Guidance Finally Released but Uncertainty Still Remains: Draft TR 2022/D1 and PCG 2022/D1

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On 23 February 2022, the Australian Taxation Office (ATO) released a number of draft guidance documents which are relevant for private groups and high-net-wealth individuals, relevantly including being draft Taxation Ruling TR 2022/D1 (Taxation Ruling) and accompanying Practical Compliance Guideline PCG 2022/D1 (Guideline),[1] the “100A Guidance”.

The 100A Guidance provides the Commissioner of Taxation’s views as to the application of section 100A of the Income Tax Assessment Act 1936 (Cth) with respect to certain arrangements involving trusts and is an unsurprising crack down on family trust distributions which comes immediately after the taxpayer won Guardian AIT Pty Ltd v FCT [2021] FCA 1619 (subject to appeal) (Guardian Case). 

This 100A Guidance has caused significant uproar in the tax community owing to its departure from the ATO’s 2014 guidance, the industry’s common understanding on the issue and its purported retrospective application. Indeed, this outrage of the tax community on a set of draft guidance caused the Government to intervene to assure taxpayers that it the guidance will not have retrospective application.[2] However, there is still a question of whether this commitment by the Morrison Government will be honoured if there is a change in Government next month.

The industry and taxpayers have been waiting patiently for certainty on trust issues with private companies and here the ATO has missed the mark in providing that certainty on what is clearly a community sensitive issue.

So what has changed?

Primarily, the ATO has expanded their view on the operation of section 100A by providing some views on the elements of section 100A that must be satisfied but the ATO primarily relies on numerous examples to demonstrate its potential (broader) application.

It will be a lost opportunity if the ATO do not further develop and publish their views on the application of section 100A, but rather continues to rely on examples.  Guidance for taxpayers should include principles-based views so that in examining any examples provided the taxpayer is able to discern the application of the ATO’s views rather than just accept the example as a “high risk” arrangement.

Key takeaways

The primary focus of the ATO is family discretionary trust arrangements where distributions are made to lower taxed family members / family members who are not taxed, where the economic benefit of the distribution is received by someone other than that beneficiary.

It is hoped that as the ATO moves toward finalising the 100A Guidance it has regard to the taxpayer’s first instance success in the Guardian Case.  It should not be one that remans distinguished on its facts merely because the ATO is concerned with “back-to-back arrangements”.  The principles of the Guardian’s Case should be carefully considered and incorporated into the 100A Guidance.  Any subsequent decision on appeal should be cause for the ATO to go to revise the 100A Guidance and not merely rely on Decision Impact Statement.

Given the breadth of the now prospective (assuming that whatever party forms Government adopts the position of the Morrison Government) application of the 100A Guidance as well as the high evidentiary burden on taxpayers to prove an arrangement was ordinary or commercial in nature, we would recommend that now is the time for taxpayers to:

  • analyse their current trust arrangements (and mechanisms in trust deeds) to assess the risk category (pursuant to the Guideline risk matrix) of any arrangements on foot; and
  • consider whether any current arrangements, now considered a high risk, are able to be remedied should the ATO not make substantive amendments to the 100A Guidance.

Detail

Overview of Commissioner’s views

The draft Taxation Determination provides the basic requirements for a reimbursement arrangement (and therefore for section 100A to apply, with the consequence that any income to be considered taxable for the trustee at the top marginal tax rate), which relevantly does not require an actual reimbursement of funds. Rather the Commissioner’s position is that it requires the following elements:

  • Connection Requirement: legally effective entitlement, payment or application giving rise to an actual or deemed present entitlement to a share of the income of a trust estate; and
  • Benefit to Another Requirements: an agreement that provides for the payment of money to person(s) other than the beneficiary[3] (which can include via loans or the release, abandonment, failure to demand payment of or the postponing of the payment of a debt); and
  • Tax Reduction Purpose Requirement: the agreement must have been entered into for a purpose of securing that a person would be liable to pay less tax in an income year (this includes deferral benefits).

However, where the agreement is one that has been entered into in the course of ordinary family or commercial dealing, section 100A does not apply.

Importantly, whether an agreement is entered into in the course of ordinary family or commercial dealings is now a determined by providing to the Commissioner an explanation that the arrangement is one that has regular familial or commercial objects, together with the ability to  demonstrate that is not a purpose of tax avoidance.  In our view satisfying  this evidentiary burden will prove to be an onerous task so if there is any potential application of  section 100A then the retention of documentation (whether legal, correspondence or otherwise) will be crucial to be able to substantiate the ordinary or commercial nature of the dealing.

