One of the perennial items on everyone's end of financial year checklist is the proper execution of trust resolutions, ensuring that trustees are not taxed on trust income at the top marginal rate (45%).
For family trusts in particular, these distributions often require additional consideration prior to the end of this financial year following some of the most significant clarifications of the law (or the ATO's approach to the taxation of trusts) since Bamford in 2010, the legislative amendments for streaming capital gains and franked dividends in 2011, or the requirement to finalise trust resolutions pre-30 June in 2012.
Trustees should bear in mind the impact of the following important clarifications on this year's end of financial year distributions:
The High Court of Australia's decision in Commissioner of Taxation v Carter  HCA 10, regarding the timing of an effective trust disclaimer.
- This means trustees should carefully identify the members of any class of beneficiaries that they intend to distribute to, including the default beneficiaries of the trust, to ensure that there is no unintended distribution of income (which may not be validly disclaimed). It may also be appropriate to ensure that beneficiaries are aware that they may receive a distribution so that any steps to disclaim that entitlement can be made in line with the principles set out in Carter.
The ATO's position on section 100A (regarding trust stripping schemes) and the exclusion for ordinary family or commercial dealings, following the release of draft Taxation Ruling (TR) 2022/D1, Taxpayer Alert (TA) 2022/1 and draft Practical Compliance Guideline (PCG) 2022/D1.
- This means trustees should be aware of the risk associated with any distributions from the trust within family groups, particularly UPEs and the ATO's draft position on the application of section 100A and purported limitation of the exclusion for ordinary family dealings. Given the current status of the law (summarised below), trustees may decide to accept a level of risk with respect to the draft rulings and Taxpayer Alert, but at the very least Advisors (or trustees themselves) must ensure that they are aware of the any such risks when making distributions.
The Full Federal Court's decision in Greensill v Commissioner of Taxation  FCAFC 99 regarding the taxation of capital gains on non-taxable Australian property, distributed from an Australian resident discretionary trust to a non-resident.
- This means trustees and advisors must be aware that unlike unit trusts, the trustee of an Australian resident discretionary trust will be taxed at the top marginal rate on the distribution of a capital gain on non-taxable Australian property to a non-resident.
The ATO's position regarding allocation of professional profits in PCG 2021/4 should also be borne in mind for those trusts in receipt of professional (business) profits, particularly with respect to trust distributions to persons or entities other than the professional person.
Each of these matters are considered further below.
Carter and Trust disclaimer's
Earlier this year in Carter, the High Court of Australia confirmed that a disclaimer made after 30 June was not effective to disclaim an entitlement to the income of the trust for the relevant financial year for the purposes of ensuring that the beneficiary would not be taxed on the distribution. The ATO has now issued the Decision Impact Statement on Carter, which summarises the decision Carter at first instance and on appeal (ultimately to the High Court).
Prior to Carter, it was considered that a beneficiary could disclaim their interest for a prior financial year and that this would be effective for tax purposes, provided that they made the disclaimer within a reasonable time of becoming aware of the relevant gift (see withdrawn ATO ID 2010/85). Following Carter, any unintended distribution to a beneficiary will be irrevocable. This includes, for example, where a distribution to an identified beneficiary is found not to be effective, or trust income is amended and significantly increased (with unintended results for a default beneficiary). See our Alert here regarding the decision in Carter here.
For 2022 EOFY: In light of Carter, Advisors and Trustees should very carefully review any class of beneficiaries which will receive a distribution from the trust as well as the default beneficiaries (if any) who might receive a distribution of income as a result of an invalid distribution. This should be done regardless of the amount of income that a trust has received (or is expected to receive) for the financial year. If these classes cannot be finally determined prior to the 2022 resolution, care should be taken to ensure that the resolution will capture any increased income (in the event of an amendment), and may identify specific taxpayers as beneficiaries, instead of classes of beneficiaries.
The ATO and section 100A
As noted above, the ATO released TR 2022/D1, TA 2022/1 and PCG 2022/D1 in late February 2022, with respect to the Commissioner's view on the application of section 100A and critically, the scope of the exception for 'ordinary family or commercial dealings'. Put simply, the ATO draft rulings expand the application of section 100A by limiting the nature of arrangements that might otherwise have been expected to fall within the ordinary family or commercial dealings exception. TA 2022/1 in particular focuses the Commissioner's concern with respect to the distribution from family trusts to adult children in circumstances where the children do not receive the benefit of the distribution (but this is retained for the benefit of the family group). See our article regarding the ATO's draft rulings here.
