Trusts - The Problem Child
27 Apr 2022
The recent publication of the Draft Practical Compliance Guideline (PCG 2022/D1), Taxpayer Alert (TA 2022/1) and Draft Taxation Determination (TD 2022/D1) on the application of section 100A and Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) to trust and company arrangements has certainly caused a stir in the accounting profession.
Trusts have been the cause of much debate for the thirty years I have been in Australia and probably for some time before my arrival on these shores. Section 100A was introduced into the ITAA 36 in March 1979 and has largely been ignored since then. Well, that has now all changed.
Going forward, the Guidelines and the Alert provide some useful guidance as to what you should not be doing with trust distributions. The difficulty is the retrospective nature of these documents and how the ATO is set to apply their compliance approach for income years commencing 1 July 2014. The “traffic light” approach has been adopted by the ATO and if your trust arrangement falls within the blue or red zone, you can expect the ATO to come knocking on your door.
Like all good tax issues, it appears that the politicians are getting into the act by suggesting, as part of their election sales pitch, that the retrospect application of section 100A might be reviewed if they get into or back into power. There may therefore be some light at the end of the tunnel, even if it just flickering, but with a strong possibility of it being snuffed out after the election.
The use of trusts as a tax planning tool is rapidly coming to an end. In effect, a distribution to a beneficiary will need to be a genuine distribution of trust funds and that beneficiary will need to have enjoyed the economic benefit of those funds, outside the normal financial support that a beneficiary would be entitled to receive (such as the support a child is entitled to receive from his or her parents). Unpaid present entitlements (UPEs) should be used with extreme caution and if money is to be left in the trust, a proper commercial loan agreement might be preferable.
The use of bucket companies is only likely to work if the trust income is actually paid into the company and the company then uses the after-tax income to make proper financial investments, such as a commercial loan to the trust or acquisition of income producing assets itself. It is more likely that the company will then become the investment vehicle rather than the trust. This is not an altogether bad outcome, as company tax rates are still less than the individual rates and any dividends can still be fully franked.
The question of what to do with existing UPEs is creating some serious headaches, particularly if they were created post 1 July 2014 and fall within the blue or red zones. The ATO invite you to “engage” with them to determine what “modifications may be appropriate” for existing arrangements. This is a scary thought for most taxpayers. Fronting up to the ATO and revealing all your “sins” takes some courage, particularly when you do not necessarily know what the outcome might be and what further review might be triggered. But having said that, it is always better to have early engagement with the ATO than to simply hope the ATO spotlight does not fall on you. If your accountant has indicated that you might be at risk, then a good way of avoiding nasty penalties and interest is to front up to the ATO and discuss how a solution can be found. The ATO is a little more accommodating these days so early engagement might be something to seriously consider.
If you have a family trust and there are UPEs in the balance sheet, it is time to have a conversation with your accountant to determine which ATO zone your arrangement falls into. White or green, not too bad; blue or red something needs to be done.
If you need any assistance with these or any other tax issues, please do not hesitate to contact Mike Frampton at Murfett Legal on +61 8 9388 3100.
Note: The above is a summary for general information purposes only. It is not intended to be comprehensive or constitute legal advice. You should seek formal legal or other professional advice in relation to your particular circumstances before relying on the content of this article.
Author: Mike Frampton (Partner: Tax, Commercial and Estate Planning)
Email: [email protected]
Murfett Legal is a leading law firm in WA, providing services in litigation, corporate and commercial, employment and workplace relations, insolvency, debt collection, business restructuring, Wills & estates, property, leasing, settlements, liquor licensing and intellectual property.
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