On 23 February 2022, the Australian Taxation Office (ATO) handed down its draft ruling and guidance on how it will apply anti-avoidance measures to crack down on complex trust structures used for the purpose of minimising tax. The ruling will change the way that section 100A (s100A) of the Income Tax Assessment Act is applied by the ATO, and will affect how the discretionary trusts of many medical professionals will determine distributions, particularly in a situation where there are adult children or other low-income beneficiaries.
We note that medicos who are structured as a trust and derive their patient income through a trust structure are still bound by the personal exertion income rules and must distribute the income to themselves. Therefore, the s100A rules discussed in this article apply to discretionary trusts used for service entities or for investment purposes, not medical practice trusts.
What is s100A?
Under s100A, trust distributions are considered to not be effective when they arise from “reimbursement agreements” between parties, entered into with the purpose of reducing tax liabilities. The ATO says a reimbursement agreement generally involves making someone presently entitled to distributable income of a trust in circumstances where both: someone else actually benefits from that income, and a purpose of a party to the agreement is obtaining a tax benefit.
An arrangement will not be a reimbursement agreement where it is considered an “ordinary family or commercial dealing”. Exactly what constitutes an ordinary family or commercial dealing has long been a grey area, but this has now been somewhat clarified by the ATO through this ruling.
What’s in the draft ruling?
The ATO has reinforced that what constitutes an ordinary family or commercial dealing under s100A will depend on the facts of the case. However, in order to be an ordinary family or commercial dealing, the acts undertaken must be capable of explanation by the familial or commercial objects they are designed to achieve.
Note that the ATO will not consider an arrangement to be an ordinary family or commercial dealing just because it is commonplace, or undertaken between family members.
We have expanded on some of the key “high-risk” examples in the draft ruling and Practical Compliance Guideline below.
i) Adult children beneficiaries
The ATO sees mischief where adult children with low marginal tax rates are made presently entitled to trust income, and there is a history of the entitlement not being paid to the child. Additional factors that would trigger s100A (and would not be considered ordinary family dealings) include where the cash that represents the child’s trust entitlement is loaned or gifted to his/her parents, or is applied to repay his/her parents for costs incurred by the parents when the child was a minor. The same logic can be applied to distributions to other family members, such as parents, siblings or in-laws.
ii) Beneficiaries with losses
The ATO has indicated that they are likely to apply audit resources to situations where beneficiaries with tax losses are made presently entitled to trust income, and the cash representing the entitlement does not flow to the beneficiaries.
Next steps for Trustees
The views adopted by the ATO represent a significant shift in the previously accepted norms, and medical professionals with trusts may need to adopt different approaches or obtain further advice in the future.