Australia: Section 100A Reimbursement Agreements: The ATO finalises its views…for now

The recent explosion of interest in the taxation of discretionary trust distributions would suggest that there has been a radical amendment of the Australian law. Nothing could be further from the truth.

What has occurred, particularly over the last eighteen months, is the culmination of multi-year campaign by the Australian Tax Office (ATO) to re-purpose a trust tax avoidance provision - section 100A of the Income Tax Assessment Act 1936 (ITAA36) - that was enacted in 1979, just prior to the introduction of the now familiar general anti-avoidance rules in Part IVA ITAA36.

Unlike Part IVA, section 100A is specifically constrained from acting where something was done in the course of an 'ordinary family or commercial dealing'. This phrase derives from a famous judgment of Lord Denning in the Judicial Committee of the Privy Council on the operation of section 260, the predecessor to Part IVA.¹

It is the meaning of this phrase (ordinary family or commercial dealing) which has been the subject of so much recent attention from the ATO, including:

• Taxation Ruling TR 2022/4;
• Practical Compliance Guideline PCG 2022/2; and
• Taxpayers Alert TA 2022/1.

These three ATO products were released in draft on 23 February 2022 and finalised on 8 December 2022.²

In addition, the recent judgment of his Honour Justice Logan in the Federal Court of Australia in Guardian closely examined the history, context and language of the ordinary family or commercial dealing exclusion, and concluded that it does not operate as argued by the Commissioner of Taxation.³ The Commissioner appealed that decision to the Full Court of the Federal Court,⁴ which on 24 January 2023 upheld the decision at first instance on section 100A.⁵

To paraphrase another judgment of Lord Denning, when he was Master of the Rolls, the difference between an ordinary family or commercial dealing and tax avoidance is:

'. like the border between day and night, or between red and orange. Everyone can tell the difference except in the marginal cases; and then everyone is in doubt.'⁶

Our summary of the judgment of his Honour Justice Logan in Guardian, and the introduction of the draft Tax Rulings and PCG, and the final ATO products can be found here - Guardian, draft products TR 2022/D1 and PCG 2022/D1 and TA 2022/1, final TR 2022/4 and PCG 2022/2.

Ordinary family or commercial dealing - artificial or not?

In 2010, in a published speech on Part IVA,⁷ Mr Peter Walmsley, the Deputy Chief Tax Counsel of the ATO said:

'The drafters of Part IVA were faced with two principal difficulties . the first, and the most important, was the necessity in the context of general provisions, to distinguish behaviour affected or indeed motivated, subjectively, by taxation considerations - which covers a lot of behaviour that is normal and expected and wholly inoffensive or even desirable - from artificial tax avoidance. The distinction that they derived from the cases was that between ordinary commercial of family dealing and its opposite. But they were advised not to use the actual words "ordinary commercial or family dealing" - wisely, in the author's opinion as they are a little too vague and subjective.'

(emphasis added)

Despite this previously held view by the ATO's Deputy Chief Tax Counsel, the earlier draft tax ruling and associated products from the ATO professes much less uncertainty:

'Dealing is not ordinary just because it is commonplace. Similarly, dealing can fail to be ordinary even where it is not artificial.⁸

This last statement disagreed with the judgment of Logan J (as acknowledged in footnote 45 in TR 2022/D1). His Honour said⁹

'Read in context, the adjective "ordinary" in "ordinary family or commercial dealing" has particular work to do. It is used in contradistinction to "extraordinary". It refers to a dealing which contains no element of artificiality. .

As it happens such an understanding of "ordinary family or commercial dealing" does accord with what the Judicial Committee in Newton and Heerey J in Rippon did not regard as tax avoidance.'

The final tax ruling TR 2022/4 somewhat addressed this issue (after the Commissioner received significant criticism from the industry regarding his dismissive attitude towards a judgment of the Federal Court):¹⁰

Note: In Guardian, there are comments by the Court (Logan J) that the word 'ordinary' in ordinary family or commercial dealings 'is used in contradistinction to "extraordinary"' and 'refers to a dealing which contains no element of artificiality'. The Commissioner does not take his Honour to be saying that all dealings with no element of artificiality will necessarily be ordinary family or commercial dealings, nor that where there is some family or commercial feature to a dealing, it is only the factor of artificiality that could result in the exception not being met.

