deciphering section 100A and the ordinary family or commercial dealing exemption
6 mins reading time
Since the release of the Draft Tax Ruling TR2022/D1, it is fair to say that our Taxation team have fielded a steady stream of enquiries from Accountants concerning the potential application of Section 100A of the Income Tax Assessment Act 1936 (Cth) to past and anticipated distributions of trust income amongst family members and closely held family companies.
What is common to most enquiries is that the beneficiary will not receive the initial cash benefit of the distribution and that there is some form of tax element in the choice to distribute to them (whether or not it is a dominant or significant element). With some justified hysteria surrounding its potential application at the moment, there is a tendency to link those two elements as a fatal combination that can attract section 100A.
Although in the context of section 100A, there is now little doubt that the ATO sees these elements as fertile ground for anti-avoidance. The foundation from which those elements must spring in order to attract section 100A, is the reimbursement agreement itself.
timing is everything
The arrangement must exist at or before the time that the beneficiary was made presently entitled to the distribution. This was at the heart of the striking and deciding findings of fact that arose in the decision of Guardian AIT atf Australian Investment Trust v FCT [2021] FCA 1619 (Guardian), where it was accepted by Justice Logan that at the time the present entitlement was conferred, there were no arrangements underpinning the distributions, even tacitly accepted by the parties, as to what to do with the funds.
quality of evidence
The importance of evidence here cannot be underestimated. In tax controversy, all the ATO needs to do to crystallise their suspicions, is to allege that a reimbursement agreement exists, and to raise assessments. It is the taxpayer that needs to prove either that the agreement doesn’t exist or that it arose after the beneficiary was made presently entitled to the relevant trust income.
The quality of written records of the conversations in June and the pre-tax return meeting in the following income year, will be absolutely crucial to the taxpayer in establishing to the Commissioner, Tribunal or Court to the required standard of proof, the timing of any reimbursement agreement arising out of those distributions.
What this shows us, like the vast majority of tax cases that are won by the taxpayer, is how absolutely crucial evidence will be to either:
- convincing the ATO at an early stage of enquiry, that section 100A has no application; or
- coming to a favourable settlement with the ATO, based on an agreed ‘litigation risk’ of the ATO losing the matter or otherwise; or
- winning the matter, should it be litigated.
ordinary family or commercial dealing exemption
The second element that we see as having an elevated role in defending against allegations of section 100A transgressions, is the ordinary family or commercial dealing exception. The issue here in respect of family dealings, is that they are typically characterised by an absence of documentation.
In the absence of formally documented ordinary family arrangements (such as loan agreements or agreements to leave funds in), contemporaneous records of conversations and meetings evidencing the same, will be crucial here.
However, simply having a document that evidences an arrangement between family members does not make it an “ordinary” family dealing. There is also very little judicial guidance on the topic.
As things currently stand, we would suggest that the weight of authority provides that the absence of steps in the arrangements that are artificial or contrived or that necessarily carry the inference of tax avoidance, should put the arrangement outside of the scope of section 100A. It is consistent with both the legislation and cases considering the relevant concepts, that the existence of a tax purpose should not be seen as fatal, unless it occurs in one or more steps that are “necessarily” explained by that tax purpose and not by any other purpose.
As an example, a further exception in section 100A to the concept of a reimbursement agreement is, broadly speaking, an agreement that does not have the requisite tax reduction purpose (Tax Purpose Exemption). To say then, that the existence of a tax purpose disqualifies an arrangement from meeting the description of ordinary family dealing, renders the ordinary family dealing exception largely superfluous.
That is, if an agreement can’t have a tax purpose in order for the ordinary family dealing exemption to operate, then in the absence of that tax purpose, the agreement will always be exempt anyway, (i.e., because the Tax Purpose Exemption will apply), leaving the ordinary family or commercial dealing exemption with no work to do.
implications for taxpayers
So how is all of this useful to a taxpayer that seeks to fend off an allegation that their trust distributions are the subject of a reimbursement agreement?
Many decisions to distribute trust income to members of the family are made, amongst other purposes, with tax purposes in mind. For these distributions however, it does not automatically follow, where that distribution is not paid, or is paid and passed to another family member, that section 100A will apply.
As we have discussed, timing – and evidence as to timing – are both critical. If the agreement not to immediately benefit a beneficiary with distribution funds post-dates the conferral of the present entitlement to those funds, section100A cannot apply. We hear you when you say that all the Commissioner needs to do is to assert that section 100A applies and to raise the assessments! However, in that case as in all cases, the taxpayer will need evidence to displace those assessments.
Where there is an agreement to benefit another beneficiary in place at or before the present entitlement is conferred (or a lack of evidence to prove otherwise), it is the ordinary family or commercial dealing exemption to which most taxpayers will turn their attention.
In our team’s view, the ordinary family or commercial dealing exemption potentially much broader in its scope than the Commissioner will have you believe. The decisions to date show that the exemption can co-exist with and trump a tax purpose in the arrangements, provided it can be shown that the arrangements are ordinary (in the sense that there is no artificiality) and there are no one or more steps in the arrangements that are “necessarily” described by that tax avoidance purpose.
