When the trust reimbursement agreement provision of section 100A of the Income Tax Assessment Act 1936 (ITAA36) was introduced in 1978 as a specific anti-avoidance measure, it was intended to counter tax avoidance activities through trust stripping schemes at the time. However, the legislation is drafted so broadly that the provision can apply beyond this original intention.
This has become a live issue in recent years when the Australian Taxation Office (ATO) originally issued a fact sheet in 2014, then a website document in 2016 and have begun applying the provision in its audit activities on discretionary trust distributions.
In short, section 100A applies where all of the following conditions are satisfied:
- There must be a beneficiary who is not under any legal disability and is ‘presently entitled to a share of the income of the trust estate’;
- There must be an ‘agreement’;
- That agreement must be a ‘reimbursement agreement’;
- The present entitlement of the beneficiary arose:
- out of the reimbursement agreement; or
- by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement.
The drafting of the term ‘agreement’ is intentionally broad and includes any agreement, arrangement or understanding, whether formal or informal, express or implied, and either enforceable or unenforceable. Agreements also include where a person abandons their rights to a repayment of loan or fails to take action to recover loan monies, postponement of the repayment of any debt also constitutes an agreement.
Generally, a reimbursement agreement involves making someone presently entitled to trust income in circumstances where both of the following circumstances are present:
- someone other than the presently entitled beneficiary actually benefits from that income; and
- at least one party enters into the agreement for purposes that include getting a tax benefit.
Where the provision applies, the trust distributions are assessed to the trustee under section 99A at the top marginal tax rate. Further, the ATO has an unlimited period within which to make an assessment under section 100A.
However, section 100A does not apply to an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing.
Ordinary Family or Commercial Dealing
The majority of trusts will heavily rely on this exclusion to escape section 100A. Unfortunately, the term is not defined in the legislation. Despite its 35 years of history, there is limited guidance in this area and the few court cases that have considered section 100A do not provide clear guidance on this.
The ATO on its website provides examples whether certain arrangements do and do not constitute ordinary commercial or family dealings. Common features in the examples that do not satisfy ‘ordinary family or commercial dealing’ include:
- a beneficiary who was made presently entitled pays a lower amount of tax than the person actually enjoying the economic benefit of that income;
- a beneficiary is a tax-exempt entity;
- a beneficiary is a non-resident of Australia and net income includes foreign source income or income subject to withholding tax in Australia;
- a beneficiary has tax losses or excess deductions; and
- a restructure where a new class of beneficiaries are introduced with the above features.
It is common in family tax planning for discretionary trusts to distribute income to beneficiaries on lower tax brackets, such as adult children or foreign resident beneficiaries. The ATO has made it clear that trust distributions made to family members on lower tax rates in itself may not be sufficient to constitute ‘ordinary family dealings’. The gifting or forgiveness of entitlements owed to family members to the parents is also an area of concern for the ATO.
Therefore, consideration must be given to the potential application of section 100A to these distributions, particularly when they remain unpaid for some time.