ATO issues draft guidance on trusts

“We have identified cases where a private group seeks to extinguish unpaid present entitlements (UPEs) or avoid obligations under Division 7A by implementing an arrangement where a private company subscribes for units in a unit trust. The unit trust may then provide payments or loans to other entities within the private group,” the ATO explained.

“These arrangements have attracted our attention, as they may give rise to various income tax consequences, such as the application of Division 7A of the ITAA 1936, section 100A of the ITAA 1936, Part IVA of the ITAA 1936.”

The ATO said Division 7A may apply where there is a UPE. For example, where a private company is a beneficiary of a trust and is made presently entitled to the income of the trust but does not receive payment of the distribution.

One of the activities that will attract the ATO’s attention, it said, are private companies that include assessable trust distributions but do not receive payment of the distribution from the trust before the earlier of the due date for lodgement or the lodgement date of the trust’s tax return for the year in which the loan was made.

The ATO will also be scrutinising arrangements where funds have not been put on a sub-trust for the sole benefit of the private company beneficiary or where there has been a failure to repay loans or sub-trust investments at the conclusion of the term specified in the original agreement.

Arrangements purporting to extinguish the UPE of the private company beneficiary and non-lodgement of returns and activity statements will also attract scrutiny, it said.

The ATO has released a package of draft advice and guidance products for consultation, which sets out its evolving view on the tax treatment of trust entitlements and unpaid present entitlements of trust beneficiaries.

The Tax Office said that the products had been developed in response to submissions by tax advisers and their clients that they need greater certainty through ATO guidance to meet their tax obligations.

The guidance, it said, will be relevant to any trustee or controller of a closely held trust that may have concerns about whether the trust anti-avoidance provision in section 100A may apply when trust income is distributed to relatively favourably taxed beneficiaries, but the benefits of that income are enjoyed by others.

Section 100A is an anti-avoidance rule that applies where lower or concessionally taxed beneficiaries of a trust are made entitled to trust income by the trustee, while the income is enjoyed by another person who would otherwise have had to pay more income tax if they were made entitled to the trust income.

When the rule applies, the trustee (and not the beneficiary) is liable to tax on the income at the top marginal rate.

The guidance is also relevant to any trustee or controller of a closely held trust that intends to or has in the past made a private company beneficiary presently entitled to trust income but not paid the amount on the basis that the amount is held in a sub-trust for the benefit of the private company and the arrangement avoids the application of Division 7A.

“The existing view on sub-trust arrangements has become difficult to maintain over time. It is unsupported by what we now understand to be the operation of the law and subsequent judicial decisions, and the practical administration of the position has the effect that the ATO’s ability to collect tax which has become due is impeded,” the ATO stated.

One of the pieces of draft guidance, TR 2022/D1, provides the Commissioner’s sought-after views on section 100A reimbursement agreements, for which there is limited judicial guidance.

Draft Practical Compliance Guideline PCG 2022/D1 gives practical certainty about how the Commissioner will dedicate compliance resources to cases where section 100A may potentially apply.

When PCG 2022/D1 is finalised, it will set out the ATO’s compliance approach in relation to beneficiary entitlements conferred on or after 1 July 2022.

TD 2022/D1 explains when an unpaid present entitlement or amount held on sub-trust becomes the provision of “financial accommodation”.

“Our view in TD 2022/D1 is that a private company with unpaid trust entitlements (UPEs) will broadly provide financial accommodation to anyone the company allows to have access to the amounts to which they are entitled (whether or not they pay interest or other compensation). As a result, Division 7A can apply,” said the ATO.

“The position taken in this draft determination is the ATO’s considered view on when outstanding trust entitlements will be ‘financial accommodation’ for the purposes of Division 7A.”

The ATO has also issued an alert TA 2022/1, which outline’s the regulator’s concerns with arrangements where family members who have relatively low tax rates are made presently entitled to trust income in circumstances where those members are not intended to retain any benefit.

“We emphasise that the scope of our concerns on these arrangements is not limited to section 100A, and extends to whether the arrangements are legally effective, and whether the general anti-avoidance rules in Part IVA of the ITAA 1936 may apply,” it said.

Speaking to SMSF Adviser, Insyt chief executive Darren Wynen said this guidance is really looking at situations where someone else has received the benefit of the distribution.

Mr Wynen noted that some SMSFs hold more complicated structures where they’ve invested in an unrelated trust which has other investments in entities higher up the chain.

“Practitioners with clients [in that kind of situation], would need to be mindful of this guidance,” he said.

“I’m seeing more complicated structures now where you’ve got a pre-August 1999 trust investing in a company that’s investing in another unit trust and it can be quite a deep structure. So these entities that are operating above are funnelling down income to the SMSF ultimately, and you need to be really mindful of keeping within these rules.”

However, the overlaying issue for SMSFs, Mr Wynen said, is that SMSFs shouldn’t be providing benefits outside of the trust for other parties on non-commercial terms anyway.

“That could give rise to sole purpose issues under section 62, and could potentially give rise to financial assistance issues under section 65 and it could also give rise to a breach of the arm’s length requirements under section 109,” he warned.

“Hopefully this guidance reinforces that ultimately where the super fund owns the interest, it should be the party that is benefiting from any profits flowing down stream.”