The ATO recently released a suite of four publications giving long-awaited draft guidance addressing their concerns on the tax consequences of common trust distribution arrangements.
The concerns relate to the fact some beneficiaries pay lower tax rates on the trust income distributed but may not actually benefit from the funds that were recorded as having been distributed to them.
The publications take a much more restricted approach when it comes to distributions by trusts to family members from different generations (such as adult children or retired parents), as well as tightening up the ATO’s views on the appropriate treatment of trust distributions made to related companies.
There are clear statements that if the trustee wishes to continue to distribute to these beneficiaries, then the beneficiaries must receive and enjoy the economic benefits of the distribution.
Key to understanding the implications is the concept of a ‘reimbursement agreement’ and the anti-avoidance rule. The ATO has confirmed that it takes a very broad view of the range of situations in which this anti-avoidance rule should be applied.
In applying the rule, the trustee would be taxed on the income at the top marginal tax rate (47 per cent) instead of the beneficiary being taxed, with franking credits available to the trustee but no ability for the trustee to claim a refund of any excess franking credits.
The ATO has also canvassed the exclusion for ‘ordinary family or commercial dealings’, giving examples of situations it believes should reasonably fall within this exclusion and other situations where the ATO believes that it should not, and would therefore be subject to review and possible action.
The scope of ‘ordinary family dealing’ should, in the view of the ATO, be relatively narrow so it will in many cases be necessary to review current and prior years arrangements, although have still not spelt out exactly what they believe this term means.
One of the main conclusions from the ATO documents is that it will be more important than ever for families to document their family trust arrangements in real time, allowing them to clearly demonstrate what they are doing in terms of trust distributions and why.
The crux of the ATO’s guidance demonstrates a follow-the-money remit, and there is certainly nothing wrong with distributing income from your family trust to your adult children, as long as you legitimately intend for them to receive the money.
The ATO says its guidance has been issued in response to appeals from tax advisors for greater clarity given the brevity and lack of clarity offered by previous guidelines released in 2014.
The game is not up just yet on the ATO guidance either, depending on whether any significant changes are made to the documents when they are released in final form.
In any case, it will be critical for taxpayers and their advisors to plan their distributions of trust income very carefully for the 2022 tax year, and to consider their situation for previous years.
The family trust guidance article was first published in the Winter 2022 issue of Financial Times.