Practical Compliance Guideline

The draft Taxation Ruling has been published alongside draft Guideline. The Guideline sets out the ATO’s compliance approach for arrangements to which section 100A might apply in a risk matrix:

Risk Zone

Risk Rating

Description/ Compliance Approach

Examples

White Zone

Low

Applies to arrangements entered into prior to income years that ended 1 July 2014 (Relevant Period) unless its outside the green zone and the ATO is otherwise considering your income tax affairs, the arrangement continues before and after the Relevant Period or tax returns for the Relevant Period were not lodged before 1 July 2017

 

It is anticipated that if the Government follows through then this date will now be pushed out to be arrangements entered into prior to income years that ended 1 July 2014

Green Zone

Low

The ATO will not dedicate compliance resources to these arrangements other than to confirm the arrangement is a “green zone” arrangement.

These arrangements include where the income of a trust (i) is paid to a beneficiary but is comingled with spouse’s funds and/or benefit a person who is a dependant of the beneficiary; or (ii) is used in an arrangement that would likely be entered into in the course of ordinary family or commercial dealings; or (iii) is retained by the trustee for use in working capital of an active business, for investment purposes or to lend to an associate (on terms that satisfy section 109N) for the above purposes.

Blue Zone

Medium

While less likely to attract the ATOs attention (as compared to red zone arrangements), these may still be subject to ATO review

Captures arrangements that do not fit within one of the other risk zones.

Red Zone

High

The ATO will prioritise conducting further analysis on the facts and circumstances of these arrangements

These arrangements are those where beneficiaries’ entitlements appear motivated by sheltering the trust’s (taxable) net income from higher rates of tax and those arrangements involving contrived elements directed at enabling someone other than the presently entitlement beneficiary to have use and enjoyment of the economic benefits of the trust net income.

The ATO provides a number of examples of what the ATO considers are “Red Zone” arrangements:

  • Expense funding arrangements: the entitlement (whole or part) of an adult beneficiary is paid to parent/caregiver or applied against a debit account balance for the beneficiary by the trustee, in connection with expenses incurred before the beneficiary turned 18 years of age.
  • Gift/Loan arrangements: where a gift or loan made by beneficiary to parent or caregiver (or if the beneficiary is non-resident where this gift or loan is made to any other party).
  • Back-to-back arrangements: where a trustee of a trust owns shares in a private company and that company is also a beneficiary of the trust who receives distributions from and makes fully franked distributions to the trustee, which is repeated in subsequent years (consistent with the 2014 guidance).
  • Set-Off arrangements: where a trustee sets-off a beneficiary’s unpaid present entitlement with an amount the trustee is owed for the subscription for units and the subscription price is greater than their market value or trust deed provides for a unilateral right for trustee to issue new units in satisfaction of any unpaid present entitlement.
  • Income mismatch arrangements: where the trust net income included in a beneficiary’s assessable income is significantly more than their entitlements to income from the trust as a result of contrivance, where the difference between the amount has been retained by someone other than the presently entitled beneficiary and the tax paid by the beneficiary is significantly less than the tax paid by the entity that retains the difference.
  • Utilisation of losses arrangements: where the taxable income /net capital gain is less than the trust net income / trust capital gains included in the beneficiary’s assessable income and a reasonable person would conclude the beneficiary was made entitled to utilise their deductions or capital losses and the economic benefit associated with the trust net income is utilised by the trustee or an entity other than the beneficiary.
  • Taxpayer Alert arrangements: any arrangements that the Commissioner has expressed a concern that section 100A applies, in a previous Taxpayer Alert (e.g. Taxpayer Alert TA 2016/12).

The combined effect of the 100A Guidance is to provide the Commissioner’s view on the application of section 100A. However, the resulting draft guidance documents provide a limited framework and rather provides extensive examples to establish where the Commissioner has concerns. Given the breadth of the examples in the Guideline, we would recommend that taxpayers analyse their trust arrangements (and mechanisms in trust deeds) to assess the risk category (pursuant to the risk matrix) of any arrangements on foot.

References

[1] For further details about the other alerts seethe KWM Tax Alert on Division 7A: UPE and Sub-Trusts (here).

[2] Media release:  The Honourable Michael Sukkar: Assistant Treasurer; “Certainty and Stability for Family Trusts”

[3] Provided that the beneficiary is over 18 years of age.

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