ATO Crackdown on Family Trusts

The long – awaited Division 7A and trust arrangements guidance in the form of draft rulings was released on the 23 February 2022 by the ATO.

Family groups will need to reconsider the way they use their family trusts in light of the new guidance.

The package of ATO materials released comprises the following:

  • Draft Taxation Ruling: section 100A reimbursement agreements
  • Draft Practical Compliance Guideline (PCG )2022/D1: section 100A reimbursement agreements- ATO compliance approach
  • Taxpayer Alert: Parents benefitting from the trust entitlement of their children over 18 years of age
  • Draft Taxation Determination: Division 7A: When will an unpaid present entitlement or amount held on sub-trust become the provision of ‘financial accommodation’?

Points to note:

  • The draft rulings and guidance are currently in draft form onlyand are submitted for public consultation.  Even when finalised, rulings merely outline the Commissioner’s view and are binding on the Commissioner – but not the taxpayer.
  • Whilst the revised ATO position on Unpaid Present Entitlements (UPE) is not anticipated to apply to 2022 distributions, we recommend you review your existing distribution and tax planning strategies in the current financial year.
  • Any distributions to adult children from trusts already made in prior years will also need to be reviewed.
  • Ensure documentation and governance on trust distributions and arrangements are adequately maintained

What are section 100A and reimbursement agreements?

Section 100A is an integrity provision and applies to arrangements where trust income is paid or applied on behalf of a beneficiary (generally with a lower tax rate) but the economic benefit of the distribution is effectively passed to a second beneficiary (usually on a higher tax rate).

If s 100A applies, the trustee of the trust is assessed rather than the beneficiary presently entitled to income, whereby income is taxed at the top marginal tax rates.

Draft Ruling TR 2022/D1

The draft ruling set out the ATO’s view on the four basic requirements for s 100A to apply:

  1. ‘Connection’ requirement – present entitlement arose in connection with a Reimbursement agreement
  2. There is a benefit provided to someone other than the beneficiary;
  3. There is a tax reduction purpose – this does not have to be the sole or dominant purpose and can also include a deferral of tax
  4. The agreement is not excepted as ‘ordinary family or commercial dealing’

Draft PCG 2022/D1

The draft PCG outlines the ATO’s compliance approach to these arrangements.  The ATO has outlined a risk assessment framework outlining 4 risk zones – White Zone, Green Zone, Blue Zone and Red Zone, depending upon the perceived risk of the taxpayer arrangement.  The ATO has also outlined the potential compliance action it will take for each of the zones.

Taxpayer Alert TA 2022/1

This TA targets arrangements whereby families are using adult children to distribute their trust income, however the parents still exercise control and benefit of the income.

It draws attention to the scenario whereby parents use trust income appointed to adult children to offset expenses paid by parents for their usual parental responsibilities, such as education expenses .

The ATO’s view is that such arrangements may give rise to a section 100A issue.

Draft Determination UPE

The draft determination deals with trust distributions to corporate beneficiaries and specifically addresses whether the unpaid present entitlement to the company is taken to be financial accommodation and hence a loan for Division 7A purposes.

Further, in circumstances where the UPE is dealt with via a sub-trust it may also be seen to be a loan for Division 7A purposes.

The draft determination provides the ATO with a new compliance approach on the application to Division 7A to unpaid present entitlements and sub-trusts.

Once finalised, previous guidance released by the ATO, TR 2010/3 and PS LA 2010/4 will be withdrawn and the final draft determination will be in effect from 1 July 2022.

We encourage you to contact us to discuss how the above draft changes could impact your family group