On Wed 23.2.2022, the ATO released its long awaiting guidance on trust reimbursement agreements, Draft TR 2022/D1. A companion product – Draft Practical Compliance Guideline PCG 2022/D1 – was also issued. See related TT article.

Draft TR 2022/D1 identifies, and discusses, 4 basic requirements for s100A of the ITAA36 to apply:

  • the “connection” requirement – there must be a legally-effective present entitlement, or deemed present entitlement, of a beneficiary (other than one under a legal disability) to a share of trust income, which has arisen out of, in connection with, or as a result of a pre-existing agreement that meets the requirements to be a reimbursement agreement.;
  • the “benefit to another” requirement – the agreement must provide for the payment of money or the transfer of property to, or the provision of services or other benefits for, a person other than the presently entitled beneficiary;
  • the “tax reduction purpose” requirement; and
  • the “ordinary family or commercial dealing” exception. This is where the key uncertainty has been. I’ve set out below (sadly at some length) the relevant part of the draft Ruling, which is an ‘Explanation’ of that part of the Ruling. It helps in some ways (but has its limitations too).

Draft PCG 2022/D1 explains how the ATO proposes to differentiate risk for a range of trust arrangements to which s100A might apply (which I’ll address separately).

  • It contains 4 risk zones: white (low risk) for arrangements entered into in income years ending before 1 July 2014; green (low risk); blue (medium risk) and red (high risk).
  • The ATO will not generally dedicate new compliance resources to consider the application of s 100A to white and green zone arrangements (unless a pre-1 July 2014 arrangement would come with the blue or red zone). The real interest will be in the subject matter of this practical guidance, and what is in each of those ‘zones’.

PROPOSED DATE OF EFFECT: the final ruling and guidance are intended to apply retrospectively. However, for entitlements conferred before 1 July 2022, the ATO will stand by any administrative position reflected in a 2014 website guide, to the extent that view is more favourable to the taxpayer’s circumstances

[ATO website: TR 2022/D1, PCG 2022/D1; LTN 35, 23/2/22]

[Tax Month – February 2022 – Previous 2022, 24.2.22]

 

EXTRACT FROM DRAFT RULING – ‘ordinary family or commercial dealing

Ordinary dealing exception

76. A further exception to the operation of section 100A is contained in the final words of subsection 100A(13):

agreement … does not include an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing.

77. The exception is satisfied where an agreement has the quality of being entered into in the course of ordinary family or commercial dealing. The composite phrase ‘ordinary family or commercial dealing’ is not defined for the purposes of section 100A and so takes its ordinary and legal meaning, having regard to its statutory context.

78. Statutory context is relevant. Section 100A is an income tax anti-avoidance provision. As observed in the leading judgment of Hill and Sackville JJ in Prestige Motors[44]:

The wording of the exclusion in s 100A(13) derives from the judgment of Lord Denning, on behalf of the Privy Council, in Newton v Federal Commissioner of Taxation (1958) 98 CLR 1, at 8. There his Lordship, in discussing s 260 of the ITAA, contrasted an arrangement implemented in a particular way to avoid tax with “transactions that are capable of explanation by reference to ordinary business or family dealing”.

79. The essential feature of ordinary family or commercial dealing is that it is ordinary. Consistent with the approach of the Court in Newton, dealing is ordinary where a person can examine the acts and predicate that they can be explained by the familial and/or commercial objects they are apt to achieve without further explanation.[45] This predication test is an evaluative standard that requires an examination of the facts and circumstances of each case. It is the test by which the composite phrase ‘ordinary family or commercial dealing’ is interpreted in the statutory context in which it appears (an anti-avoidance provision). This test cannot be substituted with an approach that classifies transactions by reference to a dictionary meaning or synonym for the word ‘ordinary’ separate from statutory context. Dealing is not ordinary just because it is commonplace.[46] Similarly, dealing can fail to be ordinary dealing even where it is not artificial.[47]

Dealing

80. The definition of agreement provides it is the dealing ‘in the course of’ which the agreement is entered into that is examined against the evaluative standard of ‘ordinary family or commercial dealing’. The Oxford Dictionary sets out that ‘dealing’, among other things, refers to business relations, trading or conduct in relation to others.[48]

81. The dealing to be tested is identified by reference to the subject matter and terms of the agreement; that is, the transaction, set of transactions or other actions which implement and give effect to the agreement. In order to engage the exception, it is these transactions or other actions which must have the quality of ordinary dealing.[49]

82. The whole course of dealing contemplated by the agreement must be examined. For example, the sale of a business between related entities may of itself be ordinary dealing. However, the sale may be one element of a larger transaction or series of transactions contemplated by the agreement. The larger transaction or other steps in the transaction may be very different from a straightforward business sale and not be ordinary dealing.[50]

83. While the dealing to be tested is the conduct of the transaction, set of transactions or other actions to give effect to the agreement, contextual facts and circumstances are highly relevant. Context may inform the commercial and family objectives of an agreement. These may include, for example, the relationship or association between the parties and their economic or other relevant circumstances. For example, assume in an income year, family members agree to gift their trust distributions to one family member, Paul, who has significant medical bills. The arrangement is implemented via trust distributions to the family members and a gift by each of them to Paul. That Paul has significant medical bills is not a construct of the agreement; however, it is a highly relevant contextual fact which bears on what are familial objectives. In this context, there is nothing extraordinary about the arrangement or the transactions (trust distributions and gifts) which give effect to the agreement.

