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Section 100A: ATO’s new draft guidance

The long-awaited draft guidance on section 100A of the ITAA 1936 has been issued by the ATO. The package of guidance materials provides new insights into the ATO’s preliminary view of the operation of the provision. This article explains the relevance of section 100A and the importance of the ATO’s new guidance for taxpayers with trusts.

Section 100A: ATO’s new draft guidance
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On 23 February 2022, the ATO released new draft guidance materials on the application and operation of section 100A (s 100A) and Division 7A (Div 7A) of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

We have known for some time that the ATO’s new draft guidance materials on s 100A would feature prominently on the tax landscape in the early part of 2022. So now that that it is here, what does it mean for your clients with trusts?

Background

Section 100A was inserted in its current form into the ITAA 1936 on 13 March 1979 to apply to assessments in respect of the 1977–78 and later income years (i.e. from 1 July 1977). However, the provision applies only to arrangements where trust income is paid to or applied on behalf of a beneficiary after 11 June 1978, the day on which the government announced its intention to introduce legislation to overcome certain tax avoidance arrangements designed to enable trading profits and other income derived by trusts to escape taxation.

The government was concerned about avoidance arrangements where a beneficiary is made presently entitled to income of a trust estate so that the trustee is relieved of any tax liability on the income, but the beneficiary also does not pay tax. This may be, for example, because the beneficiary’s income is exempt from income tax or there is another trust with sufficient deductible losses to absorb its share of income as a beneficiary of the first trust estate.

Key points of s 100A

  • Section 100A applies where a beneficiary who is not a minor or otherwise under any legal disability becomes presently entitled to a share of the income of a trust estate under, or as a result of, a reimbursement agreement.
  • A ‘reimbursement agreement’ is defined to be an agreement, whether entered into before or after the commencement of s 100A, that provides for money to be paid, property transferred, or services or other benefits provided to someone other than the beneficiary or to the beneficiary and some other person or persons (this includes natural persons, companies and trustees).
  • Despite the term ‘reimbursement agreement’, the payment of money to, transfer of property to or provision of services or other benefits for a person other than the beneficiary alone need not necessarily be a ‘reimbursement’ as such.
  • The term ‘agreement’ includes arrangements or understandings that are not legally enforceable and specifically excludes from the definition an agreement, arrangement or understanding entered into in the course of an ordinary family or commercial dealing.
  • A notional calculation is made of the increased amount — i.e. the extent to which the beneficiary’s present entitlement (the amount actually paid or applied for their benefit) exceeds the amount the beneficiary would have been, or could reasonably be expected to have been, presently entitled to in the absence of the reimbursement agreement. The excess, the increased amount, is deemed to have arisen out of or resulted from the reimbursement agreement. The taxpayer has the onus of establishing a reasonable expectation that the beneficiary would have been presently entitled to the original amount if the reimbursement agreement had not been entered into.
  • Where s 100A applies, the income is not assessable to the beneficiary; instead, the trustee is assessed on the income.
  • Section 100A is concerned only with tax avoidance arrangements. Excluded from the scope of s 100A is any agreement that was not entered into or carried out for a purpose of securing for any person a reduction in that person’s income tax liability in respect of an income year.

Key guidance to date

The ATO web guidance on s 100A was first issued in 2014, and, until the release of the latest draft guidance materials, provided limited guidance on what is a reimbursement agreement, what is an ordinary family or commercial dealing and some other exclusions, and the interaction of s 100A with Div 7A.

Against a backdrop of cases before the courts that have considered and applied s 100A, such as FCT v Prestige Motors Pty Ltd [1998] FCA 221, Idlecroft Pty Ltd v FCT [2005] FCAFC 141 and Raftland Pty Ltd as trustee of the Raftland Trust v FCT [2008] HCA 21, the Federal Court recently held that s 100A did not apply to the taxpayer’s arrangement in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619 (Guardian). The Commissioner has appealed Logan J’s decision to the Full Federal Court.

What does the ATO’s new draft guidance say?

On 23 February 2022, the ATO released their long-awaited draft guidance on s 100A.

The package of draft guidance materials consists of:

  • a draft Taxation Ruling, TR 2022/D1  Income tax: s 100A reimbursement agreements (draft Ruling) (when finalised, the Ruling will apply both before and after its date of issue)
  • a draft Practical Compliance Guideline, PCG 2022/D1  Section 100A reimbursement agreements — ATO compliance approach (draft PCG)
  • a Taxpayer Alert, TA 2022/1  Parents benefitting from the trust entitlement of their children over 18 years of age (TA).

The draft Ruling explains the ATO’s views on the four requirements for s 100A to operate.

‘Connection’ requirement

Firstly, there needs to be a ‘connection’ between the creation of the present entitlement to a share of the income of a trust estate that is legally effective (i.e. not a sham or purportedly in favour of a party who is not a beneficiary of the trust) and an agreement that is a ‘reimbursement agreement’.

