An aggressive new ATO approach to discretionary trust distributions

An aggressive new ATO approach to discretionary trust distributions has been announced and may have significant tax impacts moving forward if you have a trust in your group structure.

Many family groups face paying higher amounts in tax now (and potentially retrospectively) as a result of this new approach.

There is an integrity provision in the tax legislation, contained in section 100A, which looks at situations where income from a trust is distributed, on paper, to a beneficiary but the economic benefit of the distribution is provided to a different individual or entity. If s.100A is deemed to apply, the ATO will tax the trustee at the high penalty rates rather than the intended beneficiary paying tax at their own lower marginal tax rates.

Previously accepted tax planning strategies are at risk

Latest guidance suggests the ATO’s focus is honing in on previously accepted, commonly utilized tax planning strategies for family groups, including distribution to family members and ‘bucket companies’.

The legislation is not new but previously has only been invoked by the ATO where there was obvious tax mischief at play and there are some important exceptions to s.100A including where the arrangement is part of an ordinary family or commercial dealing. The majority of the new guidance and change in approach relates to what is accepted as ‘ordinary family or commercial dealings’, noting that arrangements will not be excluded simply because they are commonplace or involve members of the same family group.

Distributions to adult children are high on the ATO’s list of potential s.100A arrangements, where previously it may have been accepted to treat the distribution as a repayment to the parents for costs involved with raising the child prior to them turning 18.

Where distributions are being made to adult children, or other adults in your family group but the cash hasn’t flowed to those individuals, and the ATO deem s.100A to apply, tax will be applied at the top marginal tax rate and penalties may be imposed.

Circular arrangements

Where a trust distributes to a company in which it owns shares, there is a high risk the ATO would apply s.100A. If a trust is distributing income to a company which it receives dividend income from, there is a circular, re-cycling of income and tax is essentially avoided or at least delayed during the period the circular distributions and dividends are continued. This is less of a revelation and something accountants have long been cautious of but important to note.

Distributions to soak up tax losses may be subject to s.100A penalty tax if the economic benefit of the distribution does not flow to the beneficiary with the losses. Careful planning needs to be employed for groups with tax losses.

Companies entitled to trust income will come under further scrutiny and the ATO have released an additional draft determination dealing specifically with unpaid distributions owed by trusts to corporate beneficiaries. If amounts owed by trusts are deemed to be loans they may fall within the scope of Division 7A, another integrity provision in the tax law. Again, this is not new but the ATO have made clear these arrangements may be subject to review.

What is new is the removal of the 1 year grace period for trusts to make payment of distributions to companies before the ‘unpaid present entitlement’ (UPE) is potentially caught within Division 7A. Where previously an unpaid distribution wouldn’t be deemed a ‘Div7A loan’ until the year after the distribution is recorded, the new ATO guidance suggests the UPE may be treated as a loan from the post of distribution. This is relevant in determining when a complying loan agreement needs to be put in place to prevent the full unpaid distribution amount being treated as a deemed dividend and as taxable income in the shareholder(s) returns.

Further, the ATO are suggesting that ‘sub-trust arrangements’ will no longer be effective, which could result in simplification your group structure if this strategy has previously been employed.

The new guidance represents as significant change in the ATO’s position on use of trusts within family and business groups and management of unpaid present entitlements to trust income, for many, will need to change.

IMPORTANT DISCLAIMER: This article is published as a guide to clients and for their private information. This article does not constitute advice. Clients should not act solely on the basis of the material contained in this article. Items herein are general comments only and do not convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of these areas.