Do we still trust “Trusts”?
Attention Trust Fund Members.
Learn how the updated ATO trust rules may effect you.
By Thomas Warner
Accountants don’t scare easily, but there are many getting weak at the knees at the moment. This is all due to the Australian Taxation Office (ATO) and their ever-evolving thoughts and application of our tax laws. In February the ATO came out with new commentaries on the application of trust rules which caused ripples of fear throughout the accounting profession. You may very well have heard about the “death of discretionary trusts” and not made the connection. Well, in this article we are going to answer the question “Do we still trust Trusts?
In February the ATO released documents that talk about a section in the Tax Act called Section 100a. This is designed as an anti-avoidance provision relating to trust distributions. Businesses have been using trusts to split income with family members to make the most of lower tax brackets for over 40 years and while these new rules do not prevent that entirely, they do mean there will be some changes moving forward.
Section 100a looks at an arrangement or scheme where a trustee of a trust allocates an amount to a beneficiary (ie, they distribute income to them in the tax return) but the economic benefit of that entitlement (ie, the cash that relates to that distribution) is received by a person other than that beneficiary. This arrangement has the effect of reducing a family’s overall tax liability. If the ATO considers this to be the case, they could apply Section 100a and unwind the distributions in question. If this happens, it will mean the trustee is taxed at the top marginal tax rate which is 45%.
What this means in plain English is: if your trust distributes income to your adult children or other family members who are not connected with running the business and does not pay the actual cash to them or put an agreement such as a loan in place, then the ATO could unwind this distribution and tax that income at 45%. The ATO have made it clear that they will not specifically go back and audit prior years on the basis of s100a alone. However, in the future, if they find a reason to audit a trust either under these rules or for other reasons, then they can go back and amend prior years.
The laws surrounding this have been around for quite some time. However, they were always very vague. The ATO has long talked about bringing out their commentaries around these rules and how they determine they should be applied, however, we only got these in February. This is why you are only hearing about this now.
So, at this stage you are probably wondering how your accountant is going to assist you in determining how to distribute your trust income going forward. But there are some carve outs in the law and the ATO have said if the arrangement is an “ordinary commercial or family dealing” they will not apply Section 100a. But what is an ordinary commercial or family dealing? Well, that is a very good question and one that is not clarified in case law yet, however we do know from the tax determination the following may be considered an ordinary commercial or family dealing.
Spouses of the owners or directors of a business are exempt from these rules;
Making an adult child a beneficiary of the income from a trust and offsetting those trust distributions against costs paid for the beneficiary during the year such as housing or university costs; or
Making a distribution of income to another family member such as a retired parent and them entering into a loan agreement with your trust that the trust will pay them interest and principal over time to be able to use those funds in your business a bit longer.
The ATO have expressed the view that just because something happens frequently or is accepted as a common practice that does not make it an ordinary commercial or family dealing. This means arrangements that we considered common like these below are at risk of Section 100a being applied.
Making an adult child a beneficiary of the income from a trust and them gifting their entitlement to mum and dad or to the trustee of the trust;
Making an adult child a beneficiary of the income from a trust and applying against historical costs of parenting incurred when the beneficiary was a minor i.e., school fees and food; or
Offsetting a beneficiary’s entitlements against costs that were not actually paid for by the trust.
So back to that question we started with, do we still trust “Trusts”? Yes, we do still trust a “Trust” as a vehicle for your business, farming or investment operations. Though some of the tax planning windows could be closed to us, trusts are still a great vehicle for other forms of tax planning, asset protection and succession planning. Using a trust allows you to hand control of a business or group of assets without selling them to the next generation, saving large amounts of tax and transfer duty. Trusts are also great structures to protect and segregate your business assets from your personal assets such as your family home.
If you have any concerns about how it will be impacted by these changes, please know that this will be a discussion point your accountant will already be planning to discuss with you during tax planning season or when determining your trust distributions for the 2022 financial year. However, as always, please get in contact with us if you want to have a chat about your situation.