[AFR 23.2.22] The Tax Office’s latest crackdown on payments from family trusts will limit “washing machine” cash distributions and tax-saving arrangements completed under the guise of ordinary family business. A long-awaited draft ruling and practical compliance guidelines were released by the Australian Taxation Office on Wednesday, flagging permanent changes that accounting experts said would ring alarm bells for beneficiaries of thousands of trusts around the country. [See related TT articles on s100A reimbursement agreements; Division 7A and TTI summary.]
The draft guidance materials were part of a broader release by the ATO, including on division 7A of the Income Tax Assessment Act.
Enforcement of anti-avoidance measures under section 100A means trustees of family trusts are required to detail distributions to beneficiaries, including adult children, to ensure they comply with rules about “ordinary family dealings”.
The provision is decades old and was designed to stop trust stripping, where trustees distribute money to individuals with low or zero tax obligations.
In some recent cases, senior external lawyers and barristers have been engaged by the ATO to conduct reviews of spending on household costs, family holidays, cars and a range of other living expenses.
Around in circles
BDO’s tax technical national leader, Lance Cunningham, said the new draft guidance was designed to target trust distributions from family trusts to lower-taxed family members, where repayments and reimbursement are made by the beneficiary back to the trust or to another family member.
He said it would limit circular “washing machine” distributions, where a trust distributes to a company which it owns.
“[So] the company in the following year distributes the money back to the trust, via a franked dividend, and then the trust can the next year distribute that franked dividend back to the company.
“It can go around in circles for as long as you like.”
The guidance provides tighter rules for distributions to trust beneficiaries.
“The ATO has provided a definition of what is an ordinary family or commercial dealing in which they conclude where there is a purpose of tax saving in the arrangement it would be difficult to say is an ordinary family or commercial dealing, particularly where the beneficiary does not call on the distribution and has a lower tax rate than other family member,” Mr Cunningham said.
KPMG Enterprise national tax leader Clive Bird told The Australian Financial Review the guidelines were far-reaching, ending a lack of clarity around anti-avoidance rules.
“It will ring alarm bells for trusts right across Australia that are carrying on business and investment activity,” he said.
Trust distributions allocated to adult children still living at home, including for education and lifestyle expenses, face tougher scrutiny, Mr Bird said, especially when they belonged to parents but were being used to access lower tax rates.
“The ATO is clearly looking at situations where that family trust makes distributions to the adult children who are still living at home on the basis that the cash doesn’t go to them,” he said.
“They’re effectively saying it translates to distributions, and the cash doesn’t pass to them. Then we’re looking at that as a real reimbursement agreement.”
Mr Bird said the huge number of trusts in Australia included those carrying on investment activities or controlling small and medium-sized businesses.
“The idea of distributing to adult children who are in that phase of being educated and maintained is actually very commonplace. The ATO notes that the fact that something is common doesn’t mean that it’s an ordinary family dealing.”
Section 100A has an unlimited amendment period, so standard review rules and record-keeping requirements do not apply.
The Tax Institute’s senior advocate Robyn Jacobson said the release represented the most significant guidance on trusts in more than 10 years.
“It is not uncommon for adult beneficiaries to receive distributions from trusts controlled by their parents, but the ATO is being very clear that it will be watching these arrangements closely,” she said.
“Trustees may find that common set-ups like using an adult child’s trust entitlement to repay living costs and the cost of raising them as children are subject to tax under section 100A.”
Ms Jacobson said other than some exceptions, the ATO generally won’t review arrangements entered into before July 1, 2014, and for arrangements entered into before July 1, 2022, taxpayers can follow existing ATO web guidance if it is more favourable to their circumstances.
Trusts are not alone in facing higher levels of scrutiny from the ATO.
By 2024, Australia’s entire high net worth population, including the biggest companies and the people who control them, will face additional and detailed examination by the ATO.