On 2 July 2014, the Australian Taxation Office (ATO) released the much anticipated guidance on how it intends applying the trust reimbursement agreement provisions of section 100A of the Income Tax Assessment Act 1936.
Section 100A is relevant for all taxpayers who have a trust in their entity group, which owes unpaid present entitlements (UPEs) to trust income. Where section 100A applies, trust income is adversely taxed to the trustee at the top marginal rate of 49% as opposed to a beneficiary’s ordinary marginal tax rate.
Section 100A is dangerous because its terms are broad and the ATO has an unlimited time period to amend tax returns where section 100A applies.
An example where concerns have been raised as to section 100A’s potential application is where a trust makes a company beneficiary presently entitled to trust income (to access the lower company tax rate), leaves that entitlement unpaid and instead uses the trust income to make a payment or loan to another person who is on a higher tax rate.
Another situation where section 100A could potentially apply relates to the common practice of conferring UPEs on family members on lower marginal tax rates, whilst providing the principal beneficiary of the trust (who is on a higher marginal tax rate) with the benefit of such trust income (via loans or capital distributions).
Significantly, section 100A does not apply to arrangements entered into the course of an ‘ordinary family or commercial dealing’. There is no statutory definition of what an ‘ordinary family or commercial dealing’ is.
Given that the conferral of UPEs on company beneficiaries and low tax family members are common practices, guidance was sought from the ATO on its views as to the operation of section 100A and in particular the application of the ‘ordinary family or commercial dealing’ exclusion.
The guidance issued by the ATO is helpful in that it indicates that it generally does not consider that section 100A applies in a situation where a trust owes a UPE to a company beneficiary and retains the UPE funds to use as working capital. In such a circumstance the ATO considers that the ‘ordinary family or commercial dealing’ exclusion applies. Consequently, the ATO indicates that it will not devote compliance resources to pre-16 December 2009 company UPEs or company UPEs arising after that date.
Overall, the guidance issued by the ATO is disappointing and unsatisfactory as the examples the ATO explores in its guidance are contrived and do not fully address the above mentioned standard practices. In particular the ATO guidance does not address the more relevant situations where amounts are paid out or loaned interest-free to family members and how the ‘ordinary family or commercial dealing’ exclusion applies in such a context.