A bad spaghetti western: the ATO’s focus on Australia’s high wealth private groups

Key points:

• The ATO has high-wealth private groups in its cross-hairs. The Commissioner has been given a massive funding boost to ensure compliance in this sector and he isn’t afraid to use it. There are now three active compliance programs focused on high-wealth private groups. Your client may be lucky enough to be in one!
• The ATO is focused on trust arrangements and offshore structures. The Commissioner’s weapons of choice are sections 100A, 99B and 47A. These are old(ish) provisions and not well understood. But they’re dangerous.
• Section 100A attacks trust distributions, even where resolutions are made before 30 June. It is a powerful provision in tax law because the Commissioner has an unlimited amendment period to apply it, even without a finding of fraud or evasion.
• The risk for taxpayers and their advisors is that section 100A can apply to common and seemingly innocuous arrangements. For example, section 100A can apply where a valid distribution is made by a trust in favour of an adult child, but the funds remain unpaid (an ‘unpaid present entitlement’) and are put to personal or investment use elsewhere in the family group (for example, by mum or dad). Sure, there’s an exception for ‘ordinary family or commercial dealings’. But no one really knows what that means! We’ll be hearing more from the Commissioner about that shortly.
• Section 99B attacks all distributions from trusts, whether the trust is resident in Australia or offshore. For example, many people think that a trust giving back its capital to its beneficiaries should be untaxed. Generally that’s right, but taxpayers need to prove that the capital is not just accumulated income, which is not exempt!
• All taxpayers with links to offshore trust should be wary of section 99B. For example, a gift by mum and dad from a New Zealand trust to their Australian daughter will trigger 99B; unless it can be proven that the distribution is sourced from the capital (not being accumulated or retained income) of the trust. This presents a high evidentiary burden, as well as a legal and trust law burden of proving what comprises the capital of an offshore trust.
• Section 47A and its close cousin section 109BC focus on foreign companies. Most practitioners will be well acquainted with the deemed dividend rules in Division 7A. These provisions apply in a similar way (indeed, section 109BC is part of Division 7A) but to foreign companies. Unlike Division 7A, section 47A can trigger a deemed dividend for an Australian resident shareholder even where the relevant transaction has occurred between two foreign companies. Moreover, section 47A can apply to a much wider range of transactions than Division 7A, including – a waiver or release of an obligation to pay or repay an amount; a loan; an acquisition of shares or units, or rights to acquire shares or units; a transfer of property or services; and payments in relation to a call on shares.

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Mise-en-scene:  The manpower and the focus

Make no mistake, the Commissioner has plenty of cash to spend on compliance and enforcement activity in the high-wealth and private group sector; and he is using it.

The Australian government has committed funding in the order of $1.7 billion over the 2016 to 2024 fiscal years to the Commissioner’s Tax Avoidance Taskforce.  This funding is allocated to the Commissioner’s compliance activities across international and multinational groups, private groups and tax avoidance arrangements involving trusts.  It is reasonable to think that private groups and trusts receives a fair share of this funding and focus.

Also, there is evidence that the ATO is keeping a close eye on the high-wealth and private group sector and its compliance behaviour.  At his address at the Tax Institute Tax Summit 2020, Commissioner Chris Jordan, announced the release of the ATO’s ‘high wealth private groups gap analysis’.  Basically, this is a financial model the ATO uses to determine the ‘gap’ between what the high wealth private groups should pay in tax, compared to what they do pay voluntarily and following audit activity.

Based on the ATO’s 2016-2017 income year, the net income tax gap estimate was put at $772 million (or 7.7% of the total of the tax that should have been paid) for high wealth private groups.  This is higher than the ‘tax gap’ for the large market and individuals (4% and 6.4% respectively) but lower than the tax gap for the small business sector (12.5%).

To close this tax ‘gap’ for high wealth private groups, the ATO runs three active compliance programs focused on this sector:

• The Top 500 program: As the name suggests, the program is focused on the Top 500 private groups, who will be subject to compliance activity on an ongoing basis.
• The High wealth private groups program: This program applies to Australian resident individuals who, together with their associates, control wealth of more than $50 million (sometimes, this is the owners of entities that are in the Top 500 program).
• The Medium and emerging private groups program: This program is aimed at:
  • private groups linked to Australian resident individuals who, together with their associates, control wealth between $5 million and $50 million; and
  • businesses with an annual turnover of more than $10 million, that are not public or foreign owned and are not linked to a high wealth private group.

As you can see, the coverage is pretty wide.  And one might observe that in a country where the average house price in many nondescript suburbs is above $1 million, $5 million of wealth wouldn’t exactly buy a champagne and caviar lifestyle.  Nonetheless, you may well be in the ATO’s high wealth club!