Unfortunately, the Full Federal Court chose not to address this issue in Guardian. At first instance, Logan J found that there was no reimbursement agreement in either year in question on two grounds:

• Firstly, that the decision of the beneficiary to make the relevant payment (a dividend from the corporate beneficiary) occurred after receipt of the trust distribution and not before. There was, therefore, no reimbursement agreement as a question of fact.
• Secondly, for the reasons set out above, the agreement was consistent with an ordinary family dealing, within the legal meaning of that term from cases such as Newton and Rippon.

The Full Federal Court agreed with the first point (as a question of fact that there was no reimbursement agreement), but then declined to consider the meaning of ordinary family or commercial dealing:¹¹

This conclusion makes it unnecessary to consider the issues of purpose and the scope of the phrase "ordinary commercial or family dealing". It is noted that the Commissioner's submissions on both of these issues were necessarily predicated on the payment of the dividend forming part of the reimbursement agreement. Counsel for the Commissioner expressly and, in our view, correctly denied that the mere inclusion of a corporate beneficiary as an eligible beneficiary and the fact that a distribution may be made to such a beneficiary would be sufficient to demonstrate a dealing that was not an ordinary commercial or family dealing.

The phrase ordinary family or commercial dealing was also recently considered in BBlood Enterprises Pty Ltd v Commissioner of Taxation (see our summary of that judgment here).¹² The overly complex nature of the transactions in that case allowed the Court to conclude quite readily that the agreement was unusual and complex, with the complexity unable to be explained as achieving family objectives.

Accordingly, we are left with an unsatisfactory gap between the decisions of the Courts (and Logan J in particular), and with the current view of the ATO on the question as to whether dealings with no artificiality can fail the ordinary family or commercial dealing test.

What this means

Record keeping

So how should we proceed in the lead up to the end of the current financial year?

The Commissioner acknowledges the informality typically attended by ordinary family arrangements (without a hint of irony) yet highlights the importance of record keeping to establish the bona fides of arrangements:¹³

While each arrangement depends on its facts, the following documents and records are important and should be kept wherever possible:

• the trust deed (including amendments), trustee resolutions and contact details of the trustee and former trustees
• notes, contemporaneous documents and records of discussions or meetings explaining the transactions that have happened or calculations that have been made
• details of how the beneficiary was notified of their present entitlement to trust income
• details of how the present entitlement to trust income was satisfied and, where practical, used by the beneficiary
• details of how the trustee utilised the underlying funds; for example, to satisfy the trustee retention of funds or the trustee working capital condition referred to in paragraph 25 of this Guideline
• copies of loan agreements and records showing how the loan repayments were satisfied from time to time.

From a practical perspective, the understanding of beneficiaries of the nature and effect of transactions involving their present entitlement is absolutely critical, as this has been a significant focus of audit activity to date.

Where this leaves us

This issue is too important and prevalent to be left in its current state. Section 100A is not a provision that has had the benefit of the analysis and jurisprudence that has attended the development of Part IVA. It is an anachronism in the modern anti-avoidance regime.

It is far preferable for the Commissioner's concerns relating to the perceived misuse of discretionary trusts to be properly considered by parliament and, if necessary, the subject of specific legislation that better addresses these concerns. Nevertheless, the ATO threat of devoting compliance resources is sufficiently serious to strongly encourage close attention to the examples in the various products.

Footnotes

¹ Newton v Federal Commissioner of Taxation (1958) 98 CLR 1.

² The Taxpayer Alert was released as a final document with the release of the draft TR 2022/4 and PCG 2022/2.

³ Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619.

⁴ QUD 36/2022 and QUD 37/2022.

⁵ Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3.

⁶ Heather v P-E Consulting Group Ltd [1972] EWCA Civ J0714-2, speaking of the distinction between capital and revenue.

⁷ The Tax Specialist Volume 14 No. 2 October 2010.

⁸ TR 2022/D1, at [79].

⁹ Guardian, at [144] and [145].

¹⁰ TR 2022/4, at para [105].

¹¹ per Hespe J, at [126].

¹² [2022] FCA 1112 per Thawley J, which is on appeal.

¹³ PCG 2022/2, at [50].

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.