice, especially in complex scenarios involving multiple family members, corporate beneficiaries, and trust distribution arrangements.
The compliance approach emphasises appropriate documentation and adherence to tax legislation to stay within the low-risk green zone and avoid high-risk arrangements that may attract the ATO's scrutiny.
Example: trust distributions to a parent and their adult child
The Smith Investment Trust (the ‘trust’) is an investment trust established to benefit the Smith family. The beneficiaries of the trust comprise members of the Smith family, Emma, and her spouse, Mark (the controllers of the trust), and their two children, Liam (aged 12) and Ava (aged 20).
Ava is pursuing full-time studies and currently has no spouse or children. She presently resides with her parents and relies on them for financial support. Emma, due to her activities outside the trust (operating a successful online business as a sole trader), falls into the top marginal tax rate. Mark, who works part-time, is subject to a lower marginal tax rate than Emma.
Emma and Mark jointly manage their financial responsibilities and sustain their lifestyle from a shared pool of assets. For the 2023 income year, the trust generated income of $90,000, with a net (taxable) income also amounting to $90,000.
The trustee decided to allocate the trust income as follows:
The initial $500 to Liam Smith
The subsequent $20,000 to Ava Smith
The remainder to Mark Smith (totaling $69,500)
The trustee satisfied Mark’s trust entitlement by transferring $69,500 into a bank account jointly held by Emma and Mark.
Green Zone Scenario 2: Trust distributions received by the presently entitled beneficiary within two years
The ATO has outlined criteria for trust distributions retained by the trustee, deeming them low-risk under S.100A, assuming the ordinary family or commercial dealings exclusion is in play. In the context of Green Zone Scenario 2, addressing retention for less than two years, a trust distribution to an individual beneficiary, like Mum or Dad (the 'controllers' of a trust), not disbursed by the trustee, falls within low-risk Green Zone Scenario 2 if the following conditions are satisfied:
The beneficiary 'receives their entitlement' within two years of becoming presently entitled. Notably, the 'two-year window' might not cover distributions lent back to the trustee for less than two years, an aspect not explicitly covered in the guidelines but likely considered in relation to the 'two-year window.'
The beneficiary 'uses the entitlement' upon receipt. This is fulfilled when the entitlement is retained or used for purchases, meeting liabilities or expenses, or investing for the beneficiary, their spouse, or dependants. Exclusive use by a beneficiary's spouse is acceptable, given shared financial responsibilities and a common pool of assets. However, the condition is not met if the trustee holds funds beyond the two-year requirement or if distributed funds are used for an investment or transaction with a related party, where the consideration paid exceeds market value or involves non-commercial terms.
Tax advisory: no restrictions on how the trustees uses the funds
In line with new ATO guidance, trustees are provided clarity on trust entitlements and the present entitlements arising from them. The ATO outlines scenarios involving trust distributions, emphasising the importance of preventing situations that may be perceived as reducing someone's tax liability through strategic fund utilisation. To mitigate high-risk situations, trustees are encouraged to adhere to the principles set out in the practical compliance guideline, particularly when dealing with a corporate beneficiary.
For effective management of funds, trustees should consider factors such as expenses incurred, maintaining adequate working capital, and ensuring funds are genuinely representing the taxpayer's circumstances. Additionally, trustees are cautioned against any perceived tax maneuvers involving beneficiary gifts, especially when extended to other family members.
When managing income over several years, trustees should consider the parents' benefit and plan for the future responsibly. Trustees have unlimited power to make changes, but it's essential to understand the white or green zone guidelines to determine the right trust structure. Allocating a beneficiary's share should match the planned distribution, and if there are disputes, they might involve the federal court.
In the context of trust structures, the idea of commercial dealings is crucial. Trustees must also be mindful of the integrity rule to stay compliant with changing tax regulations.
Green Zone Scenario 3: Trust distributions that are retained by the trustee for a period of two years or more
Green Zone Scenario 3 covers certain scenarios in which a trustee holds onto a trust distribution for two years or longer, including situations with individual beneficiaries such as Mum or Dad. To fall within the low-risk green zone in these cases, certain conditions need to be satisfied:
Low Risk Green Zone Condition 1: Trustee retention of funds
The beneficiary permits the trustee to hold onto the trust distribution for two years or more. In cases where the distribution is paid out, the beneficiary may lend the funds back to the trustee for the stipulated period.
Low Risk Green Zone Condition 2: Trustee working capital condition
The trustee must adhere to the working capital condition, using or holding the funds representing the beneficiary's entitlement in specific ways:
In the working capital of a business actively carried on by the trustee
For the acquisition, maintenance, or improvement of trust investment assets or servicing debt related to these assets
Lending the funds to another entity within the 'family group' on 'commercial terms,' where the borrowing entity aligns with (a) and/or (b) above
It's important to note that the term 'entity' encompasses natural persons for this purpose. A family group is determined through a Family Trust Election (FTE) and applies to eligible members of the specified individual's family group. Without an FTE, an entity falls within the same family group if it's a company or trustee of another trust controlled by the individual controlling the trust or that individual’s spouse.
However, this provision does not apply if the trustee lends funds to a natural person unless an FTE was made. A loan is considered on 'commercial terms' if it aligns with Division 7A complying loan agreement principles.
It's essential to highlight that the working capital condition is not satisfied if an arrangement confers a benefit (except for a loan under 2(c)) to a person(s) other than the beneficiary, their spouse, or their dependants. For instance, the condition would be unsatisfied if the trustee allowed someone other than the beneficiary or their immediate family to occupy a rental property for less than market value.
Low Risk Green Zone Condition 3: Either
The individual and/or their spouse serves as a trustee of the trust or controls the trustee, where control involves the trustee acting in accordance with their wishes or the individual having the power to appoint and remove the trustee. The individual is engaged in the management of a business conducted by the trustee.
Trust distributions and trust controllers
When addressing trust distributions to the 'controllers' of a discretionary trust, such as Mum or Dad, it becomes evident that the likelihood of the arrangement falling within the low-risk green zone is higher.
For instance, if a trustee decides to distribute trust income to the controller of a discretionary trust and/or their spouse, the trustee can retain the use of those funds and stay within the low-risk green zone, provided, in essence, that:
The beneficiary is presently entitled to the distribution
The funds are used by the trustee for working capital or investment purposes
The funds are lent to another entity within the 'family group' under 'commercial terms,' and are used for working capital or investment purposes
However, an arrangement would not qualify for the green zone if a trust distribution is made to an individual controller of a trust (or their spouse), and the funds are held by the trustee and subsequently lent for private purposes or interest-free on-lending. In such cases, the risk of S.100A applying to that distribution significantly increases, especially if the recipient of the loan is on a higher marginal tax rate than the beneficiary, and the arrangement is recurrent. This heightened risk falls within the high-risk category.
It's crucial to note that compliance resources should be dedicated to ensuring that these arrangements align with the low-risk green zone criteria, and ordinary family dealings within the same family group are eligible for exclusions. A trustee should consider the applicable integrity provisions and be cautious of falling into the high-risk category. The arrangement's adherence to the trust deed and the trustee's use of distributable income play a pivotal role in maintaining a low-risk green zone status.
For more insights into ATO compliance risk zones and trust distribution impacts, contact us. We offer expert advice on tax regulations, ensuring compliance with zone criteria. Our team assists in understanding trust structures, compliance guidelines, and optimising tax planning within low-risk parameters.
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Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.