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The compliance guidelines of the Australian Taxation Office's (ATO's) Section 100A (S.100A) include two specific scenarios, referred to as "green zone" scenarios. These apply in cases where a trust distribution made to a bucket company (also known as a 'corporate beneficiary') remains within the trust.
In this article, we present an overview of these green zone scenarios and emphasize the necessary requirements that must be met to qualify for the green zone.
The ATO also draws attention to several scenarios that may pose challenges from a S.100A standpoint when handling distributions to bucket companies, particularly those involving non-resident taxpayers.
Section 100A serves as an anti-avoidance rule that comes into play when a beneficiary's entitlement in a trust arises from a reimbursement agreement. In essence, a reimbursement agreement refers to a setup where a beneficiary gains immediate entitlement to trust income and:
A bucket company (otherwise known as a corporate beneficiary) is a company that is set up as a beneficiary of a trust with the purpose of allowing any income the trust distributes to the bucket company to be payable at the company tax rate, currently 25% (only if it is a base rate entity), as opposed to the individual marginal tax rate (the top tax rate for individuals is currently 49% including Medicare levy).
They're called bucket companies because they sit below a trust like a bucket and are used to distribute income to it. For more information about bucket companies, see our article how do bucket companies work here.
Frequently, trust distributions are directed to a bucket company, and the funds representing these distributions are kept by the trustee (with the company's share of net taxable income taxed at a maximum rate of 30%). The ATO has established specific criteria to determine whether a trustee's retention of funds falls within the low-risk green zone under the S.100A compliance guidelines.
In this context, it is essential to acknowledge that various "rules" or factors are applicable for the S.100A compliance guidelines, contingent upon whether the trust distribution is:
A trust distribution to a bucket company that is retained by the trustee will fall within the S.100A compliance guidelines if:
Essentially, the ATO allows the trustee a "two-year window" to utilize a trust distribution, given that the bucket company receives the present entitlement within two years of it being established, and the company puts this entitlement to use (which may involve paying dividends to shareholders using the distribution funds).
However, when dealing with such arrangements involving a company, it becomes imperative to consider not only S.100A, but also Division 7A.
Should a distribution to a bucket company go unsettled (termed an 'unpaid present entitlement'), this entitlement essentially transforms into a loan for the intentions of Division 7A (as it qualifies as the offering of financial support). Ordinarily, the loan arises in the year subsequent to the distribution. The Australian Taxation Office (ATO) stipulates that a Division 7A loan comes into existence when the bucket company becomes aware of the sum of its entitlement and refrains from requesting payment (usually occurring the year following the distribution).
After the emergence of this loan, the involved parties possess two alternatives to prevent the activation of a presumed dividend as per Section 109D by the conclusion of the year in which the loan originated (subject to the company's available distributable surplus). By the deadline for filing the company's tax return for the fiscal year in which the loan came into being, the subsequent course of action can be pursued:
Maintaining vigilance is crucial, as both Section 100A and Division 7A warrant ongoing oversight, even if a distribution to a bucket company is disbursed. From the perspective of Section 100A, the use of distributed funds might, in specific instances, lead to the nullification of the initial bucket company distribution. An illustrative instance is provided in the S.100A compliance guidelines, where the ATO clarifies that a bucket company distribution won't fit into any of the green scenarios:
Further to the above, Division 7A must also be considered with respect to any use of distributed funds made by the bucket company. For example, if a bucket company loans distributed funds to a shareholder (or an associate), the loan must be repaid, or a S.109N complying loan agreement must be entered into, by lodgment day to avoid triggering a deemed dividend.
On June 30, 2023, the trustee of the Frank Family Discretionary Trust (referred to as the 'trust') decides to allocate the entire trust income for the 2023 fiscal year to Bucket Company Pty Ltd.
As of June 30, 2023, Bucket Company Pty Ltd was unaware of the specific amount of trust income, if any, that it could immediately demand from the trust (this means no Division 7A 'loan' comes into existence at this point).
By August 1, 2023, the trust's trustee determines the trust income and the net taxable income for the 2023 fiscal year. No cash payment is made to Bucket Company Pty Ltd, except for the amount needed to cover its tax liability. Consequently, the remaining entitlement of $100,000 becomes an 'unpaid present entitlement.'
On August 1, 2023, Bucket Company Pty Ltd is considered to have granted a loan for Division 7A purposes to the trust. This stems from the fact that this is the time when Bucket Company Pty Ltd becomes aware of the sum it could demand immediate payment for, but fails to do so.
As Bucket Company Pty Ltd is deemed to have lent $100,000 to the trust in the 2024 fiscal year, the involved parties have until the 'lodgment day' for Bucket Company Pty Ltd's 2024 tax return (for instance, May 14, 2025) to either repay the loan or postpone the payment by establishing a S.109N compliant loan agreement. This action is taken to prevent the activation of a $100,000 presumed dividend on June 30, 2024.
