Section 100A
The tax legislation contains an integrity rule, section 100A, which is aimed at situations where income of a trust is appointed in favour of a beneficiary, but the economic benefit of the distribution is provided to another individual or entity.
Distributions to minor beneficiaries and other beneficiaries who are under a legal disability are not impacted by these rules.
If trust distributions are caught by section 100A, this generally results in the trustee being taxed on the income at penalty rates rather than the beneficiary being taxed at their own marginal tax rates.
High risk areas
Until recently many people have relied on the exclusions to section 100A which prevent the rules applying when the distribution is to a beneficiary who is under a legal disability (e.g., a minor) or where the arrangement is part of an ordinary family or commercial dealing (the ‘ordinary dealing’ exception). It is the ordinary dealing exception that is currently in the spotlight.
For example, let’s assume that a university student who is over 18 and has no other sources of income is made presently entitled to $100,000 of trust income. The student agrees to pay the funds (less tax they need to pay to the ATO) to their parents to reimburse them for costs that were incurred when the student was a minor. This situation is likely to be considered high risk if the student is on a lower marginal tax rate than the parents because the parents are receiving the real benefit of the income.
The ATO is also concerned with scenarios involving circular distributions. For example, this could occur when a trust distributes income to a company that is owned by the trust. The company then pays dividends back to the trust, which distributes some or all of the dividends back to the company. And so on. The ATO views these arrangements as high risk from a section 100A perspective.
Where to from here?
If you have a discretionary trust, it will be important to ensure that all trust distribution arrangements are reviewed in light of the ATO’s guidance to determine the level of risk associated with the arrangements.
It is also vital to ensure that appropriate documentation is in place to demonstrate how funds relating to trust distributions are being used or applied for the benefit of the beneficiaries.
We understand this may be confusing and concerning to all members of discretionary trusts, so we’re here to help. If you need assistance with your discretionary trust, please contact our office.