As always, our Taxation team is very happy to assist Accountants or clients requiring further assistance when navigating the complexities of Section 100A.
more
insights
stay up to date with our news & insights
deciphering section 100A and the ordinary family or commercial dealing exemption
Since the release of the Draft Tax Ruling TR2022/D1, it is fair to say that our Taxation team have fielded a steady stream of enquiries from Accountants concerning the potential application of Section 100A of the Income Tax Assessment Act 1936 (Cth) to past and anticipated distributions of trust income amongst family members and closely held family companies.
What is common to most enquiries is that the beneficiary will not receive the initial cash benefit of the distribution and that there is some form of tax element in the choice to distribute to them (whether or not it is a dominant or significant element). With some justified hysteria surrounding its potential application at the moment, there is a tendency to link those two elements as a fatal combination that can attract section 100A.
Although in the context of section 100A, there is now little doubt that the ATO sees these elements as fertile ground for anti-avoidance. The foundation from which those elements must spring in order to attract section 100A, is the reimbursement agreement itself.
timing is everything
The arrangement must exist at or before the time that the beneficiary was made presently entitled to the distribution. This was at the heart of the striking and deciding findings of fact that arose in the decision of Guardian AIT atf Australian Investment Trust v FCT [2021] FCA 1619 (Guardian), where it was accepted by Justice Logan that at the time the present entitlement was conferred, there were no arrangements underpinning the distributions, even tacitly accepted by the parties, as to what to do with the funds.
quality of evidence
The importance of evidence here cannot be underestimated. In tax controversy, all the ATO needs to do to crystallise their suspicions, is to allege that a reimbursement agreement exists, and to raise assessments. It is the taxpayer that needs to prove either that the agreement doesn’t exist or that it arose after the beneficiary was made presently entitled to the relevant trust income.
The quality of written records of the conversations in June and the pre-tax return meeting in the following income year, will be absolutely crucial to the taxpayer in establishing to the Commissioner, Tribunal or Court to the required standard of proof, the timing of any reimbursement agreement arising out of those distributions.
What this shows us, like the vast majority of tax cases that are won by the taxpayer, is how absolutely crucial evidence will be to either:
- convincing the ATO at an early stage of enquiry, that section 100A has no application; or
- coming to a favourable settlement with the ATO, based on an agreed ‘litigation risk’ of the ATO losing the matter or otherwise; or
- winning the matter, should it be litigated.
ordinary family or commercial dealing exemption
The second element that we see as having an elevated role in defending against allegations of section 100A transgressions, is the ordinary family or commercial dealing exception. The issue here in respect of family dealings, is that they are typically characterised by an absence of documentation.
In the absence of formally documented ordinary family arrangements (such as loan agreements or agreements to leave funds in), contemporaneous records of conversations and meetings evidencing the same, will be crucial here.
However, simply having a document that evidences an arrangement between family members does not make it an “ordinary” family dealing. There is also very little judicial guidance on the topic.
As things currently stand, we would suggest that the weight of authority provides that the absence of steps in the arrangements that are artificial or contrived or that necessarily carry the inference of tax avoidance, should put the arrangement outside of the scope of section 100A. It is consistent with both the legislation and cases considering the relevant concepts, that the existence of a tax purpose should not be seen as fatal, unless it occurs in one or more steps that are “necessarily” explained by that tax purpose and not by any other purpose.
As an example, a further exception in section 100A to the concept of a reimbursement agreement is, broadly speaking, an agreement that does not have the requisite tax reduction purpose (Tax Purpose Exemption). To say then, that the existence of a tax purpose disqualifies an arrangement from meeting the description of ordinary family dealing, renders the ordinary family dealing exception largely superfluous.
That is, if an agreement can’t have a tax purpose in order for the ordinary family dealing exemption to operate, then in the absence of that tax purpose, the agreement will always be exempt anyway, (i.e., because the Tax Purpose Exemption will apply), leaving the ordinary family or commercial dealing exemption with no work to do.
implications for taxpayers
So how is all of this useful to a taxpayer that seeks to fend off an allegation that their trust distributions are the subject of a reimbursement agreement?
Many decisions to distribute trust income to members of the family are made, amongst other purposes, with tax purposes in mind. For these distributions however, it does not automatically follow, where that distribution is not paid, or is paid and passed to another family member, that section 100A will apply.
As we have discussed, timing – and evidence as to timing – are both critical. If the agreement not to immediately benefit a beneficiary with distribution funds post-dates the conferral of the present entitlement to those funds, section100A cannot apply. We hear you when you say that all the Commissioner needs to do is to assert that section 100A applies and to raise the assessments! However, in that case as in all cases, the taxpayer will need evidence to displace those assessments.
Where there is an agreement to benefit another beneficiary in place at or before the present entitlement is conferred (or a lack of evidence to prove otherwise), it is the ordinary family or commercial dealing exemption to which most taxpayers will turn their attention.
In our team’s view, the ordinary family or commercial dealing exemption potentially much broader in its scope than the Commissioner will have you believe. The decisions to date show that the exemption can co-exist with and trump a tax purpose in the arrangements, provided it can be shown that the arrangements are ordinary (in the sense that there is no artificiality) and there are no one or more steps in the arrangements that are “necessarily” described by that tax avoidance purpose.
As always, our Taxation team is very happy to assist Accountants or clients requiring further assistance when navigating the complexities of Section 100A.