For the sake of comprehensiveness, it's important to note that if triggered, the presumed dividend would be incorporated into the assessable income of the trust, contingent upon the distributable surplus of Bucket Company Pty Ltd.
On May 1, 2025, the trustee of the trust disburses the entitlement to Bucket Company Pty Ltd. This implies that the trust retained control of the distribution funds from July 1, 2023, until May 1, 2025 (approximately 1 year and 10 months, totaling 22 months).
Upon receiving the funds, Bucket Company Pty Ltd invested them in listed shares. Notably, the arrangement does not encompass any of the 'exclusion factors.'
In brief, the answer is no. Through the prompt disbursement of the current entitlement, the trustee successfully averted the initiation of a presumed dividend according to Division 7A in connection to the distribution to the bucket company.
Apart from fulfilling their obligations under Division 7A, the involved parties must also take into account the potential exposure under Section 100A due to the retention of funds by the trustee for a span of 22 months.
In this instance, the parties can capitalize on the 'two-year window' as stipulated in the second scenario of the green zone within the S.100A compliance guidelines. This indicates that the ATO perceives a minimal risk of Section 100A being applicable to the arrangement. This conclusion is drawn from the fact that the current entitlement was received and disbursed within two years of its origination (meaning it was paid out) and the bucket company proceeded to employ the funds after receipt (illustrated by the company's investment of the funds).
If a trust distribution is directed towards a bucket company and the trustee maintains control of the funds for a duration of two years or more, it typically leads to the trustee retaining the funds under the terms of a S.109N compliant loan agreement. This type of agreement is established between the involved parties to address specific issues related to Division 7A, as explained earlier.
A common misconception that often arises regarding S.100A and entitlements of bucket companies is the belief that the presence of a complying loan agreement automatically excludes the potential application of S.100A. However, this assumption is incorrect, as both S.100A and Division 7A operate independently, with neither provision preventing the functioning of the other.
Should a trust distribution be allocated to a bucket company, and the trustee maintains control over the funds for a duration of two years or longer, the configuration aligns with the low-risk category of green zone scenario, granted that all the subsequent conditions are met:
Many trustees tend to believe that by placing the funds equivalent to an outstanding present entitlement for a bucket company on compliant loan terms according to S.109N, they gain unrestricted liberty to use the preserved funds according to their preferences. Unfortunately, this presumption is incorrect.
The context surrounding the distribution and subsequent utilization of the funds by the trustee also requires examination to determine whether S.100A might pose a concern. For instance, it is essential to deliberate upon the intended purpose of the retained funds. Furthermore, if these funds are intended for lending, it becomes crucial to contemplate factors such as the loan's recipient, the recipient's tax rate, and the intended utilization of the funds.
Some common situations in which the ‘working capital condition’ would not be satisfied include:
In these cases, the S.100A risk should be considered and assessed on a case-by-case basis. Consideration should also be given to Division 7A.
The Mannon Discretionary Trust (referred to as the 'trust') operates a retail enterprise centered on selling pet-related products.
The beneficiaries of the trust encompass members of the Mannon family and their interconnected entities, including Patricia and Jerry Mannon, as well as Mannon Pty Ltd (commonly known as the 'Bucket Company'). Patricia holds sway over the trust, while her spouse, Jerry, serves as the exclusive director and shareholder of Bucket Company.
On June 30, 2023, the trust's trustee made a resolution to allocate the entirety of its trust income to Bucket Company. At the time of this decision, an arrangement was established between the parties, indicating that Bucket Company would permit the unsettled portion of its entitlement to remain within the trust.
Under a S.109N compliant loan agreement, the trustee retained the disbursed funds and utilized them to enhance the operational capital of the business overseen by the trust.
Throughout the 2024 fiscal year and subsequent income periods, the trust's trustee employed the earnings derived from the trust (business revenue) to fulfill its repayment obligations in accordance with the Division 7A loan agreement.
In brief, the response is no. This setup falls within the low-risk category of green zone scenario 3B as outlined in the S.100A compliance guidelines. Consequently, the Australian Taxation Office (ATO) will not allocate regulatory resources to assess the potential application of S.100A. Specifically, this arrangement fulfills the criteria of the 'working capital condition' (where the distributed amount is used for trust's working capital), the Bucket Company is under the control of the spouse of the individual in charge of the trust, and the retained distribution has been structured in compliance with S.109N terms.
A crucial matter to remain aware of concerning S.100A and distributions to bucket companies pertains to the concept of 'circular trust distribution arrangements.' The Australian Taxation Office (ATO) has verified that the subsequent circular arrangement falls within the high-risk category of red zone scenario 2 within the S.100A compliance guidelines. Consequently, this arrangement will be prioritized and scrutinized by the ATO.
The ATO views this as an atypical arrangement that lacks justification based on any genuine commercial purpose. Instead, it seems to be more accurately explained by the intention of minimizing the tax liability that would have otherwise arisen if the trustee had chosen to retain the income.
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