Will Guardian protect family trust distributions from attack by the ATO?
On 8 February 2022, the Commissioner appealed Justice Logan’s decision on section 100A in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation  FCA 1619(Guardian) to the Full Court of the Federal Court of Australia.
Over the past several years, section 100A of the Income Tax Assessment Act 1936 (Cth) has become an area of significant focus for the Australian Tax Office (ATO) and, consequently, Australian tax advisors. We have seen the Commissioner commence numerous audits of private client groups – in particular, with a focus on challenging the purview of the ordinary family or commercial dealing exclusion.
Alongside the development of a draft ruling and practical compliance guideline, which were both due to issue February this year, the Commissioner has been looking for a case to test the exclusions from 100A – both the exclusion for an agreement entered in the course of ordinary family or commercial dealings and for agreements not entered into with the purpose to reduce or eliminate a person’s income tax liability (see status of the ruling here).
This makes the Commissioner’s initial decision to run Guardian and Justice Logan’s decision at first instance particularly interesting.
In the decision, Justice Logan has made findings of fact in favour of the taxpayer such that section 100A did not apply to the arrangement in question and moreover, has confirmed and established legal precedent for the application of each element of section 100A, including the meaning of the phrase ordinary family or commercial dealing for the purposes of ensuring an arrangement falls outside of section 100A. As appeals of decisions of the Federal Court must be based on an error of law, to be successful on appeal, the Commissioner will be required to establish that Justice Logan’s findings of fact were based on legal error (it will not be open for the Commissioner to simply challenge the factual findings).
What is section 100A?
Section 100A was introduced to apply to tax avoidance arrangements where:
(a) a beneficiary is presently entitled to the income of the trust (relieving the trustee from taxation on that income) under a reimbursement agreement;
(b) a person other than the beneficiary receives money or property that would otherwise be liable to taxation (or higher taxation);
(c) the purpose of the reimbursement agreement was to secure the reduction or elimination of tax for the person other than the beneficiary; and
(d) the relevant agreement was not an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing.
The key factors in relation to any section 100A determination are emphasised above.
Where the Commissioner determines that section 100A applies to an arrangement, the trustee is assessed on the income of that beneficiary at the top marginal rate. Importantly, a section 100A determination is not subject to a limited amendment period, meaning that the Commissioner has an unlimited period to issue the trustee with an assessment pursuant to section 100A with respect to arrangements in previous years.
Overview of the decision
In Guardian, Justice Logan considered whether section 100A applied to the following arrangement (significantly simplified):
- AIT Corporate Services Pty Ltd (AITCS), was a corporate beneficiary of the Australian Investment Trust (AI Trust). All of the shares in AITCS were owned by Guardian AIT Pty Ltd (Guardian) as trustee for the AI Trust;
- The AI Trust distributed income to AITCS, such that AITCS was presently entitled to trust income and paid tax on the amount at the corporate tax rate. That entitlement initially remained unpaid; and
- AITCS subsequently called for the distribution and declared a fully franked dividend to the AI Trust. The distribution was then paid to a non-resident beneficiary, Mr Springer, who was not required to pay further tax on the distribution.
Mr Springer effectively controlled Guardian, the AI Trust and AITCS.
The Commissioner determined that:
- AITCS was presently entitled to the income of the AI Trust under a reimbursement agreement; and
- the purpose of the reimbursement agreement was to secure the reduction of Mr Springer’s tax liability, as a foreign beneficiary.
The Commissioner considered that the AI Trust could have distributed directly to Mr Springer, and he would have been liable to pay tax at 47% on the trust distribution, as opposed to receiving a distribution sourced from funds in respect of which tax had been paid at the corporate rate (by AITCS).
Guardian maintained that there was no reimbursement agreement, and even if there was, the distributions were made to AITCS as the corporate beneficiary in circumstances where Mr Springer was retiring and wanted to simply his life – thus the transactions were for the purpose of risk minimisation, asset protection, passive investment and wealth accumulation (amongst others). The taxpayer contended that this amounted to ordinary family and commercial dealings.
In the decision of the Federal Court, Justice Logan worked through the three key elements of section 100A, as follows:
1 Was there an agreement in fact that AITCS be made presently entitled to the AIT Trust income and Mr Springer receive the benefit?
2 Was the agreement in the course of ordinary family or commercial dealings and thereby excluded from section 100A?
3 Was there a purpose to reduce or eliminate Mr Springer’s tax liability?
On every matter, Justice Logan found in favour of Guardian.
Interestingly, Justice Logan took the opportunity to provide a decision on each of these three key questions, notwithstanding that if any one of the tests was answered in the negative, section 100A would not apply. In doing so, Justice Logan confirmed and established legal precedent relating to the determination of each question relevant to a finding that section 100A applies.
In summary, Justice Logan outlined the following key principles on each of the factors relevant to a section 100A determination:
1 Is there a reimbursement agreement?
(a) An agreement must predate the present entitlement of a beneficiary, such that there is a connection between the agreement and the present entitlement. The agreement must also provide for the payment of money or other benefit to another person.
(b) A connection based on legal or factual hypotheticals (a hypothetical contingency) is not sufficient to create a reimbursement agreement.
(c) Only the trustee and the other person need to be parties to the agreement (the presently entitled beneficiary need not be).
(d) An agreement does not need to be legally enforceable, and may in fact be quite informal if it includes the requisite features.
2 Is an agreement in the course of ordinary family and commercial dealing?
(a) The adjective ordinary is used in contradistinction from dealings that are extraordinary, and refers to a dealing which contains no element of artificiality, instead occurring naturally.
(b) The introduction of a corporate beneficiary for risk minimisation may be nothing more than an ordinary family or commercial dealing in circumstances where it is done for the familial and commercial advantages of such flexibility.
3 Was there a purpose to reduce or eliminate a tax liability?
(a) The requirement to consider a counterfactual that would have resulted in a tax liability (or higher liability), is a higher standard than consideration of a counterfactual that might arise.
(b) A fact in the arrangement in question may be incorporated in the counterfactual – the actions of the taxpayer and its associates can be taken into consideration and are likely to shed more light on (objectively)what would have been done.
What does it mean?
Justice Logan’s statements of law regarding the elements of section 100A and the establishment of legal precedent on each of the key elements of section 100A appear to significantly restrict the Commissioner’s approach terms of the potential application of section 100A to a wide range of circumstances – which may affect many private client groups. In particular, the comments made by Justice Logan with respect to the exclusion of agreements on the basis of ordinary family or commercial dealings are invaluable to taxpayers in defending a section 100A determination.
It is also important to note that in seeking to overturn Justice Logan’s decision (and the legal precedent established), the Commissioner can only appeal to the Full Federal Court contending that the court at first instance has failed in relation to the proper application of the law to the facts before the Court.
Ultimately, we would expect a finding that section 100A applied to an arrangement which merely sought to maximise the flexibility of trust beneficiaries for asset protection and risk minimisation purposes to be unlikely.
However, until the outcome of the appeal is known, the situation in terms of the application of section 100A remains uncertain. We expect that the Commissioner’s guidance on the application of section 100A will be further delayed until the appeal decision is handed down.
In December 2021, Partner in our Tax team, Melinda Peters, provided her insights on the tighter and better-policed application of section 100A to trust distributions.
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.