Section 100A and capital distributions: Deficiencies of the anti-avoidance provision

The recent release of a trio of tax guidance documents by the ATO addressing section 100A (TR 2022/D1, PCG 2022/D1 and TA 2022/1) has been described as being the most significant development for trust taxation in almost 40 years. Whilst the commentary on the aforementioned ATO guidance has largely focused on what section 100A can do to the taxation of trusts, in this article we focus on a key shortcoming of the anti-avoidance provision.

Brief History of Section 100A

As you are likely aware, section 100A is an anti-avoidance provision enacted in 1979 that was designed mainly to target trust stripping and similar arrangements. It is important to note that section 100A was enacted prior to the introduction of both the CGT regime and the trust streaming provisions in subdivisions 115-C and 207-B.

Since its enactment, section 100A has had multiple amendments. With the exception of two amendments (one in relation to the subsection (6B), which deals with trading stock, and the other in relation to subsection (13), which was amended to include a note about determining family relationships), all of these amendments occurred prior to the introduction of the CGT provisions. Furthermore, there have been no amendments to the section since the introduction of the trust streaming provisions.

As is the case with other provisions enacted prior to the introduction of the CGT regime, section 100A is frustrated in achieving its purpose, broadly being to prevent the bifurcation of economic benefits and taxation consequences in respect of trust distributions, when capital gains are involved.

The Deficiencies of Section 100A relating to capital gains

To understand how the deficiencies of section 100A arise, we must first look at the wording of section 100A. The relevant parts of section 100A for the purpose of this article are as follows (emphasis added):

(1) Where:

(a) apart from this section, a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate; and

(b) …

…

(2) Where:

(a)  apart from this section, a beneficiary of a trust estate who is not under any legal disability would, by reason that income of the trust estate was paid to, or applied for the benefit of, the beneficiary, be deemed to be presently entitled to income of the trust estate; and

(b) …

…

As can be seen from the above excerpt, section 100A is solely focused on situations where a beneficiary is presently entitled to income of the trust estate. Given that section 100A was drafted prior to the introduction of the CGT regime, this is unsurprising. Prior to the introduction of the streaming provisions in 2011, the main way in which a beneficiary could be assessed on a portion of the net income of a trust estate was to be presently entitled to a part of the income of the trust estate. However, since the introduction of the streaming provisions, a beneficiary is capable of being assessed a part of the net income of a trust estate without being presently entitled to a part of the income of the trust estate. This can occur where a beneficiary is made specifically entitled to a capital gain realised by a trust in an income year by way of a capital distribution made to the beneficiary within the  permitted time (i.e. before 31 August).

Due to this, where the income of the trust does not include capital gains (whether by the definition of distributable income in the trust deed or lack thereof or by the exercise of a trustee’s discretion), there is the potential for situations to arise whereby a reimbursement agreement is not caught by section 100A.

For example, in the 2023 income year Trust A, a discretionary trust controlled by Mum and Dad, received $350,000 of fully franked dividends and realised a $100,000 gross capital gain. Due to the terms of the trust, the capital gain is not included in the trust’s distributable income. The trust distributes the entirety of its income equally between mum and dad. Prior to 31 August, the trust makes a capital distribution of the $100,000 capital gain to Adult Child (who has a low level of income) on the understanding that Adult Child will gift the $100,000 back to the Trust. Provided that the capital distribution is made in a manner that satisfies the specific entitlement requirements in section 115-228, Adult Child will be assessed on the capital gain. However, as Adult Child was not presently entitled or deemed to be presently entitled to any of the income of the trust estate, section 100A cannot apply.

The Commissioner’s views on the application of section 100A to stream capital gains and franked distributions is contained in TR 2022/D1 at paragraphs 36 to 38, where the ruling states (emphasis added):

37. Where some beneficiary would otherwise be ‘specifically entitled’ (within the meaning of the streaming rules) to a capital gain or franked distribution (or part thereof) included in the income of the trust estate (a gain or distribution) on the basis that they have received or have an entitlement to receive (and therefore expect to receive) the financial benefits in respect of that gain or distribution, the operation of section 100A (in creating a statutory fiction where that receipt or entitlement did not arise) will result in no beneficiary being specifically entitled to that gain or distribution. It will therefore also result in the allocation of the amount of the gain or distribution between the parties according to their respective adjusted Division 6 percentages (within the meaning of the streaming rules), worked out in that fictional state of affairs.
38. Where no beneficiary would otherwise be so specifically entitled, the operation of section 100A in creating a statutory fiction will result in an adjustment of the parties’ adjusted Division 6 percentages for the purposes of assessing that gain or distribution.

Although the ATO conclude that where section 100A applies to treat a beneficiary as not being presently entitled, then no beneficiary will be specifically entitled to the capital gains or franked distributions relating to that present entitlement, this is only to the extent that the capital gain or franked distribution is included in the income of the trust estate, as evidenced by the wording of section 100A replicated above and the bolded part of TR 2022/D1.

Can a capital distribution reimbursement agreement affect income distributions?

Whilst section 100A appears to be largely deficient in relation to capital distributions used to make beneficiaries specifically entitled, the existence of a reimbursement agreement in relation to such a capital distribution may be sufficient to result in any income distributions made to the same beneficiary being brought within the scope of section 100A. This is the case even where the entirety of the income distribution is paid to or applied for the benefit of the beneficiary and is not itself ‘reimbursed’. For example, where an income distribution is made to an adult child beneficiary prior to 30 June followed by a capital distribution prior to 31 August (such that the beneficiary is specifically entitled to a capital gain), with the view that the entirety of the income distribution would be used to pay the income tax arising from the receipt of both distributions, it is arguable that section 100A would still apply to the income distribution. This is because, firstly subsection 100A(7), does not require that the money or property that is to be ‘reimbursed’ be the same money or property paid by the trustee to satisfy the beneficiary’s income entitlement (in fact subsection 100A(7) does not require an actual ‘reimbursement’ rather it merely requires an agreement that provides for a ‘reimbursement’) and secondly, the entitlement to the income distribution arose either in connection with or as a result of a reimbursement agreement (in this case being the reimbursement of the capital distribution).

On this basis it appears that there is a material risk that a reimbursement agreement in relation to a capital distribution could cause an income distribution to the same beneficiary to be caught by section 100A.

Does Part IVA pick up the slack?

Wherever a specific anti-avoidance provision does not apply, the natural line of inquisition is to ascertain whether the general anti-avoidance provision, Part IVA, could apply.

Whilst it is not the intention of this article to analyse whether Part IVA could apply to various arrangements, we will briefly outline some key considerations.

A key difference between section 100A and Part IVA is that section 100A has a significantly lower threshold for it to apply. Section 100A merely requires a tax reduction purpose (which does not need to be a sole or dominant purpose of the reimbursement agreement) whereas Part IVA requires that a scheme is entered into for the sole or dominant purpose of obtaining a tax benefit for a taxpayer.

Due to the vastly differing thresholds at which the two anti-avoidance provisions are triggered, it is quite conceivable that a wide array of circumstances involving capital distributions and specific entitlement are neither caught by section 100A nor Part IVA.

It is also worth noting that section 100A is a self-executing provision, in that it does not require the Commissioner to exercise a discretion for it to apply, whereas Part IVA does require the Commissioner to exercise a discretion to cancel any tax benefits arising out of the scheme.

Conclusion

As is evident from the above it appears that there is a genuine deficiency in section 100A as an anti-avoidance provision in relation to the streaming of capital gains. This deficiency could conceivably allow controllers of trusts to circumvent the mischief to which section 100A was directed.

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