Update on ATO changes to discretionary trusts

Back in February we wrote about the recent change in the ATO’s approach to discretionary trusts, in particular where distributions of trust income are made to adult children as beneficiaries; a common tax planning strategy.

Since then there has been a lot of discussion in professional circles regarding the ATO’s change of view regarding the application of section 100A. The Federal Government has partly listened to criticism of the ATO’s approach, in particular the ATO position that their new interpretation would apply both prospectively and retrospectively, and has clarified that taxpayers and advisers can continue to rely on the ATO’s previous guidance released in 2014 for distributions made from that point in time. In practice, however, the 2014 guidance was limited and really aimed at discouraging circular flows of trust income between a trust and a company beneficiary.

The ATO recently lost a Federal Court case (the Guardian case) where they were arguing that section 100A applied. This case has been appealed to the Full Court of the FCA, however, it may take many months for the appeal to be heard. Some commentators have argued that the ATO should have waited for the appeal to be heard before prematurely releasing their new guidance for trust distributions and causing such disruption for taxpayers and advisers. It appears that the ATO are placing more importance on trying to discourage tax planning using trusts, rather than first waiting for the courts to clarify the law in the area.

So what are trustees to do for their 30 June 2022 income distributions?

In draft Practical Compliance Guideline PCG 2022/D1 the ATO set out a ‘risk assessment framework’ that they will use in reviewing trust distributions from 1 July 2022. In the draft guidelines they state that, “if your circumstances align with the low-risk ratings set out in this Guideline, we will generally not allocate compliance resources to test the tax outcomes of your arrangement”.

So if your trust falls into a ‘low risk’ zone, the ATO will generally (no guarantees) not review or audit you.

Here’s a summary of the risk zones in the draft guidelines:

White zone – Low risk. The ATO describe White Zone arrangements as those entered into before 1 July 2014.
Green zone – Low risk. E.g. Distributions to individual family members where the distribution is paid in cash to the beneficiary and used for family purposes and/or to benefit a dependent; distributions to adult children to meet university fees or pay the deposit on a house; trust distribution retained by the trust and invested to produce income.
Blue zone – Medium risk. E.g. An adult beneficiary makes a gift of their trust entitlement to a parent who controls the trust; where a dividend payable by a corporate beneficiary to the trustee is set-off against the amount payable by the trust. An arrangement being in the Blue zone does not mean that there is a tax problem, however, the ATO state that they would need to review the facts ‘to better understand your arrangement’.
Red zone – High risk. If the ATO identify red zone arrangements, they state that they will review/audit the trust. E.g. Where an adult beneficiary loans or gifts their entitlement to a parent and it is understood that this would occur at the time of the distribution; circular distributions of income between a trust and a wholly owned company.

Whilst the ATO’s new guidelines are stated to apply from 1 July 2022, the ATO could possibly review trust distributions for the year ending 30 June 2022 through the lens of their new interpretation. Until the law in this area is clarified by the appeal in the Guardian case, if trustees wish to comply with the new ATO guidance in deciding the distribution of trust income going forward, trustees should pay particular attention to the points below:

Consider the level of risk of section 100A to their proposed distributions, in light of the ATO’s published guidance (i.e. which zone do you fall into?)
Maintain a bank account for the trust and conduct all transactions through the account
Limit trust distributions to adult children:
- To amounts that will be paid directly to their personal bank account by the trust in cash (and not subsequently loaned or gifted to the trustees or directors); or
- Where the beneficiary directs the trustee to pay expenses on their behalf, ensure that the obligation/assets are in the name of the child e.g. university fees, home deposits, superannuation contributions, etc.
- If the balance payable by a trust to an adult child is increasing year on year and will at some point be paid to the beneficiary (e.g. the trust is saving for their home deposit) then the ‘family investment strategy’ should be documented including this goal.

As always, please let us know if you have any questions.

IMPORTANT NOTICE

This blog post contains general information only and has been prepared by Allworths without reference to your objectives, financial situation or needs. Allworths cannot guarantee the accuracy, completeness or timeliness of the information contained here. By making this information available to you, we are not providing professional advice or recommendations. Before acting on any of the information contained here, you should seek professional advice.