Recent ATO audit activity signals a tighter, tougher and better-policed application of section 100A to trust distributions

Section 100A of the Income Tax Assessment Act 1936 (Section 100A) has attracted significant attention amongst tax advisors in recent years – and for good reason. With the much-anticipated ATO ruling expected to be released early in 2022, the question is what should you be doing now in preparation for its release.

The Commissioner’s view in the ruling is expected to apply to arrangements entered into both before and after the ruling is issued, although an accompanying practical compliance guideline is expected to state that the Commissioner will not devote compliance resources to arrangements in place prior to 1 July 2014. However, this still leaves up to six years of trust distributions open to challenge (or a potentially unlimited review period under audit).

Why the concern?

In broad terms, Section 100A has the effect of disallowing distributions of trust income to beneficiaries where those distributions resulted in a reduction in the income tax payable by a taxpayer and the arrangements around the distribution were not part of ordinary family or commercial reasons.

Our recent Section 100A audit experience suggests that the ATO intends to take an extremely narrow view on what constitutes ordinary family or commercial dealings. For instance, the ATO has in some cases refused to accept that there is an ordinary family reason for not paying distributions made to adult children – even where the purpose of that retention is to establish a capital base for those adult children.

While this is likely to concern young families which own income producing assets, or conduct businesses through family trusts and have not been accounting to family members for their annual distributions of income (despite the family or commercial for retaining that income), the proposed extension of section 100A to disallow trust distributions in the event there is an income tax savings (whether the dominant purpose or not), should be of concern for all trustees and beneficiaries of unit and discretionary trusts.

What should you do?

In light of the impending ruling, it is incumbent on the trustees of discretionary and unit trusts and their advisers to undertake a review of the arrangements around those trusts to ensure all potential exposure to reassessments and penalties is appropriately managed.

In our experience dealing with Section 100A audits, a number of strategies can be used (and should be considered now), with a view to being in the best possible position to defend any contention that Section 100A applies to prior year trust distributions once the ATO guidance is released.

Five key areas for consideration include:

• Review beneficiary entitlements – in particular, give thought to the character of any expenses incurred on behalf of beneficiaries and the substantiation of those expenses (against which distributions have been applied). Expenses recorded as incurred on behalf of minors are likely to be a particular target.

• Payment of entitlements – if possible, look to fund the payment of beneficiary accounts.

• Acknowledgment – where it is not possible to pay entitlements to beneficiaries, unpaid entitlements may be acknowledged by the beneficiaries, including their existence, the balance and the purpose for retention of the funds, if relevant (i.e. to purchase a house in the future).

• Confirmation – consideration should be given to obtaining a private ruling to confirm the taxation treatment of distributions made in prior years, particularly where entitlements are paid following the end of the relevant financial year.

• Restructure – a particular target appears to be where a Trust owns 100% of the shares in a company, which also receives distributions as a corporate beneficiary of the trust. Often such arrangements are put in place with a view to maintaining a simple structure and avoiding the incorporation of additional entities. Consideration should be given to whether any Unpaid Present Entitlements (UPE) can be paid out, new companies used moving forward, or shares otherwise transferred.

McCullough Robertson’s Section 100A specialised experience

Our experience in dealing with recent ATO activity has provided us with a high degree of insight into the ATO’s approach and has highlighted to us the need for taxpayers and advisers to take immediate steps to reduce the risk of Section 100A exposure. Given this, those of us who have been involved in advising on the application of this section and been at the forefront of the ATO’s recent audit activity into Section 100A compliance have established a specialised subgroup focussing on strategies and solutions to manage the impact the proposed ruling might otherwise have on taxpayers. This experience enables us to provide critical and timely advice to our clients on this issue.

Q&A session

Following the release of the Commissioner’s ruling, we will be hosting a Q&A session on this topic, where we aim to answer a range of questions on section 100A. We invite you to register your interest here.

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.