Understanding Section 100A: Critical Considerations for Trust Distributions

As the end of the financial year approaches, it is crucial for trustees to be aware of the complexities surrounding trust distributions.

One area that requires special attention is Section 100A of the income tax legislation.

What is Section 100A?

Section 100A of the income tax legislation addresses reimbursement agreements in relation to trust distributions. It is utilised to capture distributions to lower taxed beneficiaries where the benefit is enjoyed by another person. This section has been around for many years, however the Australian Taxation Office (ATO) has recently changed its interpretation of the section.

A reimbursement agreement occurs when a beneficiary’s distribution entitlement arises from, or is connected to, an arrangement that a) involves providing a benefit to someone other than the beneficiary, b) intends to reduce someone’s tax liability and c) is not part of ordinary family or commercial dealings.

Consequences of Section 100A Applying

Where the ATO determines that Section 100A applies and that a reimbursement agreement exists, the beneficiary is deemed not to be presently entitled to the trust income and the trustee will be assessed on the distribution and liable to tax at the top marginal rate. Section 100A also has an unlimited amendment period meaning that the ATO can investigate this at any time in the future.

Green Zone and Red Zone

To help trustees assess the risk associated with their trust distributions, the ATO has introduced Practical Compliance Guideline PCG 2022/2.

This guideline establishes the concept of “green zone and red zone arrangements”.

Understanding the Green Zone

Green zone arrangements are those which are deemed to have a low risk of ATO compliance activity. Green zone arrangements fall into two main categories:

1. Distributions benefiting the beneficiary, spouse, and dependents:

Trust distributions made to individuals fall within the green zone if the entitlement is paid within two years and used for the benefit of the beneficiary, their spouse, and/or dependents.

2. Trust-retained funds with strict limitations:

Distributions, where the trust retains the funds representing the beneficiary’s entitlement, may be considered green zone arrangements. However, certain conditions must be met:

If the beneficiary is an individual, they must be involved in the management of a business carried on by the trust, or they (or their spouse) must control the trust.

If the beneficiary is a company or trust, the unpaid entitlement must be covered by a Division 7A (7-year) complying loan.

Factors that may deny a green zone rating include:

• situations where the arrangement falls into the red zone (see below)
• the beneficiary gifts or lends their entitlement to another person, or
• if the beneficiary’s assessable income significantly exceeds their share of distributable income
• if the trustee fails to notify the beneficiary of their entitlement or the beneficiary fails to lodge a tax return or omits the distribution from their return.

Understanding the Red Zone

Red zone arrangements are subject to close scrutiny by the ATO, and compliance activity is likely to be undertaken.

Here are some examples of red zone arrangements:

Gifts or loans:
Distributions made to adult beneficiaries that are subsequently paid to parents (by way of gift, loan, or other means) to cover living expenses incurred by the parents before the beneficiaries turned 18.

Similarly, distributions made to non-resident relatives, which are then used to benefit a resident beneficiary through loans, gifts, or other means.

Circular distributions:
This involves a trust owning all shares in a company and making a distribution to the company in one year. In the subsequent year, the after-tax amount is used to pay a fully franked dividend back to the trust, who then distributes back to the company.

These steps are then repeated in later years. The ATO closely reviews these arrangements, irrespective of subsequent distributions being made to other taxpayers.

Substantial timing differences:
Arrangements where the amount included in the beneficiary’s taxable income is significantly greater than their entitled distribution, resulting from deliberate actions that affect the computation of trust distributable income.

Losses:
Situations where a beneficiary who is not part of the family group experiences tax losses, and receives a taxable distribution but not the economic advantages linked to the distribution.

Seek Professional Advice

Section 100A of the tax legislation introduces important considerations for trustees regarding trust distributions. Understanding the distinction between green zone and red zone arrangements, as well as the associated risks and compliance obligations, is vital for trustees to make informed decisions.

At Johnsons MME, we specialise in trust structures and taxation. We can provide you with tailored advice and guidance to ensure your trust distributions are managed in a compliant and tax-efficient manner.

As the end of the financial year approaches, we encourage you to reach out to us for professional assistance. Our team will carefully analyse your trust arrangements, evaluate the potential impact of Section 100A, and provide practical strategies to optimise your trust distributions.