Act 1:  Section 100A:  Old dog, new tricks

The backstory

Like Larry David[1] and Samuel L. Jackson[2], section 100A got famous after it turned 40:  it has even received some press lately.[3]  However, it would appear that section 100A, at least from an ATO perspective, had a renaissance following the release of the ATO’s factsheet on 100A and ‘reimbursement agreements’ in May 2016.

Section 100A was introduced in 1978 as part of a package of anti-tax avoidance measures.  John Howard was the Treasurer then, and in his second reading speech he said it was a measure which specifically targeted ‘trust stripping schemes’ which:

‘[seek] to bring about the happy situation that neither the trustee nor any intended beneficiary, nor anyone else, pays tax on substantial income derived by the trust estate.’[4]

Despite this, it is clear section 100A isn’t limited to ‘trust tripping arrangements’ nor has a narrow anti-avoidance purpose.  This has been made clear in the cases that have considered section 100A (and there are only four).  In FCT v Prestige Motors Pty Ltd the Court stated that:

‘the mere fact that s 100A can be characterised as a specific anti-avoidance provision does not demonstrate that it should be given a narrower approach than its ordinary meaning and grammatical sense suggest.[5]‘

The risk for taxpayers and their advisors is that section 100A can apply to common and seemingly innocuous arrangements, like a situation where a distribution is made by a trust in favour of an adult child, but the funds remain unpaid (an ‘unpaid present entitlement’) and are put to personal or investment use elsewhere in the family group (for example, by mum or dad).

How it works

Section 100A applies where a beneficiary’s present entitlement to trust income arises out of a ‘reimbursement agreement’[6].  For the section to apply, there must be an ‘agreement’ in relation to a beneficiary (but not necessarily between the beneficiary and the trustee), which provides for the:

• payment of money to;
• transfer of property to; or
• the provision of services or other benefits for,

a person or persons other than the beneficiary[7].

If it is established that there is an ‘agreement’ (and that is pretty easy), there is a purposive element to satisfy as well.  That is, the agreement must have been entered into for the purpose of securing that a person does not pay tax, or pays less than what would otherwise be payable.[8]

Where the section applies, it deems the present entitlement not to have arisen, and the trust income will be assessable to the trustee under section 99A of the 1936 Act at the highest marginal rate.  An important thing to note here is that for section 100A to apply, the present entitlement created by the trustee in favour of a beneficiary must be valid.

If it is invalid, say because the beneficiary was not a beneficiary under the terms of the deed or because of the trustee failed to make a valid resolution by 30 June, then in our view section 100A can’t be triggered.  In many cases, there is no difference to the overall tax outcome; section 99A would still apply to assess the trustee.  Where a difference can arise is in terms of the limitation period, which for section 100A is unlimited (see below).

The exception

Section 100A is subject to an important exception.  It will not apply to an agreement, arrangement or understanding entered into in the ‘course of ordinary family or commercial dealing‘.  The legislation doesn’t define this term which, on its words, is open to different subjective interpretations.

Despite what anyone may claim, we don’t really know what will constitute an arrangement or understanding entered into in the ‘course of ordinary family or commercial dealing‘ in the context of section 100A.  We don’t get much help from the decided cases on section 100A, which have mostly dealt with facts that have been at the more contrived end of the spectrum that could hardly be described as ‘ordinary’ (or even ‘commercial’).  So, what might seem like an ‘ordinary family or commercial dealing’ to you or your client might look very different to an ATO auditor.

The Commissioner is due to release Tax Ruling this year (expected soon) outlining his view on what the term ‘ordinary family or commercial dealing’ means in the context of section 100A.  While we can expect this to fill in the picture that the ATO first painted when it released its 100A factsheet it 2016, it remains to be seen how much practical and compliance certainty it will provide.  Of course, when the Tax Ruling is released, we will report back to you about it.

Our practical experience

We are involved in a number of audits where section 100A is the central issue.  In all of them, facts and evidence have been crucial.  In one matter, section 100A has arisen because of distributions that were made by an Australian resident trust to non-resident beneficiaries.  There, our client has been put to the task of substantiating the identity of the non-resident beneficiaries, their awareness about their entitlement to a distribution from the trust and their consent to not having the distribution paid out to them but instead retained by the trustee.

In another matter, section 100A has arisen as a result of distributions made by a trust to a corporate beneficiary (the shares in which were held by the trust making the distribution), in circumstances where funds were retained and reinvested within the family group structure.  There it has been necessary to furnish evidence to substantiate the taxpayer’s assertion that, among other things, the arrangement was entered into for an asset protection purpose and to simplify compliance.  In both matters, the clients and their advisors have been the subject of a formal ATO interview.

