Long awaited guidance on s100A, but read with caution!

By Andrew O'Bryan, Frank Hinoporos and Todd Bromwich

Since 2010, section 100A of the Income Tax Assessment Act 1936 has experienced something of a ‘renaissance’ and been a central focus in the review and audit of many private and middle-market taxpayers. It is a complex provision and, while it has been around for 43 years, we have limited judicial guidance as to its application.

An arrangement may be excluded from the operation of section 100A if it comprises an ‘ordinary family or commercial dealing’. Again, there has been limited judicial interpretation of the meaning of an ‘ordinary family or commercial dealing’ as it applies for the purposes of section 100A. The Commissioner of Taxation is in the process of formulating his interpretative view on the meaning of an ‘ordinary family or commercial dealing’, though this has been in development for some time pending (among other things) the determination of the case discussed in this article.

In a very important development, Justice Logan of the Federal Court handed down his decision in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619, in relation to section 100A and the Part IVA anti-avoidance provisions. This case concerned what has come to be described as a typical ‘washing machine’ arrangement: that is, an arrangement where a trust makes a distribution of income to a corporate beneficiary, and the corporate beneficiary in sequence distributes a dividend back to the trust. This type of arrangement was one of a number of examples provided by the ATO of arrangements that may offend section 100A in its section 100A ‘fact sheet’ of 12 May 2016 (example 5).

This case provides some (limited) much-needed clarification on some of the more opaque issues surrounding the application of section 100A, but read with caution! Keep in mind that this is an old but underdeveloped area of taxation law, this is the ruling of a single judge at first instance, and the Commissioner will most likely appeal the decision to the Full Federal Court.

Having said that, we are not one to look a gift horse in the mouth. So we will take what we can get, and we provide our views on the judgment below.

The case in question

Justice Logan’s decision was a win for the Taxpayer, overturning the Commissioner of Taxation’s objection decision and allowing the Taxpayer’s objection in full.

It involves three key entities: a discretionary trust with a corporate trustee, a corporate beneficiary wholly-owned by the trustee, and an individual.

The individual is the sole shareholder of the trustee, and a beneficiary and ‘Principal’ of the discretionary trust (with the Principal being afforded powers consistent with those typically held by an Appointor).

In the 2012 and 2013 income years, the trustee appointed an amount of the trust’s income to the recently established corporate beneficiary. Part of the entitlement was paid out to the corporate beneficiary to allow it to pay tax on the distribution. The balance was not paid, and remained in the beneficiary’s accounts as an unpaid present entitlement (UPE).

In the subsequent income years, the corporate beneficiary declared a fully-franked dividend in favour of the trust equal to the balance of the UPE. The dividend and the UPE were offset against one another, thereby reducing the UPE to nil. The trustee set aside the income referrable to the franked dividends to be held on trust absolutely for the individual beneficiary.

In 2014, a similar arrangement was entered into, but the parties entered into a Division 7A-compliant loan agreement in relation to the balance of the 2014 UPE, which was repaid in full in the 2016 income year.

The Commissioner asserted that on or before the relevant distributions of income, the trustee and individual beneficiary reached an understanding that the corporate beneficiary would be incorporated to be made presently entitled to the income of the AIT, the trustee would benefit from the amounts to which the corporate beneficiary was made presently entitled and the individual would ultimately benefit from that same amount. The Commissioner argued that this was an interlinked series of arrangements that constituted a reimbursement agreement under section 100A and the trustee should be taxed on the net income of the trust for each year, noting that the effect of 100A is to invalidate a purported ‘present entitlement’ to a distribution of trust income, triggering a trustee assessment under section 99A. It is also relevant that the usual assessment limitation periods do not apply to section 100A, so it was possible for the Commissioner to seek to amend as far back as he chooses.

The Court ultimately held that section 100A had no application to the taxpayer group’s circumstances, determining that no such reimbursement agreement existed at the relevant times.

Key takeaways

The following key takeaways can be gleaned from Justice Logan’s judgment (both his decision and his statements in passing).

• The alleged reimbursement agreement must exist at a point in time and it must pre-exist two things:
  • the present entitlement of a beneficiary to trust income that is the subject of consideration under section 100A(1)(b); and
  • the ‘payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary…’ necessary to establish the presence of a reimbursement agreement under section 100A(8).
• Further to the above, a ‘hypothetical contingency’ open in law but never actually considered is insufficient to establish the existence of a reimbursement agreement. The requisite temporal sequence, and connection between the existence of a reimbursement agreement and the items noted above, must be established on the evidence.
• Where an agreement exists, but prior to the relevant appointment of income that agreement only contemplates the conferral of a present entitlement to trust income, and not the ‘payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary…’ this will not be sufficient to establish that a reimbursement agreement existed at the requisite time.
• The beneficiary presently entitled to the relevant trust income need not be a party to the alleged reimbursement agreement.
• As to the ‘ordinary family and commercial dealing’ exclusion:
  • The adjective ‘ordinary’ is used in contradistinction to ‘extraordinary’ and refers to a dealing which contains no element of artificiality.
  • The use of a corporate beneficiary does not necessarily bear the stamp of tax avoidance and is not necessarily incompatible with this exclusion.
  • By inference, where an arrangement is borne out of a desire for risk minimisation and the accumulation of wealth that arrangement may be nothing more than an ordinary family or commercial dealing.
• A finding that a reimbursement agreement existed at the relevant time is less likely where the taxpayer’s decisions are not driven by tax considerations and the taxpayer is not fully informed as to their future tax planning options.
• In determining whether the agreement was entered into for a tax avoidance purpose, as required by section 100A(8), the Court must determine what income tax ‘would’ (rather than ‘might’) have been payable had the agreement not been entered into. It must be established, objectively, what would have occurred, rather than adopting some lawful and theoretically available possibility. This may be established by proving what the prevailing circumstances (both commercial and personal) were at that time and what the taxpayer and their associates might have done in light of them, keeping in mind this is an objective test. In undertaking this exercise, a fact is not disqualified from consideration merely by reason of it having been an element of the reimbursement agreement.

What don’t we know?

While this decision provides some degree of guidance on the application of section 100A, it remains to be seen whether a principle of broader application in relation to the ‘ordinary family and commercial dealing’ exclusion, which is the most opaque aspect of this provision, can be drawn from this case given its particular facts.

This is particularly important as, based on our audit experience, section 100A cases can be very factual and a section 100A review is very much a forensic fact gathering exercise, where assertions by the taxpayer that an arrangement was entered into for asset protection or wealth accumulation purposes will be rigorously tested.

The good news (for tax practitioners, not the taxpayer) is that the Commissioner will most likely appeal this decision. This is the first proper judicial guidance we have received since the Raftland case in 2008 and it has not gone the Commissioner’s way.

Given the strategic importance to the Commissioner of any new case law in relation to section 100A, we expect the Commissioner to lodge an appeal imminently. A Full Federal Court decision would hopefully tease out the legal issues in greater depth and provide us with statements of principles of broader application.

It remains to be seen whether the Commissioner will now publish his much anticipated draft taxation rulings on section 100A and Division 7A, or wait until this matter (and others before the Federal Court) are finalised.

Appeal update: On 8 February 2022, the Commissioner lodged a notice of appeal to the Full Federal Court in respect of this decision. Further updates will be provided as they become available.