ATO focus on discretionary trusts could impact your clients
Lawyers need to ensure that clients with discretionary trusts are complying with the obligations imposed by the trust deeds and the tax obligations imposed on trusts and beneficiaries.
A well-known requirement is that minutes of trust distributions are completed before 30 June of each year. Matters relevant to distribution decisions will be even more complicated this year as the ATO has released four guidance products on the taxation of trusts and section 100A of the tax legislation (Guidance) that will require detailed consideration. You should not assume that the client’s accountants will deal with these issues. Legal input could be required.
For example, do you have clients who distribute tax income to adult children who are on lower marginal tax rates? If so, they need to know that the ATO will want to ensure that the adult children get receive the economic benefit of the money. If the money is loaned back to the parents, you will need valid loan agreements evidencing it.
The Guidance has arguably shifted the goalposts from where lawyers and other advisers understood them to be. On 6 April 2022, Senator McDonald, at an Economics Legislation Committee hearing, said to the ATO, “As you know, accountants are usually mild-mannered people who are not up for fisticuffs, but I’m receiving a huge amount of concern from them about the way the ATO is addressing section 100A”. Lawyers should be concerned too. Many businesses and individuals routinely use trusts, so a change in interpretation of longstanding tax provisions is always going to be keenly observed, especially where the ATO asserts a retrospective impact.
Section 100A is an anti-avoidance provision that applies when a beneficiary is presently entitled to trust income but the trust income is directed to, or enjoyed by a third party, with the result that less tax is paid. The section does not apply if the transaction is an “ordinary or family dealing”. When section 100A applies, the trustee is taxed on the trust income at the top marginal rates.
To date, section 100A was considered to be a provision designed to stop blatant trust stripping arrangements. It has always had an exclusion for “ordinary commercial and family dealings”. The ATO has acknowledged that some judicial clarification of the meaning of “ordinary commercial and family dealings” would be of assistance. For example, is it an ordinary family dealing for parents to make trust distributions to adult children but to withhold providing them with the benefit of those funds until the child is ready to commit to a house deposit?
The few cases on section 100A have dealt with more aggressive or blatant anti-avoidance trust stripping scenarios.
But now the ATO is seeking to potentially apply section 100A to what many lawyers and accountants consider to be within the ordinary family dealing exception. This is notwithstanding a recent first instance decision in Guardian v Federal Commissioner of Taxation  FCA 1619, where the Federal Court found against the ATO on this question. The Guardian tax case is an important one and is the only case to date that does not fall into the trust-stripping type arrangements. The ATO will appeal its first instance loss (Holding Redlich is representing the taxpayer both at first instance and on appeal).
Perhaps the most important point for lawyers is that what worked in the past from a tax perspective may now be challenged by the ATO. Taxpayers might dispute the ATO approach, but lawyers should advise clients of the risks before entering into arrangements.
Similarly, if past actions are inconsistent with the ATO, you need to advise your clients on what to do – whether to disclose to the ATO to mitigate penalties or to fight the issues.
What should lawyers do about these releases?
Lawyers should consider whether these releases could impact them and their clients. If they do, how can you best respond to these developments?
Here are our initial suggestions:
- consider before year end whether changes are required to previous practices regarding trust distribution resolutions – both who the beneficiary is and the amount distributed to the beneficiary
- do trust deeds need amending or updating?
- is there proper documentation in place for unpaid present entitlements or other arrangements where funds have been used to the benefit of non-beneficiaries
- is the 2014 trust guidance relevant to your client and can it be relied upon?
- is a voluntary disclosure to the ATO appropriate?
- if in doubt, consult with lawyers who practise in this area and who are familiar with dealing and negotiating with the ATO. Many of these lawyers will be discussing their concerns with the guidance materials with the ATO (either directly or via industry associations).