It is necessary that the reimbursement agreement must have been in existence before the present entitlement arose, but it is not necessary that the presently entitled beneficiary or the trustee needs be a party to the agreement or even in existence when the agreement is made.

‘Benefits to another’ requirement

Secondly, the reimbursement agreement must provide for the payment of money (including via loans or the release, abandonment, failure to demand payment of or the postponing of the payment of a debt), transfer of property to or provision of services or other benefits for one or more persons other than the beneficiary alone.

‘Tax reduction purpose’ requirement

Thirdly, one or more of the parties to the reimbursement agreement must have entered into it for a purpose (this need not be a sole, dominant or continuing purpose) of eliminating or reducing someone’s income tax (this includes a purpose of deferring a party’s tax to a later income year).

In determining whether there is a tax reduction purpose, where a party acts in accordance with advice from an adviser, the purpose of that adviser can be imputed to the party.

Not excepted as ordinary family or commercial dealing

Lastly, the exception to s 100A is satisfied where an agreement is not entered into in the course of ‘ordinary family or commercial dealing’. To fall within this exception, the transactions between family members and their entities must be capable of explanation as achieving normal or regular familial or commercial ends.

The draft Ruling explains that there will be ordinary dealing where a person could predicate that the acts can be explained by the familial or commercial objects they are apt to achieve, without the need for further explanation. ‘Dealing’ is not ordinary just because it is commonplace. The draft Ruling contains nine examples depicting a range of circumstances that would, or would not, constitute ‘ordinary family or commercial dealing’.

Compliance approach set out in the PCG

The draft PCG sets out a risk assessment framework to determine the allocation of ATO compliance resources. The framework contains four risk zones that determine the ATOʼs compliance approach, ranging from no compliance resources being allocated to the ATO conducting further analysis on the facts and circumstances of an arrangement as a matter of priority, which may proceed to audit.

While the final PCG will apply both before and after its date of issue, the ATO explains that:

  • they generally won’t allocate compliance resources to arrangements entered into before 1 July 2014 (note there are three exceptions); and
  • taxpayers can rely on existing ATO web guidance if this is more favourable to their circumstances than the outcome under the PCG for arrangements entered into before 1 July 2022.

Taxpayer Alert

The TA sets out the ATO’s concerns about certain arrangements involving adult children of controllers of discretionary trusts. Under the arrangements, the adult children are made presently entitled to trust income but it is not intended that they retain any benefit of that income, and the arrangements are predicated on avoiding tax.

Concurrent new draft guidance on Division 7A

The ATO’s new draft guidance on s 100A has been released in conjunction with a new draft Taxation Determination, TD 2022/D1 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become ‘any other form of financial accommodation’? that was also issued on 23 February 2022.

The draft Determination sets out the Commissioner’s preliminary view on when the UPE of a private company beneficiary will be treated as a loan for which there can be dividend consequences under Div 7A, as that beneficiary has provided ‘any other form of financial accommodation’ to the trustee.

This draft guidance material will be the subject of my column next month.

What now?

These new draft guidance materials will be of great interest and relevance to many practitioners and their clients. It will be interesting to see how long the guidance remains in draft form. As always, there will be a consultative period to allow the opportunity to provide feedback on the draft guidance by submission to the ATO.

Unquestionably, the part of the draft Ruling that explains ‘ordinary family or commercial dealing’ will generate the most discussion. Practitioners will wrestle with unpacking the explanations in the draft Ruling as they seek to understand whether their clients’ arrangements are ‘ordinary’. Analysis of arrangements will also be required using the draft PCG to ascertain the appliable risk zone and the likelihood of an ATO review or audit.

The appeal in the Guardian case, may, or may not, ultimately reshape the draft guidance. The outcome of the appeal will be keenly watched. The appeal hearing before the Full Federal Court would be expected during 2022, but there is the potential for one of the parties to seek special leave to appeal the Full Court’s decision to the High Court. Accordingly, it could be late-2022 or even into 2023 before the final outcome of the matter is known.

The ATO is keen to run a test case to obtain further judicial guidance and is working to identify taxpayers who wish to nominate themselves.

The release of the ATO’s draft guidance materials and the parallel case in Guardian are arguably the most significant developments in the taxation of trusts since the High Court’s decision in FCT v Bamford; Bamford v FCT [2010] HCA 10 in 2010 and the resulting ATO guidance that followed. The profession will be watching further developments with a keen and concerned eye.

About the Author:

Robyn Jacobson is the Senior Advocate at The Tax Institute.

About The Tax Institute:

The Tax Institute is the leading forum for the tax community in Australia. Our reach includes membership of 11,000 tax professionals from commerce and industry, academia, government and public practice and 40,000 Australian business leaders, government employees and students. We are committed to representing our members, shaping the future of the tax profession and continuous improvement of the tax system for the benefit of all, through the advancement of knowledge, member support and advocacy.

Read more at taxinstitute.com.au

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