TA 2022/1: Parents benefitting from the trust entitlements of their children over 18 years of age
The Australian Taxation Office (ATO) is currently reviewing trust arrangements where parents enjoy the economic benefit of trust income appointed to their adult 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.
The arrangements the ATO is concerned about are those which are more properly explained by the tax outcomes obtained, including the accessing of tax-free thresholds and lower marginal tax rates of family members, rather than ordinary familial considerations. The ATO is particularly concerned where the economic benefit of the arrangement is enjoyed by the parents because:
- the children are paying amounts for expenses that would ordinarily be met by their parents; or
- the children’s entitlements are otherwise being applied for the benefit of the parents either directly or indirectly, or by the charging of excessive amounts; and /or
- there are elements of contrivance.
While the Alert is focused on arrangements involving the adult children of the controlling individuals, it makes clear that the ATO is similarly concerned with arrangements involving the family members of controlling individuals who have lower marginal tax rates than those of the controlling individual.
ATO example
An example that the ATO has identified as problematic is summarised below:
The trustee of the A Family Trust is Corporate Trustee Pty Ltd. The father is the sole shareholder and controller of Corporate Trustee Pty Ltd. The A Family Trust derives assessable income in excess of $400,000 a year. The daughter, is a beneficiary of the trust. The daughter has recently turned 18 years of age, works part-time and expects to derive assessable income from her work of approximately $20,000 a year.
Before the end of the 2020-21 income year, the family meets and agrees that any distribution resolved to be made by the Trustee will, after the payment of tax, be paid to the father to reimburse him for part of the fees for secondary schooling and costs of other extracurricular activities since the daughter was five years old.
Records maintained by the family show that these expenses amounted to $315,000.
The Trustee resolves to distribute $160,000 to the daughter and pays this amount into an account held in the father’s name. The father pays income tax on the daughter's behalf.
The daughter is purportedly made entitled to a trust distribution and this amount is used to reimburse her Parents for expenses that they would ordinarily meet. The arrangement, which results in the father obtaining the economic benefit of the trust income without that income being subject to tax at the top marginal tax rate he would otherwise have paid.
What are the potential consequences?
These arrangements, if effective, may have unintended tax consequences or may attract the application of specific or general anti-avoidance provisions. These include:
- that the purported distribution to the children may be a sham or otherwise ineffective for trust purposes; or
- the arrangement may be a reimbursement agreement under section 100A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936); or
- section 95A and section 97(1) of the Income Tax Assessment Act 1997 may apply to treat the Parents as being presently entitled depending on the terms of the trust deed; or
- Part IVA of the ITAA 1936 could apply.
Assessments issued in each of these scenarios would likely result in the distribution being taxed at the highest marginal income tax rate, potentially resulting in substantial increases in the tax liability of the trustee or the parents, as well as incurring interest on any consequential unpaid tax and potentially severe penalties.
What should you do?
If you or any of your clients have entered into similar arrangements or are contemplating entering into similar arrangements, we encourage you to contact one of our experts below.
We can assist in providing advice, and if necessary, seeking private rulings or making voluntary disclosures.
The circumstance described in the Taxpayer Alert is referred to in the ATO’s recently released Draft Practical Compliance Guideline PCG 2022/D1: Section 100A reimbursement agreements – ATO compliance approach. Our summary on Draft Practical Compliance Guideline PCG 2022/D1 can be found here.
Find out more and read a copy of the taxpayer alert below.
View Taxpayer Alert TA 2022/1
Contact our tax team
If you have identified issues or would like assistance in reviewing your risks associated with Tax Alert 2022/1, please contact one of our team members below.
