The ATO has issued Taxpayer Alert (TA 2022/1) announcing a crackdown on the distribution of trust income within family groups as part of its focus on tax avoidance schemes. Taxpayers and their advisors should review current distribution agreements to avoid possible ATO compliance activity.
What arrangements will the ATO be aiming for?
Generally, the ATO will consider, consistent with its view in TA 2022/1, that trust distributions are part of a tax avoidance scheme in which parents gain the economic advantage of trust income assigned to their adult children or other family members over the age of 18. age (and therefore can benefit from the normal individual marginal tax rates).
What features will the ATO be looking for?
The ATO indicated in TA 2022/1 that it will focus on trusted distributions that display most or all of the following features:
- Trustees (or directors of a corporation that acts as a trustee) of a family discretionary trust are one or both parents of a particular family.
- Trustee resolutions allow people in the family group with lower marginal tax rates to be entitled to some or all of the income of the trust for one or more fiscal years – this often includes adult children who are still living at home or who receive financial support.
- Trust income entitlements would generally not cause individuals’ taxable income to exceed top marginal tax rates (currently 45% + Medicare levy on income $180,001 and over).
- The parties make one or more of the following assertions regarding the income rights of the trust:
- The individuals agreed to reimburse the parents for expenses related to their upbringing while they were minors (for example, tuition fees, extracurricular activity fees, and family vacation costs).
- Individuals have agreed to pay or reimburse parents to help meet family expenses beyond amounts that could reasonably be expected for personal expenses while living at home or being financially supported to some extent ( for example, pension if you live at home, rent if you live away from home, and/or car expenses).
- The individuals have agreed that their rights to the income of the trust will be managed by the parents for the benefit of the family.
Often those involved do not know or understand the financial arrangements or implications of trust distributions that are made by trustees or routinely prepared by their advisers.
What could happen if the ATO identifies that the trust’s income distributions were part of a tax avoidance scheme?
Where the ATO identifies that trust income distributions that have been made meet the characteristics set out in TA 2022/1, the ATO is likely to issue an amended tax assessment.
The result of the modified assessment will be that the trustee of the trust is assessed on the income of the trust at the highest marginal tax rate (currently 45% + Medicare levy) for the relevant fiscal years.
Penalties may also apply to participants and promoters of tax avoidance schemes.
Advisors involved in the promotion of tax evasion schemes may be referred to their competent governing bodies for breach of their ethical obligations, in particular under the Tax Agent Services Act 2009 (Cth) for Registered Tax Advisors.
Examples of how these types of arrangements work in practice
Example 1 – XYZ Trust
John is the sole trustee of XYZ Trust.
The beneficiaries of the XYZ trust are John, his wife Pamela and their two children Jackie (21) and Peter (19). Jackie and Peter both live at home and study full time and earn little income from casual employment.
As trustee of XYZ Trust, John decides to allocate the net income for the 2021-2022 fiscal year (approximately $400,000) as follows.
- $100,000 to John.
- $100,000 to Pamela.
- The equal balance between Jackie and Peter.
While the financial statements of XYZ Trust show that income from the trust has been distributed as noted above, nothing is actually paid out to Jackie and Peter.
Jackie and Peter agree that John will pay the tax notices issued to them.
John transfers the balance of the trust income allegedly distributed to Jackie and Peter to a mortgage clearing account held by him and Pamela to reduce the family home’s debt.
Under this arrangement, John and Pamela receive the economic benefit of the trust income allegedly distributed to Jackie and Peter, while paying less income tax than if all of the trust income had been distributed to them.
This arrangement would likely be viewed by the ATO as a tax avoidance scheme rather than part of an ordinary family or business transaction.
Example 2 – The Green Family Trust
Margaret and Bill work full-time in their family business, which is operated by ABC Pty Ltd (of which they are both directors) as trustees of the Green Family Trust and each earns a salary of $180,000 a year from the business .
Margaret and Bill’s daughter Sonia, who just turned 18, works part-time while studying at TAFE and earns around $20,000 a year.
ABC Pty Ltd decides as trustee on June 30, 2021 to distribute all net income of the Green Family Trust for the 2020-2021 fiscal year (approximately $150,000) to Sonia.
Sonia agrees to have the balance of the distribution (after paying her tax dues) go into Margaret and Bill’s bank account to partially reimburse them for her private education payment, the cost of which was approximately $300,000.
In 2021-22, the Green Family Trust’s net income is expected to be approximately $140,000 and Sonia’s taxable income is expected to be approximately $20,000. Margaret and Bill pass a resolution from 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 viewed by the ATO as a tax avoidance scheme rather than part of an ordinary family or business transaction. The purported distributions to Sonia are applied to the economic benefit of her parents to “reimburse” them for expenses they would normally incur while ensuring that Margaret and Bill pay less income tax than if the net income of the Green Family Trust had been distributed. for them.
What period does the ATO’s increased control over trust distributions cover?
The ATO said there will be increased scrutiny in relation to income distributions from trusts starting in the 2021-22 financial year.
It is important that income distributions from the trust made in the 2021-2022 and future financial years do not meet any of the characteristics described in TA 2022/1.
If the ATO identifies trust income distributions made as part of a tax avoidance scheme in prior years, the ATO may issue amended assessments.
Although the ATO has indicated that in general it will not review income distributions from the trust beyond the 2014-2015 financial year, there is no limit on when the ATO can trace back if it believes there has been fraud or evasion as part of a tax avoidance scheme.
I’m worried – what should I do?
If you are concerned that trust income distributions have been made or have characteristics similar to those identified in TA 2022/1, we recommend that you seek professional legal advice about your situation.