Discretionary trusts in the ATO spotlight

By Gary Anders

Discretionary trust structures continue to be widely used by many families around Australia, both for the purposes of holding assets and distributing income to their beneficiaries.

Discretionary trusts are so called because the trustee has sole discretion to determine whether any assets or income will be distributed, which beneficiaries will receive distributions, and how much will be received.

However, discretionary trusts are on the Australian Taxation Office’s (ATO) radar as the regulator steps up its efforts to clamp down on tax avoidance.

Bottom of the harbour

Under review by the ATO is a 40-year-old provision contained in the Income Tax Assessment Act 1936, known as section 100A.

It was enacted as legislation in 1978 as an integrity measure to stamp out tax avoidance schemes rampant at the time (known as “bottom of the harbour” schemes). These complex schemes used trust structures to own companies, then strip out all of the assets of those companies via distributions, leaving them unable to pay their tax liabilities.

The ATO can apply section 100A if it considers a trust agreement or arrangement as outside the bounds of what it deems to be “ordinary family or commercial dealings”, and distributions are regarded as being part of a “reimbursement agreement”.

If section 100A is applied by the ATO, a trustee is liable to pay tax on the trust's income at the top marginal tax rate of 45 per cent, which is normally applicable for income levels of A$180,001 and over.

A reimbursement agreement generally involves making someone presently entitled to trust income in circumstances where both someone other than the entitled beneficiary actually benefits from that income, and at least one party enters into the agreement for purposes that include getting a tax benefit.

A benefit includes the payment or loan of money, the transfer of property, the provision of services or other benefits, or the release, abandonment, failure to demand payment, or postponed payment of a debt.

Family distributions

The ATO is also focusing on activities where trustees distribute trust income to beneficiaries paying low or no tax (including a non-working spouse or adult children studying at university) with the intent of reducing the tax liabilities of a primary income earner and other trust beneficiaries in higher tax brackets.

Section 100A would additionally apply where distributions are paid to beneficiaries with existing tax losses, to those who have excess deductions or capital losses, or to those with an unapplied net capital loss.

If section 100A is applied by the ATO, a trustee is liable to pay tax on the trust’s income at the top marginal tax rate of 45 per cent, which is normally applicable for income levels of A$180,001 and over.

There is no statute of limitations on section 100A. While taxpayers are ordinarily required to keep their relevant tax record for five years from the date they lodge their return, section 100A has an unlimited application period.

100A draft ruling

The ATO has been working on a draft ruling on the use of section 100A. The draft sets out the Tax Commissioner’s preliminary views on the exclusions from a reimbursement agreement, such as agreements not entered into with a purpose of eliminating or reducing someone’s income tax.

The ruling is also expected to provide more clarity around the ATO’s definition of ordinary family or commercial dealings.

“Whether a particular agreement constitutes an ‘ordinary family or commercial dealing’ [which isn’t defined], and is therefore not a reimbursement agreement for the purposes of section 100A, will depend on all of the relevant facts,” the ATO notes on its website. “The courts have made it clear that the exclusion must be considered having regard to all of the steps comprising the reimbursement agreement – not merely components of it.

“An agreement won’t necessarily be considered to have been entered into in the course of an ordinary family dealing, merely because all of the entities involved are members of the same ‘family group’.”

Greg Nielsen, tax partner at Pitcher Partners, says the integrity aspect of section 100A comes in when an arrangement is designed so a person subject to tax is paying less tax than another person actually receiving the benefit.

“It could involve property being transferred out to someone for a minimal consideration, or amounts of cash may have been loaned out to that party, or where the underlying property or benefit is retained by the trust,” says Nielsen, who is also CPA Australia’s representative on the ATO’s Private Groups Stewardship Group.

“Under those scenarios, whether it’s a person who has had some value transferred out to them or to the trust, what’s being targeted is if the person would have paid a higher rate of tax if they had legally been subject to assessment on those amounts.”

The ATO has not given a completion time for its draft ruling, and notes on its public advice and guidance program that it is currently focused on providing support around the tax and superannuation issues arising from the impact of COVID-19.