The Trustees (or trustee company directors) must review and decide on the distributions they intend to make by 30 June, at the latest (the trust deed may actually require this to be done earlier).
If proper resolutions are not in place by 30 June, there is a danger that the trust’s taxable income will be assessed in the hands of a default beneficiary (if the trust deed so provides) or the trustee (in which case the highest marginal rate of tax would normally apply).
Anti-avoidance and “round-robin” distributions for trusts.
Family trusts cannot engage in circular trust distributions with other closely owned trusts due to anti-avoidance regulations.
The rules apply penalty tax rates in instances where trust revenue is allocated to one or more additional trusts and then returned to the original trust. Prior to 1 July 2019, trusts that elected to be treated as family trusts were exempt from these requirements; however, this is no longer the case.
Distributions to non-resident beneficiaries
In certain situations, non-resident beneficiaries may be taxed in Australia on gains relating to foreign assets that would not have been taxed in Australia if they had been made directly by the beneficiary.
The ATO believes that a resident discretionary trust’s capital gain will be taxed in Australia, even if the gain is paid to a non-resident beneficiary, even if the gain does not relate to Taxable Australian Property (TAP), and even if the gain is derived from a foreign source. In light of the fact that non-resident beneficiaries will be taxed at non-resident tax rates and may not be eligible for the full CGT discount, trustees of trusts with a mix of resident and non-resident beneficiaries will need to exercise caution when deciding on distributions.
The rulings of the ATO do not consider the potential application of any double tax agreements. This is another factor that must be examined in order to determine how likely it is that distributions will be taxed in the hands of non-resident beneficiaries.
Streaming of franked dividends and capital gains
Trustees can only stream franked dividends (and the associated franking credits) to a specific beneficiary for tax purposes if the beneficiary’s entitlement to the franked dividends is recognized in writing by 30 June. For streaming of capital gains to be effective for tax reasons, the beneficiary’s entitlement must be documented in writing by June 30 if the capital gains are included in the trust’s income for the year, or by August 31 if the capital gains are not included in the trust’s income.
The ATOs aggressive stance on trusts and trust distributions
The Australian Taxation Office (ATO) has produced a package of new advice material that focuses on how trusts distribute revenue. As a result of the ATO’s more aggressive approach, many family groups will pay greater taxes (both now and perhaps in the future).
Beneficiaries who may be affected
The ATO’s latest guideline focuses on distributions to adult children, corporate beneficiaries, and organizations that have suffered losses, but it is not limited to those instances:
- adolescent children
- corporate beneficiaries, as well as
- entities that have suffered damages
However, the advice is not limited to those specific scenarios.
These rules do not apply to beneficiaries who have a legal impairment (for example, children under the age of 18).
It is critical for persons with discretionary trusts to analyze all trust distribution arrangements in light of the ATO’s current guidance in order to assess the level of risk associated with the arrangements. It’s also critical to have proper documentation in place to show how monies from trust distributions are being used or applied for the benefit of beneficiaries.
Family trust beneficiaries at risk
Section 100A of the tax code has an integrity rule that applies when a trust’s income is designated in favor of a beneficiary but the economic benefit of the distribution (e.g. cash) is delivered to another individual or corporation. If a trust distribution is detected by section 100A, the trustee is taxed at penalty rates rather than the beneficiary’s marginal tax rate.
According to the current guidelines, the ATO will be looking to apply section 100A to various arrangements that are routinely utilized by family groups for tax planning purposes. As a result, the ATO’s permissible border has shrunk significantly, putting certain family trusts at risk of increased tax payments and fines.
The ATO is redrawing the lines of what is and is not acceptable
Section 100A has been established since 1979, but the ATO has rarely used it unless there is clear and deliberate tax avoidance going on. However, according to the ATO’s most recent instructions, the agency is now willing to use section 100A to address a broader range of cases.
Section 100A has some essential exceptions, such as when revenue is distributed to minor recipients or where the arrangement is part of a regular familial or commercial transaction. Much of the ATO’s new guidance focuses on whether the arrangements are part of a normal family or business transaction. The ATO points out that just because arrangements are widespread or involve members of a family group does not mean they are exempt. The ATO thinks that section 100A could apply in some cases if a child gifts money to their parents that is due to a family trust distribution.
The ATO’s guidance, which is still in draft form, identifies four ‘danger zones’: white, green, blue, and red. The ATO’s response will be determined by the risk zone for a specific arrangement:
Aimed towards pre-July 1, 2014 planning. The ATO will not investigate these arrangements unless they are part of a current inquiry, or if the trust and beneficiaries failed to file tax returns by July 1, 2017.
Low-risk arrangements are unlikely to be scrutinized by the ATO if they are adequately recorded. For example, if a trust pays income to an individual but the money are put into a joint bank account held by the individual and their spouse, this is a low-risk situation. Alternatively, where parents use their trust payout to pay for a deposit on an adult child’s mortgage, and this is a one-time agreement.
The ATO may conduct a review of the arrangements. The default zone is blue, and it covers any setups that do not fall into one of the other risk zones. The blue zone is likely to include circumstances in which the trustee retains funds but the arrangement does not fit within the scope of the green zone’s specified scenarios.
