Changes to the taxation of trust distributions

The ATO’s crackdown on the taxation of family trusts will have a significant impact on one of the most common income splitting strategies, the distribution of funds to children and grandchildren.

What does the guidance mean for you, and should you reconsider how you’re using your family trust?

The ATO has announced a major crackdown on the taxation of family trusts. In a long-awaited ruling, the ATO has focused on common tax planning strategies involving distributions to companies and family members. This crackdown means that family groups will urgently need to reconsider how they are using their family trust.

How will the crackdown operate?

The ATO is focusing its attention on a specific part of the tax law, known as section 100A.  Where 100A applies, the trust distribution will be taxed to the trustee of the trust (at the top marginal rate) rather than the beneficiary to whom it was purportedly to be taxed to (who would’ve likely paid considerably less tax than the trustee).

Broadly, section 100A can apply where:

• A beneficiary is presently entitled to a share of the income of a trust
• There is an agreement (whether formal or informal, written or unwritten) whereby a person other than the beneficiary will benefit from the amount, and
• A purpose of the agreement is that less income tax will be paid.

Section 100A does not apply if the agreement is entered into as part of an ‘ordinary family or commercial dealing’. It is this ‘ordinary family or commercial dealing’ aspect that the ATO is clamping down on. In particular, the ATO’s view is that the carve out does not operate merely because all parties to the arrangement are family members, or that the practices are widespread.

What type of distributions are problematic?

While a broad range of trust distributions could be caught by this crack down, some are more problematic than others. For example, a trust which distributes all its income to a husband and wife, who use that money to pay for their household expenses, is unlikely to be problematic.

However, if the trust is distributing to adult children, but the funds from that distribution actually end up in the hands of their parents, that is likely to be an issue. This is one of the classic income splitting strategies. For example, adult children at university and earning no other income have the full benefit of the marginal tax rates. A distribution to them of $180,000 could generate tax savings of around $30,000.  Families may be attracted by the tax savings, but baulk at the idea of actually putting $180,000 in their teenager’s bank account. Strategies have evolved to manage that concern, and these are what the ATO is questioning.

Unpaid trust distributions to companies, or circular arrangements whereby a trust distributes to a company, which in turn pays a dividend back to the trust, which then distributes back to the company, are also a focus of the ATO crack down.

Is this the end of trust distributions to kids or grandparents?

Not necessarily, but such arrangements will be subject to much closer scrutiny in the future. If the distributions genuinely take place and the family or commercial basis for them can be readily explained, the situation may be more likely to fit within the ‘ordinary family or commercial dealing’ exclusion.

For example, if an adult child who lives at home with their parents receives a $10,000 distribution from their parents’ family trust, and the child forwards that distribution to their parents to cover board and car running costs, this may withstand scrutiny under 100A. However, a distribution to the adult child of $180,000 which finds its way to the parents would be far less likely to be readily explainable as an ‘ordinary family or commercial dealing’ in the absence of other more substantial reasons (such as the child using the distribution to make a repayment on a loan that the parents previously made to that child to enable them to purchase their first home).

The ATO makes specific mention of their view that a particular situation is not an ‘ordinary family or commercial dealing’ merely because it is common practice of the family or the community. Taxpayers cannot rely on their arrangement being ‘ordinary’ merely because ‘everyone else does it’.

Documentation and detailed reasoning for their actions will be crucial in any argument that the carve out should apply.

What should I do with my trust?

The Australian Taxation Office (ATO) acknowledges there has been significant interest in its draft public advice and guidance relating to trust reimbursement agreements and unpaid present entitlements (also known as section 100A reimbursement agreements). In response to the level of community interest, the ATO extended the public consultation period for the guidance, which ended on 29 April 2022.

“The ATO’s position is that if the beneficiary of the trust gets the benefit, 100A has no role to play. The ATO is not concerned about ordinary family trusts where the relevant family members benefit from the distributions”.

Similarly, ATO Deputy Commissioner Ms Clarke also noted that the ATO is not concerned when profits from the family business are distributed to members of the family who work in the management of the business and then that family member chooses to reinvest the profits in the business.

If you have a family trust, it is important to consider whether any of the new ATO views could be problematic for you. If your trust is distributing to a range of family members, or to companies, then you should review your situation in detail.

The ATO will not be pursuing taxpayers that entered into arrangements between 1 July 2014 and 30 June 2022 where, in good faith, they concluded that section 100A did not apply to them based on the previous 2014 guidance.

“I want to reassure the community – we won’t have a retrospective element. We stand by our 2014 guidance for this interim period,” Ms Clarke said.

The ATO will carefully consider all submissions received during the consultation period as it finalises the package of public advice and guidance. A compendium of the ATO responses to the feedback will also be published.

Trusts will continue to be an effective structure for managing family wealth, but the tax planning aspect will become more complex and tailored. Most family groups will need to revisit their tax planning in the lead up to 30 June 2022.

To discuss how these changes impact you and the best ways to manage your situation, contact the team at Lockwood Partners.