Our message to practitioners is:

• be aware of section 100A and when it can arise;
• be prepared for the ATO to ‘put you to your proof’ in terms of any factual assertions your client has made (or which you have put on your client’s behalf);
• if you intend to assert a family or commercial reasons for a transaction or arrangement (including one of ‘asset protection’), consider how this stacks up against the facts and evidence; and
• given these matters often involve a probe into a taxpayer’s intention for entering into and carrying out an arrangement, prepare for the ATO to want to hear directly from the taxpayer and their advisor.

Act 2: Section 99B: The silent assassin

The backstory

The same Bill that introduced section 100A also introduced section 99B.  Going back to then Treasurer John Howard, in introducing the amending legislation into Parliament, he said:

The second group of measures [meaning 99B] contained in the Bill is designed to limit opportunities to avoid tax on income form an ex-Australian source that is derived through a trust …[9]

Like section 100A, while section 99B may have been introduced to target particular forms of egregious tax avoidance behaviour involving profit shifting offshore through trusts, which was rife at the time of its introduction, this does not necessarily confine its application or scope to any particular activities.  Indeed, there is nothing in section 99B itself which limits it to offshore trusts (although it is where the issues are more likely to arise).

How it works 

It is fair to say that section 99B(1) is largely defined by its exceptions.  It start with an ‘ambit’ claim, by  including in the assessable income of an Australian resident beneficiary any amount that is paid to, or applied for the benefit of, the beneficiary at any time during the year of income.[10] However, an amount will not include in the assessable income of a beneficiary under subsection 99B(1) if (among other things) it represents:

• corpus of the trust estate (except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer of a year of income);
• an amount that, if it had been derived by a taxpayer being a resident, would not have been included in the assessable income of that taxpayer of a year of income;
• and amount that is, or has been, included in the assessable income of the beneficiary under section 97; and
• and amount in respect of which the trustee of the trust estate is or has been assessed and liable to pay tax in pursuance of section 98, 99 or 99A of the 1936 Act.

The exception to the exception 

Where section 99B catches people out is in relation to capital distributions.  As stated above, there is an exception for distributions which represent the ‘corpus of the trust estate’.  Then, there is an exception to this exception; an amount will be assessable if it is a capital distribution that is attributable to an amount derived by the trustee, which has not been assessed to the trustee, but would have been assessed if it were assumed the trustee was an Australian resident taxpayer.

Practical experience 

As with 100A, we have been involved in a number of audits where section 99B is the central issue.  Again, in all of them, facts and evidence have been crucial; and in particular proving the source of distributions from offshore trusts.

In one matter, section 99B arose because a mother and father resident in New Zealand gifted their two daughters $100,000 each, through a trust that they controlled which was also resident in New Zealand. One of the daughters was an Australian resident, and the transfer of funds to her Australian bank account was flagged by Austrac, and ultimately discovered by the ATO during a review.

The payment was made from the accumulated profits of the New Zealand trust, and the ATO’s position was that the $100,000 was assessable under section 99B. The taxpayer’s dilemma was that she couldn’t prove that any of the exceptions to 99B applied, and in particular that the payment was sourced from the accumulated profits of the trust (ie the corpus of the trust).

Absurdly, if the mother and father had instead gifted the funds to themselves from the New Zealand trust first, and then gifted the funds to their daughters subsequently, 99B would not apply.

Ultimately the matter was resolved, but not all taxpayers in the same situation will be able to obtain the same result, as the reality is that section 99B applied to the transaction and the onus was on the taxpayer to prove there was an exception.

Another risk arises where offshore trusts reside in jurisdictions which will refuse to provide information or documentation (perhaps one of the ‘tax haven’ countries) to third parties, or even beneficiaries. In these cases, it may be impossible to prove the source of distributions and that an exception applies.

Similarly, taxpayers who came forward under ‘Project Do It’ face a similar dilemma when the time arrives for them to repatriate assets/funds held in offshore trusts. Unless their ‘Project Do It’ settlement agreement with the Commissioner contained terms which would prevent an assessment under section 99B, or they are able to prove the distributions are sourced from trust corpus, 99B could apply.

Our message to practitioners is that section 99B should concern all of their clients with links to offshore trust. Put simply, if a taxpayer has received a distribution from an offshore trust and hasn’t returned that amount, they will need to be able to prove that one of the exceptions applies.

Act 3: the dynamic duo: sections 47A and 109BC

The backstory 

Section 47A was introduced in 1991[11] as part of a broad package of measures. As noted in the Second Reading Speech:

A justification for these Bills seems to be a need to counter the perceived practice of Australians deriving income through non-resident companies based in low tax jurisdictions. Historically, Australian tax has not been payable until after profits of the type to become affected were paid by way of dividends or other income to Australian shareholders. Unlike domestically generated taxable income, the types of income now to be targeted will be taxed regardless of whether the income has actually been received.[12]

Section 109BC was introduced in 2010,[13] and was intended to put beyond doubt that Division 7A applied to non-resident companies.