Section 100A does not apply automatically to blue zone agreements; instead, the ATO must be satisfied that the agreement is not subject to section 100A.
The arrangements will be thoroughly examined. These are arrangements that the ATO believes are intended to intentionally reduce tax, or where someone or something other than the beneficiary benefits.
Arrangements in which an adult child’s entitlement to trust income is paid to a parent or other caregiver to reimburse them for expenses spent before the adult kid turned 18 are high on the ATO’s red zone list. For instance, consider the cost of attending a private school. Alternatively, where the trust provides an adult child with a loan (debit balance account) for expenses incurred before they turned 18, and the entitlement is used to repay the loan. These arrangements will be scrutinized thoroughly, and if the ATO concludes that section 100A applies, the relevant amount will be taxed at the maximum marginal rate, which might apply across a number of income years.
Entities that have suffered losses
Unless it is evident that the economic benefit connected with the revenue is supplied to the beneficiary with the losses, distributions from a trust to a business with losses may also fall into the red zone. If the trust or another entity uses the economic benefit connected with the revenue that has been assigned to the entity with losses, section 100A may apply.
Circular agreements may also fall under section 100A’s purview. Section 100A, for example, could be activated if:
- at the conclusion of year 1, the trustee decides to designate income to a corporation
- the corporation deducts its portion of the trust’s net income from its assessable income for the first year and pays corporate tax
- in year 2, the corporation pays the trustee a fully franked dividend derived from the trust income, and the payout is included in the trust income and net income in year 2
- at the end of year 2, the trustee gives the company the right to portion or all of the trust revenue (which might include the franked distribution).
In succeeding years, these steps are repeated.
The ATO has produced a draft determination dealing specifically with overdue payments owed by trusts to corporate beneficiaries as part of a larger package of new instructions addressing trusts and trust payouts. From July 1, 2022, onwards, this proposed determination will apply to unpaid payouts.
If the sum due by the trust is regarded to be a loan, it may be subject to another integrity requirement in the tax code, known as Division 7A.
Division 7A is concerned with instances in which corporate profits are accessed by shareholders or their associated parties in the form of loans, payments, or forgiven debts. These amounts can be viewed as deemed unfranked dividends for tax purposes if certain actions are not followed, such as arranging the loan under a compliant loan arrangement, and are taxable at the taxpayer’s marginal tax rate.
The ATO’s new guideline, which is currently in draft form, examines when an unpaid claim to trust income will be viewed as a loan. It’s not a new concept to classify unpaid trust income entitlements as loans for the purposes of Division 7A. What’s new is the ATO’s methodology to deciding when these amounts begin to be classified as loans. If a trustee decides to appoint income to a corporate beneficiary, the timing of the unpaid entitlement becoming a loan will be determined by how the trustee expresses the entitlement (e.g., in trust distribution resolutions, etc.):
- If the corporation is entitled to a set dollar amount of trust income, the unpaid entitlement will be treated as a loan for Division 7A purposes in the year in which the current entitlement occurs; or
- If the company is entitled to a percentage of trust income or some other calculable portion of trust income, the unpaid entitlement will be treated as a loan from the time the trust income (or the amount the company is entitled to) is calculated, which is often after the end of the year in which the entitlement arose.
This is important in establishing when a compliant loan agreement should be put in place to avoid the entire unpaid amount being treated as a presumed dividend for tax reasons and when the trust should begin making principle and interest payments to the firm.
In addition, the ATO’s position on “sub-trust arrangements” has been modified. In other words, the ATO is implying that sub-trust arrangements will no longer be effective in avoiding an unpaid trust payout from being considered as a loan for Division 7A purposes if the funds are utilized by the trust, a company shareholder, or any of their associated parties.
In some ways, the new guideline, while still in draft form, represents a considerable shift from the ATO’s previous attitude. As a result, in some cases, the way unpaid entitlements are managed will need to change. However, unlike the section 100A recommendations, these modifications will only apply to trust entitlements that arise on or after July 1, 2022.
If you are having difficulty paying your tax bill, please contact us as soon as possible so that we can negotiate a deferment or payment plan on your behalf with the ATO.
Reporting of TFN
Have you filed TFN reports for all of your beneficiaries?
Outside of filing the trust tax return each year, Trustees of closely held trusts have several extra reporting responsibilities. The Australian Taxation Office (ATO) is now conducting a review of trustees to ensure that they are complying with these requirements, including the requirement to file TFN reports for beneficiaries.
Where TFN provided
Trustees are required to provide a TFN report for each beneficiary who has provided their TFN to the trustee. The TFN report must be submitted by the end of the month after the end of the quarter in which the TFN was used. For example, if a beneficiary’s TFN is received in April, the trustee must file a TFN report by the end of July.
Where TFN not provided
When a beneficiary fails to furnish a TFN, the trustee is compelled to withhold and pay tax to the ATO at a rate of 47 percent on payments made to the beneficiary. In addition, the trustee must provide an annual report detailing any payments withheld.
Penalties may be imposed if TFN reporting and withholding requirements are not met.
If you have any questions about the above-mentioned measures for family trusts, please contact Fullstack Advisoryand we’ll be glad to assist.