Family Trust Distributions Under the ATO Microscope
Changes affecting family trust distributions that have associated ‘reimbursement agreements’ are at our doorstep; both by the 1st July 2022 and retrospectively. The ATO has changed the rules in relation to the taxing of family trusts via the issue of a draft ruling (TR 2022/D1).
This ruling targets the common tax planning strategies which involve distributions to companies and family members; typically where the trust distributes to lower taxed family members or companies and where the benefit of the distribution is diverted away from the beneficiary to another family member (or company) that would otherwise pay a higher rate of tax if distributed directly to them.
What does this mean for your family trust? It means you need to reconsider how you use your family trust and, at the very least, test your current and/or historical arrangements relative to that of the ATO Commissioner’s.
What is the ruling all about?
The tax office is seeking to impose section 100A on applicable trust distributions, resulting in the trustee of the trust being taxed (at the top marginal rate) rather than the beneficiary to whom it was purported to be taxed to (who would’ve likely paid considerably less tax than the trustee).
When s100A can apply:
- A beneficiary is presently entitled to a share of the income of a trust
- There is an agreement (formal or informal, written or unwritten) where a person other than the beneficiary will benefit from the amount, and
- A purpose of the agreement is that less income tax will be paid
When does s100A not apply:
s100A does not apply if the agreement is entered into as part of an ‘ordinary family or commercial dealing’, however, this is exactly what the ATO is targeting. And ‘ordinary family or commercial dealing’ cannot operate merely because all parties to the arrangement are family members, or because the practice is widespread.
What type of distributions may be an issue?
A broad range of trust distributions could be caught under the new draft ruling, but some appear more problematic than others.
As an example, a trust which distributes all its income to a married couple, who use that money to pay for their household expenses, is unlikely to be problematic.
But, if the trust is distributing to adult children, but the funds from that distribution actually end up in the hands of their parents, that is likely to be an issue.
If adult children are at university and earning no other income have the full benefit of the marginal tax rates. A distribution to them of $180,000 could generate tax savings of around $30,000. While families may be attracted by the tax savings, they may baulk at the idea of actually putting $180,000 in their child’s bank account.
Financial strategies have changed over time to manage that concern, and these are what the ATO is questioning.
Unpaid trust distributions to companies are also a current target of the ATO. As are circular arrangements where a trust distributes to a company, which in turn pays a dividend back to the trust, which then distributes back to the company.
Are trust distributions to kids or grandparents over?
Perhaps not, however these arrangements will be subject to much closer scrutiny by the ATO in the future. If the distributions genuinely take place and the family or commercial basis for the distributions can be readily explained, the circumstance may be more likely to fit within the ‘ordinary family or commercial dealing’ exclusion.
For example, if an adult child who lives at home with their parents receives a $10,000 distribution from their parents’ family trust, and the child passes that distribution to their parents to cover the costs of running a car or living at home then this may withstand scrutiny under s100A.
However, a distribution to the adult child of $180,000 which finds its way to the parents would be far less likely to be readily explainable as an ‘ordinary family or commercial dealing’ in the absence of other more substantial reasons – such as the child using the distribution to make a repayment on a loan that the parents previously made to that child to enable them to purchase their first property.
The ATO makes specific mention that a particular situation is not an ‘ordinary family or commercial dealing’ merely because it has become common practice. It is noted that taxpayers cannot rely on their arrangement being ‘ordinary’ merely because ‘everyone else does it’.
Detailed reasoning and documentation for actions will be crucial in any potential arguments with the ATO.
What should you do now?
If you have a family trust, it is important to consider whether any of the new tax office stances could cause you a problem. If your trust is distributing to a range of family members, or to companies, then you should review your situation in detail.
Some of the tax office views have been released in draft form, or are not proposed to apply until 1 July 2022, however other parts of the ATO view are intended to apply retrospectively. Accordingly, considering the issues and addressing them before 30 June 2022 is important.
Trusts will continue to be an effective structure for managing family wealth, but the tax planning aspect will become more complex and tailored. Most family groups will need to consider this incidental to their tax planning processes leading up to 30 June 2022.
To discuss how these changes impact you and the best ways to manage your family trust situation, please contact us at New Leaf Advisory.