On 17 November 2016, the ATO released Taxpayer Alert TA 2016/12, which deals with trust income reduction arrangements under review by the ATO. The Alert highlights the ATO's increasing concern with some trust arrangements.

In relation to the Taxpayer Alert, Deputy Commissioner Michael Cranston said "We are looking closely to see if arrangements comply with trust law, constitute a sham, or are captured by anti-avoidance provisions or integrity rules."

The Trusts Taskforce team, which was established in 2013, has identified arrangements that create contrived differences between the trust income and taxable net income. These differences are then exploited such that the taxable net income of the trust is assessed to a beneficiary that pays no tax or a low rate of tax and the trust income is then distributed tax-free or subject to a low rate of tax.

The ATO considers these arrangements display all or most of the following features:

1. An artificial difference is created between the trust income and taxable net income of a closely held trust with the primary motivation of avoiding tax. This may occur when:

  • the trust deed definition of the trustee's powers to determine trust income is changed;
  • the trustee takes steps with the principal purpose of reducing trust income; or
  • the trustee relies on a power in the trust deed to determine that trust income is less than it would otherwise have been.

2. The beneficiary who is made presently entitled to the trust income:

  • pays little or no tax on the share of taxable net income included in its assessable income; or
  • is a private company, where tax will be imposed on the net income of the trust at the rate of 30% and any increase in the accumulated profits of the company is limited so as to minimise future assessable income that arises from paying dividends out of company profits.

3. The trust retains the economic benefit reflecting the artificial difference between the trust income and taxable net income of the trust. That benefit may subsequently be extracted in a form that is tax-free or subject to a reduced rate of tax in the hands of the recipient.

Key steps to prepare now for future ATO audits and disputes

  1. Ensure all amendments or variations to the trust deed and all trustee decisions are documented and appropriate minutes prepared. Be ready to produce all relevant documents to clearly demonstrate facts and evidence of your facts to support your tax positions.
  2. Objectively assess and identify your tax risks. Ensure any difference between trust income and taxable net income of the trust have a legal or proper accounting basis (not principally directed towards the obtaining of tax benefits).
  3. Engage proactively and meaningfully with the ATO so that you understand what risks the ATO has identified, where in the lifecycle of an investigation you are and the precise nature of the information the ATO is seeking in order to prevent escalation of the dispute. Taxpayers need to be aware of their obligations particularly their burden of proof. Missteps in this area could easily result in the Commissioner utilising compulsive powers or moving straight to amended assessment.