In The Tax Institute’s TaxVine email [No.5, 24.2.23], their Tax Policy and Advocacy team reviews the application of section 100A of the Income Tax Assessment Act 1936 (ITAA1936) in light of the finalised ATO guidance and recent cases.
The end of the income year is approaching quickly. Practitioners and trustees will shortly be required to determine and prepare trust distribution minutes and resolutions for the 2022–23 income year. However, with the ATO recently releasing its finalised guidance on section 100A, and the Full Federal Court handing down its decision in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (the Guardian Case), on 24 January 2023, practitioners and trustees must be cognisant of the changes to the ATO’s guidance from the draft release and its impact on trust arrangements.
A recap of section 100A
Broadly, section 100A applies to an arrangement where the following criteria are satisfied:
- a beneficiary of a trust (who is not under a legal disability) is presently entitled to a share of the trust income;
- that present entitlement arises in connection with a reimbursement agreement — a reimbursement agreement is an agreement (whether or notwritten) that provides for money to be paid, property transferred, or the provision of services or other benefits to someone other than the beneficiary;
- at least one of the parties, to the reimbursement agreement, entered into it with a purpose of reducing, or deferring, someone’s income tax liability; and
- the arrangement was not entered into in the course of ‘ordinary family or commercial dealing’.
If section 100A applies, the beneficiary is taken to never have been presently entitled to the share of the trust income arising from the reimbursement agreement. This results in that proportionate share of the trust’s net income being assessed to the trustee (pursuant to section 99A of the ITAA 1936), who is subject to tax on the increased amount at the top marginal tax rate (plus Medicare levy). Further, the Commissioner has an unlimited time in which to amend assessments, so there’s considerable exposure, here, if it applies. All this is explained in detail in our article.
Finalised ATO guidance
On 8 December 2022, the ATO released finalised guidance regarding the Commissioner’s interpretation of section 100A. This consists of:
- Taxation Ruling TR 2022/4 Income tax: section 100A reimbursement agreements (Ruling) which replaced draft Taxation Ruling, TR 2022/D1 Income tax: section 100A reimbursement agreements;
- PCG 2022/2 Section 100A reimbursement agreements – ATO compliance approach (PCG) which replaced draft Practical Compliance Guideline, PCG 2022/D1 Section 100A reimbursement agreements – ATO compliance approach;
- an ATO media release; and
- updated ATO web guidance.
This guidance is in addition to Taxpayer Alert, TA 2022/1 — Parents benefitting from the trust entitlement of their children over 18 years of age that was released on 23 February 2022.
TR 2022/4
The Ruling has clearer explanations of key concepts such as ‘connection’, ‘benefit to another’ and ‘tax reduction purpose’. However, more importantly, the Ruling removes descriptors and terminology that were ambiguous or would require the use of value judgments (as highlighted in our submission). The Ruling details the factors that may indicate an arrangement will not satisfy the ‘ordinary family and commercial dealing’ exception. Such factors include arrangements that:
- are artificial or contrived;
- are overly complex;
- contain steps that are not needed to achieve the family or commercial objectives; or
- contain steps that might be explained by other objectives.
PCG 2022/2
Key changes from the draft PCG include the removal of the proposed blue zone, expansion of the green zone to include additional examples, addition of specific exclusions from the green zone and further guidance on record-keeping requirements.
Removal of the blue zone
The removal of the blue zone results in just three risk zones for characterising arrangements. As the white risk zone applies only to certain entitlements that arose in income years ended before 1 July 2014, the ATO will be able to characterise current and future arrangements into only two risk zones — the green or red risk zone. Various trust arrangements will fall outside of the green zone because they are not considered low risk. However, they may also fall short of being in the red zone as they are not high risk. This will leave many practitioners and taxpayers unclear as to whether the ATO will allocate compliance resources to review their trust arrangements for the purposes ofsection 100A.
Expanded green zone examples
The additional green zone examples are a welcome addition to the PCG. All green zone arrangements are subject to the requirement that they do not contain any of the high risk features described in paragraph 32 of the PCG.
The additional green zone examples are as follows:
- Green zone scenario 1 — relates to distributions to individuals who are members of a family and where the funds are paid to the beneficiary.
