Autumn 2022 Tax Bulletin

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In this issue

ATO focus on parents benefitting from the trust entitlements of adult children

For many years, business owners and investors who use Family (Discretionary) Trusts have looked to spreading the trust income across family member beneficiaries, often made to adult children for asset protection and estate planning purposes.

Sometimes, the adult children in a family may have lower tax rates than their parents, so the overall tax rate % for the family group is lower because of the spread of these trust distributions.

We outline below one of the more significant developments for the taxation of trusts in over two decades.

Firstly on 23 February 2022, the ATO issued Taxpayer Alert TA 2022/1 ”Parents benefitting from the trust entitlements of their children over 18 years of age”. This document is of immediate concern as it has been released in its final state and applies immediately, whereby the ATO encourage taxpayers who have entered into such an arrangement to effectively contact the ATO to request a ruling or make a voluntary disclosure.

In the Alert the ATO states its view that parents who make trust distributions to their adult children and then arrange for their children to give the distribution back to them are doing so only to reduce tax. The ATO plans to invalidate the trust distribution and tax the trustee of the trust at 47% on the amount of the distribution, and they may charge penalties on this as well.

The ATO have stated that they can go back as far as the 2015 tax year to review trust distributions.

Many family groups will pay higher taxes (now and potentially retrospectively) as a result of the ATO’s more aggressive approach. Most taxpayers will believe this is very unfair. It goes against what has been commonly done for many years under the ATO’s watch and their silence on the matter has been a tacit approval of these family dealings. However, their new view may vastly restrict how your trust distributes profits in the future.

In addition, the ATO have also released a Draft Tax Ruling and a Draft Practical Compliance Guideline designed to stop commonly used trust distributions to family members.

The Draft Tax Ruling TR 2022/D1 deals more generally with the ATO’s views on Section 100A Reimbursement Agreements. The Draft Practical Compliance Guideline PCG 2022/D1 outlines the ATO’s Compliance Approach to their views in the Ruling.

Whilst we recommend that you consider these documents as well, it is important to note that both documents are currently in draft and are subject to comments by 8 April.

As a result of these ATO rulings:

  • your options to spread your trust income across your family members may be vastly limited; and
  • your family group overall tax payable will probably increase.

We want to let you know about this now so you can plan for the extra tax payments that you may need to make.

In this bulletin we explain in more detail how we can help you and why you will be better off with our recommendations.

So what are the arrangements the ATO are concerned about?

Quoting from the Alert:

  1. We are currently reviewing trust arrangements where parents enjoy the economic benefit of trust income appointed to their children who are over 18 years of age (Children). The common feature of the arrangements is that trust income is appointed between members of the family group but in substance it is the parents who exercise control over and enjoy the economic benefit of the income….
  1. The arrangements may display all or most of the following features:
    • The trustees of a discretionary trust (Trust), or the directors of a corporate trustee, are either one or two individuals who are the parents in a particular family (Parents).
    • Income derived by the Trust is used during the year of derivation to meet the expenses of the Parents. These may be recorded as beneficiary loans made from the trustee to the Parents throughout the year.
    • Resolutions of the trustee for the year show one or more of the Children presently entitled to a share of the income of the Trust.
    • The entitlements are for substantial amounts but do not generally result in the Children’s taxable income exceeding the threshold for the top marginal tax rate ($180,000).
    • Amounts are not paid to the Children. Rather, at the actual or purported direction of the Children, the entitlements are satisfied by the amounts being either
      • paid to their Parents, or
      • applied against any beneficiary loans owed by the Parents.
    • The parties contend that the entitlements are paid or applied in this manner because
      • the Children are required to repay their Parents for expenses incurred in relation to their upbringing or while they were minors (for example, school fees, school uniform costs or their share of the family holidays)
      • the Children are required to pay or repay their Parents amounts to meet their share of family costs for the current year in excess of amounts it would reasonably be expected an adult child would meet for their personal living expenses while they remain living at home or otherwise supported to some extent by their Parents (those amounts being, for example, a reasonable rate for their board, lodgings or rent if living away from home, or car expenses), or
      • there is an agreement that the Parents will manage the pooled family members’ entitlements from the Trust for the benefit of the family members.
    • There is no expectation or understanding that the Children’s income they derive from sources other than the Trust distributions will be used to either repay their Parents for expenses incurred when they were a minor or pay more than their reasonable share of the household expenditures, or be placed in a pool to be managed by the Parents for the benefit of the family members.

The Alert draws a distinction between expenses incurred on behalf of children aged under 18 years, as compared with expenses incurred by or on behalf of children aged 18 and over.

The ATO are clearly of the view that expenses, including private school fees, incurred for the benefit of minor children are “parental expenses” and should not be offset against future trust entitlements of the adult children.

However, in some welcome news, the ATO provides an example in the Alert whereby a trust entitlement is used to meet University fees and board paid to a Grandmother for an adult child, accepting that they are legitimate expenses that are not subject to the Alert.

It is important to state that the ATO’s views in the Alert (and indeed the Draft Ruling and PCG) have not arisen from recent judicial guidance or legislative amendment, but represent the Commissioner’s preliminary view on how section 100A should be applied.

The key question yet to be answered by the Courts is what constitutes “ordinary family dealings” and specifically whether so called “parental expenses” would be or would not be considered “ordinary family dealings”.  Until we get that answered, the ATO’s position must be taken as a draft view.

However, given the severity of the consequences outlined by the ATO in their Alert, Family Group clients must consider the Alert when determining their June 2022 trust distributions.

This area will dominate Family Group tax planning for the coming months and we will keep you informed as to how the draft ruling progresses. But please do not hesitate to contact Shannon, Aniket or Patrick if you wish to discuss the matter further.

