Recent guidance from the Australian Tax Office (ATO) on the application of section 100A of the Income Tax Assessment Act 1936 (Act) have blown the financial community away.
Not only does that guidance apply as far back as 2015 when the advice given would have been different to the advice of today (i.e. retroactive application, which is akin to a curse word in legal circles), some say it goes against the very raison d’être for introducing this provision in the legislation in the first place.
Advice on how to optimise one’s business affairs for tax purposes has always been part of the advisory side of an accountants’ (and, indeed, lawyers’) role.
“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes.”
“Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”
– Federal Appellate Judge Learned Hand in Gregory v. Helvering, 293 U.S. 465 (1935) and Commissioner v Newma 159 F.2d 848 (1947)
Similar sentiments were expressed by Chief Justice Barwick in the leading Australian High Court case of Slutzkin v FCT  HCA 9.
However, with the ATO threatening to have accountants reported to the Tax Practitioners Board for promoting schemes to reduce tax and equating previous advice from them as promulgating “tax avoidance”, minds are boggling.
It is worth noting that from 2015 up until today, those “schemes” were legitimate and entirely legal arrangements. We argue the crux of this issue lies within the distinction of an unintended benefit vs. one which is specifically sought.
As to whether or not we will see the ATO chase down all the naughty accountants and / or problem trust distributions since 2015, only time will tell. We envisage there will be legal hurdles associated with those recoveries, so it won’t all be plain sailing for our friends at the ATO.
What is a ‘Family Trust’?
Australia is unique in that a large portion of our businesses operate through what is called a family trust, otherwise known as a discretionary trust.
Put simply, a discretionary trust is a legal arrangement whereby the trust holds assets and income (usually a family business) on behalf of a group of discretionary beneficiaries (the family). It is discretionary because those who are eligible for distributions (payment) and how much they get is at the discretion of the trustees who are the legal owners of the assets and income of the trust.
What is section 100A?
A quick check in the books of Hansard reveals that s100A of the Act was targeted at arrangements at law that specifically sought to reduce the amount of tax payable and that were outside an “ordinary family or commercial dealing”.
Essentially, those beneficiaries such as a tax-exempt body or organisation being allocated a trust distribution and retaining only part of it while giving the majority of the funds tax free to another beneficiary.
Recent guidance suggests the ATO is narrowing what they deem an ordinary family or commercial dealing. The argument that everyone else is doing it will not be enough.
What does the recent ATO guidance mean in practice?
The issue are distributions that are ‘reimbursed’.
Say you have the Simpson Family Trust. Operating through the Simpson Family Trust is their Donut Business, which is very profitable.
The trustees are Marge and Homer (mum and dad) and the beneficiaries are Bart and Lisa (their adult children).
Bart and Lisa, according to the Trust Deed, are part of the pool of potential beneficiaries, entitled to receive distributions should Marge and Homer exercise their discretion to do so.
The Donut Business has had a great year, and Marge and Homer have earned six figure incomes. If they received any further distribution from the Simpson Family Trust, the rate that distribution would be taxed at would be substantial given their existing incomes.
Meanwhile, Bart and Lisa haven’t earned anything this year. They are at University and focussing on their studies. Any income they receive would attract a much lower, marginal, tax rate.
So, Marge and Homer make a distribution to Bart and Lisa, taxed at Bart and Lisa’s much lower rate. Bart and Lisa never actually receive this distribution; they are a titular recipient for tax purposes only and so as to enable Marge and Homer, the ultimate recipients, to avoid paying a higher tax rate.
You can see, I suppose, how that starts to look a lot like a specifically sought advantage. The ATO certainly thinks so. They deem this not an ordinary family dealing and that it has the express purpose of reducing tax.
Pretty cut and dried, right? Unfortunately, not.
What if this reimbursement is Bart and Lisa’s way of paying board to Marge and Homer, who cover their children’s cost of living and allow them to remain at home while attending University? Would that not, but for the extra step of a physical exchange of money, be an “ordinary family dealing”? Without a pilot case (test case as we adversarial-minded people like to call it) before the courts, it is hard to say.
What about a larger distribution, but Bart and Lisa are trying to repay a loan advanced by Marge and Homer for the purchase of a first home?
What about distributions to a beneficiary that is a corporation that are returned to the trust as a dividend, then ultimately repaid as a distribution to the corporation in the next financial year, creating a never-ending cycle of distributions and dividend payments?
What is the answer going forward?
If you are not sure whether your current family trust arrangements are impacted, go and see your accountant and lawyer.
After all, David, they are your best bet against Goliath.
About the Author: Caitlin was admitted to the Supreme Court of Western Australia in 2021. Prior to that, she was admitted to the High Court of New Zealand in 2019. Caitlin has practised in commercial and property law, wills and estates, and also completed a short stint in family law.