- Green zone scenario 2 — is an arrangement where a beneficiary is presently entitled to income of a trust estate and the beneficiary receives and uses the entitlement within two years of becoming presently entitled. However, an unpaid present entitlement that remains unpaid after two years does not necessarily mean there is a high risk of section 100A applying.
- Green zone scenarios 3A and 3B — applies to arrangements, where the trustee retains the funds, that the beneficiary would otherwise receive, in the satisfaction of their entitlement, for one or more of the following purposes:
- in the working capital of the business;
- for the acquisition, maintenance or improvement of investment assets of the trust, or servicing of debt used to acquire, maintain or improve those assets; or
- to lend to another entity in the family group on commercial terms where the borrowing entity uses the funds in either of the two ways described above.
Exclusion from the green zone
In our submission, we highlighted that the final carve out of ‘arrangements that involve one or more features of a tax avoidance purpose’ was too broad a criterion and could cover unintended arrangements. Paragraph 32 of the PCG has replaced this criterion with more specific exclusions that more accurately identify the relevant mischief.
Updated guidance on record-keeping
The potential inability to evidence familial arrangements was of significant concern for taxpayers. We raised this in our submission where we advocated for the ATO to clarify what evidence would be accepted. Consequently, the PCG has been updated to describe the ATO’s view of the important documents that should be retained to evidence arrangements (in paragraph 50).
Recent case
On 24 January 2023, the Full Federal Court handed down its Guardian decision. The Court emphasised the importance, for meeting the requirements of section 100A, before contemplating its application, or potential exemptions. Furthermore, it highlights the importance of working through the requirements to establish that a reimbursement agreement does, in fact, exist, before section 100A can apply. Their Honours determined that no agreement was in place, at the time the beneficiaries were made presently entitled, and therefore no reimbursement could exist. Consequently, their Honours did not contemplate the meaning of the ‘ordinary family or commercial dealings’ exemption as, in their opinion, the reimbursement agreement requirement was not met for any of the relevant income years.
Guardian also demonstrates the importance of considering the application of Part IVA of the ITAA 1936, in respect of trust entitlements. In Guardian, a core feature of the 2013 scheme, was to make certain beneficiaries presently entitled, to specific trust income. This decision, and that of Minerva Financial Group Pty Ltd v Commissioner of Taxation [2022] FCA 1092, indicates that trustees’ discretion can fall within the purview of Part IVA, from the perspective of the courts. Practically, this could prove challenging for advisers, as trustees’ actions may be scrutinised for Part IVA application.
Further, explanation of the facts, and analysis of the Court’s decision, in Guardian, are detailed in this article.
Key takeaways for practitioners
When advising clients, as to the impact of section 100A, on their trust arrangements, it is important that practitioners are mindful of the following key points:
- Franked distributions and capital gains — the ATO is of the view that where a beneficiary, is no longer presently entitled, pursuant to section 100A, this also results in no beneficiary being specifically entitled. However, this will depend on the terms of trust deed.
- Date of effect — the Ruling and PCG apply to arrangements both before and after its date of release. However, the ATO will not dedicate compliance resources to taxpayers who relied on, and took reasonable steps to comply with, the Commissioner’s administrative position in the July 2014 website guidance.
- Unlimited period of review — the unlimited review period for section 100A means that it is imperative that trustees must retain sufficient records to explain transactions that have happened.
With the appeal of the decision in BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112 scheduled to be heard on 2 and 3 March 2023, practitioners should be cognisant that the legal position on section 100A could change following future decisions. Until then, the ATO will be following their finalised guidance in assessing the risk of trust arrangements and those that do not fall into the green or white zone could be subject to further ATO investigation.
Closing comments
Section 100A is an evolving space. As case law and understanding develops, further examples may be included in the relevant risk zones in the PCG. Additional guidance is needed to help minimise the difficulty in compliance for those who are finding their arrangements are stranded between the two defined risk zones.
As practitioners and trustees, prepare their trust distribution minutes and resolutions, this income year, it is important that they are well informed of the necessary actions they should take to ensure the allocation of trust entitlements are appropriately considered and do not fall within the purview of section 100A from both the Court’s and ATO’s perspective.