Unpaid Present Entitlements and Sub-Trusts – ATO Draft Guidance

Also on 23 February 2022, the ATO issued a raft of documents targeted at trust arrangements. One of these documents, ‘TD 2022/D1’, sets out the Commissioner’s view on when an unpaid present entitlement (UPE) owed to a corporate beneficiary or an amount held on sub-trust will become financial accommodation. The view set out in this draft determination is a significant shift from what was expressed in 2010 by the ATO.

Prior to 2010, UPEs owing to corporate beneficiaries were not considered to be loans for Division 7A purposes.  TR 2010/3 extended the scope of the meaning of a ‘loan’ for the purposes of Division 7A (loans from private companies) on the basis that UPEs were considered ‘financial accommodation’. This ruling effectively put an end to trusts distributing income to ‘bucket companies’, leaving the funds unpaid and effectively capping the tax on the trust income at the corporate tax rate.

However the ATO did provide the option of placing UPEs on ‘sub-trust’ arrangements whereby repayments could be made over 7 or 10 years on an interest-only basis. TD 2022/D1 effectively puts an end to sub-trust arrangements. It is now the Commissioner’s view that where a sub-trust arrangement is created but funds are inter-mingled with the general trust funds, this will amount to financial accommodation and the UPE will be considered a loan for Division 7A purposes.

This is a significant departure from the ATO’s previous view which allowed sub-trust funds to be reinvested and used for the trust itself as long as interest was charged on the sub-trust funds.

The timing on when Division 7A obligation arises pursuant to TD 2022/D1 will be important. The determination states that a UPE will amount to financial accommodation and will therefore be a loan as soon as the corporate beneficiary has knowledge of the UPE but does not demand payment of this.

For example, where a year end distribution is resolved on 30 June 2022, the corporate beneficiary would have knowledge of the UPE on that date itself. A deemed loan would therefore arise on 30 June 2022 and will need to be either repaid or placed on a complying loan agreement by the lodgement date of the 2022 company tax return, likely May 2023.

In contrast, the ATO previously deemed the UPE to be converted to a loan in the 2023 year which would need to be placed on a loan agreement by the lodgement date of the 2023 tax return, likely May 2024. Accordingly, the approach in TD 2022/D1 requires action to be taken in relation to the deemed loan a year earlier.

GST and Services to Overseas Recipients

Are services provided in Australia to recipients based overseas GST free? This is a common question we are asked from our clients who have overseas customers. The answer is, as is often the case, that it depends on the facts.

Essentially, to be considered as an export of services and hence GST-free, several criteria need to be met, otherwise GST will be applicable on these services.

The GST Act provides that a “supply of a thing” (other than goods or real property) made to a non-resident is GST-free if it is a supply that is made to a non-resident, who is not in Australia when the thing supplied is done, and (in item 2):

a. the supply is neither a supply of work physically performed on goods situated in Australia when the work is done, nor a supply directly connected with real property situated in Australia; or

b. The non-resident acquires the thing in carrying on the non-resident’s enterprise but is not registered or required to be registered for GST.

Thus a supply is GST-free if it meets the requirement that the non-residents are not in Australia, and satisfies either paragraph (a) or (b).

Even if a supplier is able to satisfy the above requirements, to be GST free, the GST Act also requires that the services must not be on-supplied to another Australian entity.

If the supply is under an agreement entered into with a non-resident entity that requires the services to be provided to another entity in Australia, the GST Act negates the GST-free status of that supply.  That is, in the above example where an Australian entity provides general consultancy services to a non-resident, the services will not be GST free if the service agreement requires that the services are provided to another entity in Australia.

Thus the first risk for an Australian supplier is in satisfying the precondition that the non-resident (company or individual) to whom you supply your service is not in Australia in relation to the supply when those services are provided.  Where the recipient is a company, a supplier needs to determine whether the company has a “presence in Australia” in relation to the supply.

Goods and Services Tax Ruling GSTR 2004/7 and Law Companion Guideline LCG 2016/1 provide some guidance in determining when a non-resident company is in Australia when the thing supplied is done.

Even if an Australian supplier can confidently confirm that the recipient is “not in Australia when the thing supplied is done”, one of the criteria above needs to be satisfied for the services to be GST free.

The GST free concession under item 2(a) requires that the services must not be work physically performed on goods situated in Australia, nor can it be a supply directly connected with real property situated in Australia.  Where this criteria is not met, the Australia supplier will need to adhere to item 2(b) for GST free treatment.

GST free treatment under item 2(b) requires the Australia supplier to confirm that the non-resident recipient acquires the services in carrying on of the non-resident’s enterprise and that the non-resident is not registered, nor is it required to be registered for GST.

This requirement is particularly onerous on suppliers as they will often not know the Australian GST profile of the non-resident.  In these instances, it would be prudent for the Australian supplier to obtain from the non-resident written confirmation that the recipient is not registered for GST.

The main indeterminate risk of the Australian supplier is in confirming that the non-resident is not “required to be registered”.  Where this is uncertain, some Australian suppliers have erred on the side of caution and charged and remitted GST on their services.  It would then be up to the non-resident recipient to provide details to the supplier that it is not required to register in order to obtain GST free treatment.

The issues discussed above are not matters that can simply be assumed or ignored.  We recommend that specific consideration of the above factors be addressed prior to an Australian supplier treating their services as GST free as the risk of getting this incorrect can be costly.

The onus is on a supplier to remit the correct amount of GST to the ATO.  If a transaction has been incorrectly assumed to be GST free when it was not, the GST shortfall will need to be remitted by Australian supplier to the ATO with possible risk of shortfall penalties and general interest charges.