The ATO has released Taxpayer Alert (TA 2022/1) foreshadowing a crackdown on trust income distributions within family groups as part of its focus on tax avoidance schemes. Taxpayers and their advisors should review current distribution arrangements to avoid potential ATO compliance activity.
By: Leon La, Associate, Geoff Cameron, Senior Associate, Alexander Strange, Special Counsel
What arrangements will the ATO be targeting?
Broadly, the ATO will consider in line with its view in TA 2022/1 that trust distributions are part of a tax avoidance scheme where parents enjoy the economic benefit of trust income appointed to their adult children or other family members who are over 18 years of age (and can therefore take advantage of normal individual marginal tax rates).
Which features will the ATO be looking for?
The ATO has indicated in TA 2022/1 that its focus will be on trust distributions that display most or all of the following features:
- The trustees (or the directors of a company that acts as the trustee) of a family discretionary trust are either or both parents of a particular family.
- Resolutions of the trustees make individuals of the family group with lower marginal tax rates entitled to some or all trust income for one or more financial years – this often includes adult children who are still living at home or are being financially supported.
- The trust income entitlements would not generally result in the individuals’ taxable income exceeding top marginal tax rates (currently 45% + Medicare levy on income $180,001 and over).
- The parties make one or more of the following contentions relating to the trust income entitlements:
- The individuals have agreed to reimburse the parents for expenses associated with their upbringing while they were minors (e.g. school fees, costs of extracurricular activities, and the cost of family holidays).
- The individuals have agreed to pay or repay the parents to assist in meeting family expenses in excess of amounts that would reasonably be expected for personal living expenses while still living at home or being financially supported to some extent (e.g. board if living at home, rent if living away from home, and/or car expenses).
- The individuals have agreed that their trust income entitlements will be managed by the parents for the benefit of the family.
It is often the case that individuals involved may not know or understand the financial arrangements or implications of the trust distributions that are being made by the trustees or routinely prepared by their advisors.
What could happen if the ATO identifies that trust income distributions are part of a tax avoidance scheme?
Where the ATO identifies that trust income distributions that have been made meet the features set out in TA 2022/1, the ATO is likely to issue an amended tax assessment.
The result of the amended assessment will be that the trustee of the trust is assessed on the trust income at the top marginal tax rate (currently 45% + the Medicare levy) for the relevant financial years.
Penalties may also apply to participants in, and promoters of, tax avoidance schemes.
Advisors involved in the promotion of tax avoidance schemes may be referred to their relevant governing bodies for a breach of their obligations regarding professional conduct, including under the Tax Agent Services Act 2009 (Cth) for registered tax advisors.
Examples of how these types of arrangements work in practice
Example 1 – The XYZ Trust
John is the sole trustee of the XYZ Trust.
The beneficiaries of the XYZ Trust include John, his wife Pamela, and their two children Jackie (aged 21) and Peter (aged 19). Jackie and Peter both live at home and study full-time and have little income from casual employment.
As trustee of the XYZ Trust, John resolves to distribute the net income for the 2021-2022 financial year (approx. $400,000) as follows.
- $100,000 to John.
- $100,000 to Pamela.
- The balance equally between Jackie and Peter.
While the financials of the XYZ Trust show that the trust income has been distributed as set out above, nothing is actually paid to Jackie and Peter.
Jackie and Peter agree that John will pay the tax assessments issued to them.
John transfers the balance of the trust income purportedly distributed to Jackie and Peter to a mortgage offset account held by him and Pamela to reduce the debt on the family home.
Under this arrangement, John and Pamela receive the economic benefit of the trust income purportedly distributed to Jackie and Peter, while paying less income tax than if the whole of the trust income had been distributed to them.
This arrangement would likely be considered by the ATO to be a tax avoidance scheme rather than part of an ordinary family or commercial dealing.
Example 2 – The Green Family Trust
Margaret and Bill work full-time in their family business, which is carried on by ABC Pty Ltd (of which they are both directors) as trustee of the Green Family Trust and each draw a salary of $180,000 per annum from the business.
Margaret and Bill’s daughter, Sonia, who has just turned 18, works part-time while studying at TAFE and earns around $20,000 per annum.
ABC Pty Ltd resolves as trustee on 30 June 2021 to distribute all the net income of the Green Family Trust for the 2020-2021 financial year (approx. $150,000) to Sonia.
Sonia agrees that the balance of the distribution (after her tax assessment is paid) will be put into Margaret and Bill’s bank account to partially reimburse them for paying for her private schooling, the cost of which amounted to approximately $300,000.
In 2021-2022, the net income of the Green Family Trust is likely to be around $140,000, and Sonia’s taxable income is likely to be around $20,000. Margaret and Bill pass a resolution of ABC Pty Ltd to distribute the net income of the Green Family Trust for 2021-2022 to Sonia, subject to the same agreement as applied in 2020-2021.
This arrangement would likely be considered by the ATO to be a tax avoidance scheme rather than part of an ordinary family or commercial dealing. The purported distributions to Sonia are being applied for the economic benefit of her parents to “reimburse” them for expenses they would ordinarily meet while also ensuring that Margaret and Bill pay less income tax than if the net income of the Green Family Trust had been distributed to them.
What period does the ATO’s increased scrutiny of trust distributions cover?
The ATO has said there will be increased scrutiny in relation to trust income distributions from the 2021-2022 financial year onwards.
It is important that distributions of trust income made in the 2021-2022 financial year and future financial years do not meet any of the features outlined in TA 2022/1.
If the ATO identifies trust income distributions made as part of a tax avoidance scheme in previous financial years, the ATO can issue amended assessments.
While ATO has indicated that generally it will not scrutinise trust income distributions further back than the 2014-2015 financial year, there is no limit on how far back the ATO may look if it forms the view there has been fraud or evasion as part of a tax avoidance scheme.
I’m concerned – what should I do?
If you are concerned that trust income distributions may have been made or show similar features to those identified in TA 2022/1, we recommend that you seek professional legal advice about your situation.
Our team is available to assist in providing specialist advice to individuals, trustees and their advisers on these issues.