How it works 

Section 47A is designed to deem a dividend where a company that is a CFC of an unlisted country[14] makes a ‘disguised distribution’ of its accumulated profits after 3 June 1990.

A disguised distribution, referred to in the legislation as an ‘eligible benefit’, can result from any one of the following transactions:

• a waiver or release of an obligation to pay or repay an amount;
• a loan;
• an acquisition of shares or units, or rights to acquire shares or units;
• a transfer of property or services; and
• payments in relation to a call on shares.

Where an eligible benefit is provided by the CFC to an entity which is associated with it, or to the associated entity by a third party ‘arranger’, the eligible benefit is treated as a ‘distribution benefit’.

Very broadly, so much of the benefit that is not otherwise a dividend, and which does not exceed the CFC’s profits, is deemed to be a dividend paid by the CFC. Importantly, section 47A is self-operative and is not dependent on the Commissioner forming an opinion that the section applies.

Also, section 47A can apply to transactions between two companies, including between two CFCs, unlike Division 7A.

Put very simply, section 109BC provides that Division 7A applies to a payment, loans or debt forgiveness from a non-resident company; with some appropriate modifications to ensure that the relevant tax accounting period for a non-resident company applies.

Both section 47A and 109BC can apply to a payment, loan and debt forgiveness from a non-resident company, but section 47A takes primacy over section 109BC.[15] Also, as it noted above, section 47A can apply to a much wider range of transactions and also between two companies.

Practical experience 

Section 47A has been the central issue in a number our recent audit matters. In one example, an Australian unit trust had been purchasing goods from a BVI company which was operated by the nephew of one of the directors of the trustee of the Australian unit trust.

The BVI company was a CFC in an unlisted country by virtue of the family relationship. After a number of years, the Australian unit trust fell behind on its payments to the BVI company. The ATO’s view was that the entire outstanding balance owed to the BVI company by the Australian unit trust had been waived or released, such that the balance was a deemed dividend paid by the BVI to the unit trust.

It was up to the taxpayer to convince the ATO that there had been no waiver or release, by demonstrating its payment history and the regular payments that had been made after the audit period.

Our message to practitioners is that:

• be aware of sections 47A and 109BC, and when they can arise;
• a payment, loan and debt forgiveness from a non-resident company will be captured by either, or both, section 47A and 109BC;
• section 47A can apply to a broad range of transactions between Australian residents, and their associates, and non-resident entities – including between two companies; and
• section 47A is self-operative, and is not dependent on the Commissioner forming an opinion that the section applies. Taxpayer’s will need to self-assess whether the section applies.

[1] American comedian and misanthrope, who was 42 when the first episode of Seinfeld appeared on TV.
[2] American actor who became a household name after appearing as Jules Winnfield in Pulp Fiction at age 46.
[3] https://www.afr.com/wealth/tax/fresh-scrutiny-of-trust-payouts-to-family-members-20200213-p540hu; https://www.theaustralian.com.au/subscribe/news/1/?sourceCode=TAWEB_WRE170_a_GGL&dest=https%3A%2F%2Fwww.theaustralian.com.au%2Fbusiness%2Fwealth%2Fato-targets-family-trust-distributions%2Fnews-story%2Fb24da372c0ad088db1abbcec30b05dbe&memtype=anonymous&mode=premium
[4] Second Reading Speech, 23 November 1978, Income Tax Assessment Amendment Bill (No.5) 1978.
[5] 98 ATC 4241.
[6] Or, to be technically accurate, ‘by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a ‘reimbursement agreement”.</span
[7] Subsection 100A(7) of the 1936 Act.
[8] Subsection s100A(8) and (9) of the 1936 Act.
[9] Second Reading Speech, 23 November 1978, Income Tax Assessment Amendment Bill (No.5) 1978.
[10] Subsection 99B(1) of the 1936 Act.
[11] Taxation Laws Amendment (Foreign Income) Act 1990 No. 5 of 1991
[12] Second Reading Speech Taxation Laws Amendment (Foreign Income) Act 1990 No. 5 of 1991; https://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;db=CHAMBER;id=chamber%2Fhansardr%2F1990-10-16%2F0045;query=Id%3A%22chamber%2Fhansardr%2F1990-10-16%2F0045%22
[13] Tax Laws Amendment (2010 Measures No. 2) Act 2010.
[14] Canada, New Zealand, France, United Kingdom, Germany, United States of America and Japan are the only listed countries; all other countries are regarded as non-listed countries.
[15] Section 109L of the 1936 Act.