24/02/22

AUSTRALIA: New draft guidance on entitlements to amounts from private trusts issued.

As published on step.org/industry-news, Thursday 24 February, 2022.

The Australian Tax Office (ATO) has issued draft advice and guidance on the tax treatment of trust entitlements arising out of reimbursement agreements and unpaid present entitlements (UPEs) of trust beneficiaries.

According to the ATO, tax advisors and their clients are demanding greater certainty on taxation of trust distributions that might trigger the operation of either the s.100A anti-avoidance provisions or the Division 7A rules of the Income Tax Assessment Act 1936.

The tax authorities can invoke the s.100A anti-avoidance rule when trust income is distributed to relatively favourably taxed beneficiaries but the benefits of that income are enjoyed by others who might have had to pay more income tax. If the rule is determined to apply, the trustee (and not the beneficiary) is liable to tax on the income at the top marginal rate.

However, the section does not apply to arrangements entered into in the course of 'ordinary family or commercial dealings' or where no party to the arrangement has a tax avoidance purpose. This was the central issue in the Guardian case (2021 FCA 1619), concerning taxation of net income of an investment trust set up by now-retired property developer Alexander Springer. The Federal Court of Australia found in Springer's favour at the end of 2021, ruling that his use of the arrangement was not intended to avoid tax.

The new ATO guidance expresses its views on these concepts, for which there is limited judicial guidance, in particular the ordinary family or commercial dealing exception, it says. 'We recognise that it is critical to give practical certainty about how the Commissioner will dedicate compliance resources to cases where section 100A may potentially apply', it says, noting that there is an unlimited period in which the ATO can amend assessments under the section.

The new guidance outlines what arrangements will attract ATO attention and which are of low risk where it will not seek to enforce compliance. The final version of the guidance will set out its approach in relation to beneficiary entitlements conferred on or after 1 July 2022.

Division 7A aims to prevent private companies distributing profits to their shareholders free of tax. It states that a loan or other 'financial accommodation' provided by a private company to its shareholder, or shareholder's associates, will usually be taxable as a dividend paid to the shareholder or associate. It can come into play when a trustee of a closely controlled trust has made a private company beneficiary presently entitled to trust income, but has not paid the amount on the basis that the amount is held in a sub-trust for the benefit of the private company.

The ATO's view is now that a private company with unpaid trust entitlements will be deemed to provide financial accommodation to anyone the company allows to have access to the amounts to which they are entitled. Consequently, from July 2023, taxpayers will need to consider the operation of Division 7A when putting in place any sub-trust arrangements or risk the loans being deemed as dividends.

'The existing view on sub-trust arrangements has become difficult to maintain over time', says the ATO. 'It is unsupported by what we now understand to be the operation of the law and subsequent judicial decisions, and the practical administration of the position has the effect that the ATO's ability to collect tax which has become due is impeded'. To continue to adhere to existing guidance could result in unintended administrative impacts, the ATO says.

The ATO is encouraging businesses that have a reimbursement agreement in place, or where Division 7A applies, to engage with their tax advisors. However, it says the vast majority of small businesses operating through a trust will not be affected by the new guidance.

The consultation on the draft public advice and guidance will run until 8 April 2022.