When making trust distributions to grandparents, who are often the parents of the trust's controllers, there is a potential tax risk, particularly under section 100A of the Income Tax Assessment Act. Grandparents are typically on a lower income level, such as due to retirement, which can create a tax incentive for distributing trust income to them. However, it's crucial to ensure that these distributions are made with the grandparents receiving the full economic benefit, as section 100A may apply if the distributions are seen as part of a reimbursement agreement. This section addresses situations where the beneficiaries, like grandparents, do not fully benefit from the income or trust's net capital gain allocated to them, which can affect the trust's taxable income.

Trustees must be mindful of how the trust deed is structured and ensure the net income and any capital gains distributed are genuinely for the grandparents' benefit. Distributions that involve adjustments to the cost base or reduced cost base of units or trust interests should be carefully considered to avoid triggering tax liabilities under section 100A. Understanding these rules and seeking appropriate advice is important to comply with tax laws and avoid potential penalties.

For tailored advice on managing trust distributions and navigating the complexities of Section 100A, we invite you to schedule a complimentary consultation with our team by using the link here.

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What happens when grandparents use trust distributions to provide a 'gift' or 'loan' to other family members?

When a trust distribution is used by a grandparent to give a gift to the controllers of the trust or other family members, Section 100A of the Income Tax Assessment Act must be considered. This is especially important if the grandparent is on a lower marginal tax rate, as it could suggest that the arrangement aims to reduce taxes. However, if the grandparent makes a gift to a family member on a lower marginal tax rate without a tax reduction purpose, Section 100A may not apply.

Taxpayers often argue that Section 100A does not apply in such cases because the gift was not part of an arrangement at the time the grandparent became entitled to the trust distribution, and it was made according to ordinary family objectives. The risk associated with these gifts depends on whether they are one-time or recurring:

Providing one time gifts

If a grandparent uses a trust distribution to buy a one-off gift for a family member, Section 100A is less likely to apply. This can be explained by family objectives, and the absence of a reimbursement agreement at the time of the entitlement can further support this. The ATO may also consider cultural factors, such as traditions where grandparents gift money or goods during festive seasons.

Providing gifts on a recurring basis

When grandparents repeatedly use their trust entitlements to gift or loan money to family members on higher tax rates, the ATO may scrutinise the arrangement under Section 100A. For instance, if a grandparent consistently gifts their trust entitlement to their adult children, this could be seen as an arrangement with a tax reduction goal rather than a family objective. The ATO might also evaluate other factors, such as the nature and size of the gifts, to determine if they are more likely to reflect a tax reduction motive.

What are the risks when grandparents use trust distributions to pay for their grandchild's private school fees?

There is a potential risk under Section 100A of the Income Tax Assessment Act when a grandparent uses a trust distribution to pay for their grandchild's private school fees. Typically, such fees are considered a parental expense, usually covered by the parents, who may also be the controllers of the trust.

If a grandparent uses their share of the trust's income or net capital gain to cover these expenses, the ATO might argue that the economic benefit of the distribution actually flows to the parents rather than the grandparent, raising concerns under Section 100A. Although the ATO has not specifically addressed this scenario, they have noted the risk level concerning Section 100A depends on the specific facts of each case. Some arrangements may be low-risk, but others could be seen as high-risk or potentially contrived.

While it could be argued the ordinary family or commercial dealings exclusion applies, reducing the risk of Section 100A, each arrangement needs to be assessed individually.

The risk is higher under certain circumstances:

Recurring arrangements

If the grandparent repeatedly uses trust distributions to pay for school fees, this could suggest a tax reduction purpose, implying that the payment is made under an agreement between the parents and grandparents connected to the present entitlement.

Financial dependence

If the grandparent lacks financial independence and relies on the trust distribution as their sole means to pay the fees, this raises concerns about the legitimacy of the arrangement under Section 100A.

Passive involvement

If the grandparent has never been actively involved in the trust's activities and is merely a passive recipient of the distribution, this could further indicate a high-risk scenario. The ATO might also consider adjustments to the cost base or reduced cost base of the trust's units or interests in future years if the arrangement is found to contravene Section 100A.

What are the exclusions from a trust distribution being attacked under S.1OOA?

When evaluating whether a trust distribution may be invalidated under Section 100A of the Income Tax Assessment Act, several key exclusions must be considered. If any of these exclusions apply to the trust income, Section 100A will not invalidate the trust distribution.

The primary exclusions are as follows:

Beneficiary under a legal disability

Section 100A does not apply if a trust distribution is made to a beneficiary under a legal disability, such as a minor or a bankrupt individual. In such cases, the trust income is assessed to the trustee on behalf of the beneficiary under Section 98. It’s important to note that in these circumstances, the beneficiary’s entitlement to the trust income arises without any intent to reduce tax. All references to a beneficiary assume the beneficiary is not under a legal disability unless otherwise stated in the trust deed.

No tax reduction purpose

Section 100A does not apply to any reimbursement agreement or commercial dealing that was not entered into for a tax reduction purpose. A tax reduction purpose is defined as an intent to ensure that a person (whether or not a party to the agreement) pays no income tax, or less income tax than would otherwise be payable if the trust distribution had been made to the person who actually benefited from it. Even if a tax reduction purpose is not the sole or dominant purpose, Section 100A can still apply, requiring further analysis to ensure genuine consideration and economic benefit were provided in the distribution.

Tax tip: S.100A is unlikely for distributions made to controllers

Section 100A is generally not applicable to trust distributions made to the controllers of the trust or their spouses. Controllers of a trust, often being primary beneficiaries, typically benefit the most from the trust’s income, so distributions made to them are usually paid directly to and used by these individuals. This alignment of benefit and distribution reduces the likelihood of a Section 100A challenge.

Moreover, controllers of a trust typically pay tax at a higher marginal tax rate than other beneficiaries, which means that distributions made to them do not generally involve a tax reduction purpose. Since there is no intention to reduce taxable income through these distributions, they are less likely to be seen as high-risk red zone arrangements under Section 100A.

In some situations, controllers may choose to retain their trust entitlements within the trust, such as for working capital or reinvestment within the trust estate. While this can have potential implications under Section 100A, the Australian Taxation Office’s guidelines outline a low-risk green zone scenario for such arrangements. This guidance suggests that as long as the retained amounts are used appropriately and reflect genuine commercial dealings, the risk of Section 100A being applied remains low.

Learn more about trust distributions under section 100a

To better understand how Section 100A can impact common trust distributions, especially those involving adult children, we recommend reading our detailed article titled "What common trust distributions to adult children can be attacked under Section 100A?"