The current position with respect to these rulings in relation to this year's EOFY trust distributions is as follows:
- The ATO rulings are not law and the ATO's position on the meaning of ordinary family and commercial dealings contradicts current judicial authority most recently stated by Justice Logan in Guardian v Commissioner of Taxation  FCA 1619. See our article regarding the decision in Guardian here.
- While the ATO has appealed the decision of Justice Logan in Guardian to the Full Court of the Federal Court of Australia, there is no prospect of the meaning of ordinary family and commercial dealings and the application of section 100A being addressed by the Court before 30 June 2022. These proceedings are not listed for hearing until mid-August 2022, and it is unlikely that the Full Federal Court will provide its judgment before October 2022 (at the earliest).
- The ATO have produced a guide to manage section ATO for the 2022 financial year, which applies the approach set out in their draft rulings.
- In an update on the rulings (here at QC 69472), the ATO has indicated that:
- they will not pursue taxpayers under their new draft rulings with respect to arrangements entered into prior to 30 June 2022; and
- they do not consider that section 100A applies to arrangements where the beneficiary receives the benefit of the distribution, or when profits from a family business are distributed to family members that work in the business and are invested.
These statements do not, of course, bind the ATO in any manner should they determine as part of an audit that section 100A may apply to the distributions.
Ultimately, if the Full Federal Court in Guardian affirms the decision of Justice Logan (for the taxpayer), the ATO will may revise the draft rulings, although, as has been the case in the past, they may simply state that Guardian is limited to its facts and maintain the current position until legislative change or further judicial comment. However, if the Commissioner is successful in his appeal in Guardian, (subject to any further appeal) the ATO will likely finalise the rulings in their current form and administer the law on this basis.
For 2022 EOFY: The level of compliance (if any) with these draft rulings with respect to resolutions in the 2022 financial year is a question of each taxpayers' appetite for risk and the relevant factual circumstances. At the very least, trustees and advisors should be aware that if, for example, family trusts accrue significant UPEs to adult children (TA 2022/1) or distribute income to beneficiaries with losses without the benefit clearly passing to that beneficiary (see PCG 2022/D1 at Redzone scenario 5), the ATO may review the distributions, and subsequently determine to apply section 100A. Advisors should ensure that their clients are aware of any risk regarding the application of Section 100A to their distributions (including those distributions which may have been considered relatively uncontroversial 12 months' ago).
Greensill and distributions to non-residents
In February 2022, the High Court of Australia effectively confirmed that Australian tax is payable on a capital gain made by an Australian resident (discretionary) trust on non-taxable Australian property distributed to non-resident beneficiaries. See a summary of the impact of Greensill in our Alert here.
For 2022 EOFY: Trustees and Advisors need to be aware of the law with respect to discretionary trusts, particularly the fact that this position is not consistent with that in relation to:
- distributions of capital gains on non-taxable Australian property by resident fixed trusts to non-residents; or
- for the sale of non-taxable Australian property owned directly by a foreign resident
where no Australian tax is typically payable.
Where appropriate, Advisors and Trustees should consider whether the capital proceeds for the sale (and thereby taxation of the gain) should be streamed to Australian resident taxpayers.
PCG 2021/4 and allocation of professional profits
Practical Compliance Guideline PCG 2021/4 was finalised in March 2021, and provides a traffic light system to assess the likelihood of ATO compliance activity as a result of the allocation of profits from a professional firm, based on the amount returned in the hands of the individual professional practitioner and the total effective tax rate (amongst other matters) of the practitioner's family group. It is important to note that the PCG only addresses the risk of audit (and if any audit were commenced, the focus would be upon whether the allocation of professional profits was an avoidance scheme to which Part IVA should apply).
For those entities that complied with the suspended 2017 guidelines Assessing the risk: allocation of profits within professional firms, the transition period available under PCG 2021/4 will end on 30 June 2022, with a further two year period (to 30 June 2024) available to those individual professional practitioners that were low risk under the suspended guidelines. For entities that do not meet the PCG 2021/4 gateways, the PCG already applies.
For 2022 EOFY: Entities that are completing a risk management review of their affairs and future tax planning in light of the matters discussed above should bear in mind PCG 2021/4, and (where relevant) the risk of compliance activity by the ATO if all income is not returned to the individual professional practitioner.
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.