84. The application of the ordinary dealing exception can raise questions about how to assess the achievement of familial or commercial objects or the presence of tax-driven elements in a dealing, and the relevance of the operation of other tax laws.

Familial or commercial objects

85. Whether the agreement was entered into in the course of ordinary dealing is an objective enquiry to be addressed, at least principally, from the perspective of the persons whose purposes are relevant to the operation of the section.[51]

86. ‘Family’ in ‘ordinary family or commercial dealing’ takes its ordinary meaning. It refers to a relationship of natural persons based on birth, affinity or co-residence. Family is not limited to any particular type of family relationship that is more common at a point in time than others.

87. To explain that acts achieve familial objects without the need for further explanation, a person would need to objectively conclude that the transactions entered into among family members (including via their entities) are adopted as a means to achieve normal or regular familial ends. The characteristics of the dealing, including the circumstances of the parties, the economic and other results of the dealing, and the type of relationship between the parties will be relevant. For example, a dependent child gifting money attributable to a family trust distribution to their parents who could otherwise have been made presently entitled to the trust income would in most cases not have the quality of ordinary dealing.

88. If carried out via one or more of the family member’s entities, it would also be necessary to consider the types of entities used, and the degree of control and ownership of those entities.

89. The dealing must be capable of explanation as being for the advancement of normal or regular familial objects. This objective enquiry can accommodate extraordinary or unusual features that apply to a particular family. However, the test is not of what is common practice for either a family or for the community.[52] For example, an arrangement between family members where the overt acts achieve a particular favourable tax result will not be ordinary dealing simply because the arrangement has become prevalent, unless it can otherwise be seen to result in the achievement of a familial or commercial object.

90. For a dealing to be capable of explanation as achieving ordinary commercial objects, the parties would be expected to advance their respective interests. It is ordinary commercial dealing where it would be normal or regular if seen in trade or commerce as a means to advance commercial objects. A complex commercial dealing may nonetheless be ‘ordinary’ if that complexity is needed to achieve the identified commercial objects.[53]

91. Parties to a commercial dealing can have commercial objectives for that dealing, even in the absence of market value or where they do not deal at arm’s length. To test whether this is the case, the intended use of funds that an entity obtains from a part of a dealing can be relevant.

The presence of tax-driven features

92. As explained in paragraph 79 of this Ruling, there will be ordinary dealing where a person could predicate that the acts can be explained by the familial or commercial objects they are apt to achieve, without the need for further explanation. Regular familial and commercial objects can still be advanced in transactions which are chosen for the reason that they are tax effective when compared to similar alternatives to achieve those objects.

93. However, a dealing that includes features that are clearly tax driven and which make the arrangement appear contrived and artificial requires close examination, as does a dealing where the method of implementation suggests that tax is driving the arrangement instead of any familial or commercial object. The Court in Prestige Motors identified the form of the transactions and the tax advantages obtained as a part of the exercise of identifying whether there was an agreement entered into in the course of ordinary commercial dealing.[54]

94. In the context of section 100A, an income tax anti-avoidance provision, a commercial or familial object of reducing collective income tax liabilities to maximise post-tax group wealth, would not of itself satisfy the ordinary dealing exception. For example, a trustee making a lower-taxed beneficiary presently entitled to trust income while paying the underlying funds to another person or persons who would otherwise pay higher tax, will not be an agreement entered into in the course of ordinary dealing solely because it can be explained as increasing collective post-tax family or group wealth.

95. The following features may indicate that a dealing that is being tested is not ordinary dealing, as the transactions cannot be properly explained without reference to the purpose of avoiding tax. The factors are not exhaustive and no one factor is decisive:

  • An arrangement, or part of an arrangement, has artificial or contrived features, taking into account
    • the manner in which the arrangement was carried out
    • whether there was a more direct way to achieve the family or commercial goals; for example, could the arrangement instead have provided the benefit to the person who actually benefited, more simply or directly, such as by making that person presently entitled to trust income, and
    • the complexity of the arrangement (noting that ‘complex’ does not necessarily mean ‘artificial’).
  • there is conduct or circumstances inconsistent with the legal or economic consequences of the beneficiary’s entitlement; for example
    • it appears unlikely that beneficiaries will ultimately receive their trust entitlements, which may occur when
      • assets or funds representing the entitlement are purportedly lent to others without any intention of being returned or repaid
      • funds representing the entitlement are invested in ways inconsistent with that entitlement, or
      • funds representing the entitlement are dealt with in a way that is inconsistent with the beneficiary’s right to demand the entitlement
    • beneficiaries are not compensated for being kept ‘out of the money’ (for example, by way of interest, although noting that loans without interest may, depending on the cultural and other familial circumstances, qualify as ordinary dealing)
    • beneficiaries are not informed of their entitlements
    • where income entitlements have actually been remitted to the beneficiary, amounts were subsequently returned or other benefits or services were provided, by way of gift or otherwise to another person (such as the trustee, another beneficiary or an associate, whether by the beneficiary or by the trustee either independently or under a power of attorney), and
    • income entitlements have not been remitted to the beneficiary, and the reasons given are false having regard to the reasons given for the purported distribution.
  • The proportion of the trust net income distributed to the beneficiary as compared to other beneficiaries.
  • The relationship between the beneficiary, settlor, trustee and default beneficiaries.

 

 

Category: Tax Month - February 2022

Author: John Morgan

John Morgan is a tax specialist lawyer of more than three decades experience now practicing at the Victorian Bar - w: www.FJMtax.com e: f.john.morgan@vicbar.com.au