Proposed Changes To Trust Distributions
The ATO’s Draft Rulings on Trusts: What you need to know (for now).
The Australian Taxation Office (ATO) released draft rulings on trust distributions, particularly section 100A, which could significantly impact how Australian trusts distribute income and are taxed.
It has caused a strong response and attracted a lot of media attention in recent weeks. However, it’s important to note that these rulings are draft only, not final. There is a consultation process which closes on 8 April 2022, which may result in changes.
Proposed Changes to Trust Distributions (Section 100A)
Section 100A is designed to catch situations where an individual or entity (other than the beneficiary) is benefiting from the distributed income of a trust specifically to avoid tax. This generally results in the trustee being taxed at higher rates.
The ATO’s latest guidance through their draft rulings suggests that the ATO is looking to apply section 100A to a wider range of scenarios. These scenarios include some arrangements that are commonly used for tax planning purposes by family groups. This means that some family trusts could be at risk of higher tax liabilities.
There are some important exceptions to section 100A, including:
- Where income is appointed to minor beneficiaries.
- Where the arrangement is part of an ‘ordinary family’ or commercial dealing.
The ATO notes that this ‘ordinary family’ exclusion won’t necessarily apply simply because arrangements are commonplace or they involve members of a family group.
To provide reassurance to tax agents and taxpayers, the ATO has stated that:
‘The vast majority of small businesses operating through a trust are not operating in a way that will attract section 100A. A distribution to an adult child who has a low marginal tax rate will not attract section 100A where they simply receive or enjoy the benefit of their distribution’.
Further, they indicated they do not mind when family business profits go to family members managing the business, especially if those members choose to reinvest the profits back into the business.
They will look at certain arrangements closely. If the ATO determines that section 100A applies, tax will be applied at the top marginal rate, potentially across a number of income years so it important to still be aware of the risks.
However, the ATO has emphasised that they will not be pursuing taxpayers who:
- Entered into their arrangements between 1 July 2014 and 30 June 2022, and
- Thoroughly considered whether section 100A would affect them.
Proposed Changes to Companies Entitled to Trust Income (Division 7A)
The ATO has also released a draft ruling dealing with unpaid distributions owed by trusts to corporate beneficiaries. If the amount owed by the trust is deemed to be a loan, then it can potentially fall within the scope of Division 7A.
Division 7A captures situations where shareholders access company profits in the form of loans, payments or forgiven debts. If you do not take certain steps, the tax authorities can treat these amounts as deemed unfranked dividends and tax them at your marginal tax rate.
The latest ATO guidance explains when the ATO will treat an unpaid entitlement to trust income as a loan. This affects when you must put a complying loan agreement in place to prevent treating the full unpaid amount as a deemed dividend and changes when the trust must start making principal and interest repayments to the company.
If finalised, these changes to Division 7A will only apply to trust entitlements arising on or after 1 July 2022.
Who is likely to be impacted?
The ATO’s updated guidance focuses primarily on distributions made to adult children, corporate beneficiaries, and entities with losses. Depending on how the trusts structure their arrangements, there is potentially a significant impact to family trusts. However, you should remember that section 100A is not confined to these situations.
Once the ATO finalises the draft rulings, discretionary trusts must have their accountants review all trust distribution arrangements. They also need to prepare appropriate documentation. This will show how funds from trust distributions are used for the benefit of beneficiaries.
A Note for Aintree Group Clients
As of May 2022, the ATO clarified some areas of this draft ruling but has not finalised anything. We will contact clients individually once confirmed.
If you have any other questions or concerns, please be in touch with your Aintree Group adviser.
This is general advice only and has not been prepared with your situation and needs in mind. For individual and personalised advice, we highly recommend that you seek out proper professional advice from your accountant and lawyer.
