Are there limits on the Commissioner applying section 100A?

by | Feb 16, 2022

Are there limits on the Commissioner applying section 100A?

Many accountants will be aware that the ATO plan to issue a draft tax ruling in relation to the Commissioner’s initial view regarding section 100A.  As section 100A has potentially a very wide application, this draft ruling is intended to address the exclusions – in other words the situations where section 100A does not apply.  Many accountants are keen to see what the draft ruling contains.

Section 100A can apply to trust distributions where a beneficiary is made presently entitled to a share of trust income and that present entitlement arose out of a reimbursement agreement.  A simple outline of section 100A has been covered in our earlier article Section 100A – The devil is in the detail.

A simple example to which section 100A might apply is as follows:

The trustee of a trust estate makes a beneficiary entitled to trust income. Instead of paying the amount of trust income to the beneficiary, the trustee gives, or lends on interest-free terms, the money to another person. The other person benefits from the trust income, but is not assessed on any part of it. This arrangement would generally constitute a reimbursement agreement if it was intended that the beneficiary who was made presently entitled to the trust income pays a lower amount of tax (this could be due to lower applicable tax rates, losses, it being a tax-exempt taxpayer  etc.) than would have been payable by the person who actually enjoyed the economic benefits of that income.

If section 100A is applied to a distribution, the resulting tax assessment which arises taxes the income to the trustee i.e. at the top marginal rate (currently 47%), rather than taxing the beneficiary.

There is an unlimited time limit for amended assessments to be issued under section 100A, and so the passage of time does not diminish a taxpayer’s risk.  The matters to consider in a situation where the ATO is considering whether to apply section 100A to a distribution are:

  • Was there an agreement?
  • Was any agreement a reimbursement agreement?
  • Is the agreement one which can be characterised as an ordinary family or commercial dealing?

The recent Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619  case highlights a number of key matters relevant to section 100A. Whilst this decision has now been appealed by the Commissioner, the judgement usefully analyses how the section applies. For the purposes of this article, the key facts revolve around distributions made by the trustee of the AIT to a wholly owned corporate beneficiary. That corporate beneficiary paid out a dividend in the following year which was distributed to Mr Springer.  Mr Springer was a non-resident at the time the distributions were made to him.

Firstly, credible witnesses and a clear contemporaneous document trail are the foundation of any position that a taxpayer wants to take

The taxpayers had a document trail which clearly showed what matters were considered, and by implication what was not considered.  It also indicated when the taxpayers thought about each matter, and when decisions were made. This document trail was supported by the evidence given by the witnesses to the extent that the court held that when each year’s trust distribution was made that there was no plan or understanding that the corporate beneficiary of the distribution would pay any dividend from the distributions received.

The Court held that section 100A requires there to be a reimbursement agreement before the distribution is made.  In the absence of any such plan or understanding before the distribution was made then the Court concluded that there was no reimbursement agreement made prior to the distributions.  Accordingly section 100A could not apply.

Secondly, the test of the tax motive in a reimbursement agreement is of a counterfactual which would happen, not one which might happen.

The Commissioner’s argument about what would have occurred if the income distribution had not been made to the company was that it would have been made to Mr Springer (and thus taxed in the majority at the top tax rate of 47%).  The Court acknowledged that this was a possibility, but accepted that it would never have  occurred.  The relevant test in section 100A(8) is what would have occurred, and not what might have occurred – this requires a higher degree of certainty as to what the alternative outcome would have been.  Distributions made by AIT in other years did not go to Mr Springer, and also did not always go to other family members either and the accountant for the taxpayer gave evidence that he would never have recommended that the relevant distributions be made to Mr Springer.  Based on this evidence the Court held that the Commissioner’s view on what distribution would have been made was flawed and that it would never have occurred.

Thirdly, use of a corporate beneficiary can be a normal family or commercial dealing.

Part of the taxpayer’s case was that Mr Springer was retiring and was winding up trading entities.  To assist with this, a new company beneficiary was set up and profits were distributed to it.  There was evidence of at least one business being sold and Mr Springer having concerns that the incoming owner did not have the expertise to make him believe that there was no risk for him even after the sale was completed.  Mr Springer also had times where his relationships with his wife and his sons was not harmonious, and so distributions to them did not always occur.

In that context, the Court decided that the incorporation of a new beneficiary company ‘…and the resolution to make a distribution to it of trust income were each nothing more than an ordinary family or commercial dealing.’

From this case taxpayers know that they should have good records (which is not a new thing to learn, but one which bears repeating).  They also know that the defence of risk minimisation can be valid, but only where there is genuine evidence of risk and the actions taken to reduce that risk are unremarkable.

We hope that the Court’s messages that there are dealings which are ordinary family or commercial dealings, and that arguments about what might otherwise have happened must be about what would have otherwise happened, are also heard.

Whilst the above is not the final outcome now that the case is on appeal, it is hopefully the start of a process whereby we gain a better insight into the impact that this section has on taxpayers.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

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