Section 100A guidance: highway to the danger (red) zone
After a long wait and much anticipation, we now have the Commissioner’s position on the meaning and scope of section 100A of the Income Tax Assessment Act 1936 (Cth) (1936 Act). We also have a statement on how the Commissioner intends to dedicate compliance resources to examining arrangements that have been entered into involving trusts. All this has landed some 43 years since the provision was enacted and eight years since the Commissioner’s section 100A online fact sheet was published.
While Section 100A was originally introduced as a self-executing anti-avoidance provision to combat trust-stripping arrangements, its present scope and application by the Commissioner of Taxation has not been limited to arrangements at the egregious end of the tax-risk spectrum.
Section 100A is a complex provision and, while it has been around for 43 years, we have long had limited judicial or administrative guidance as to its application – until now!
The Commissioner’s position is set out in Draft Taxation Ruling TR 2022/D1 - Income tax: section 100A reimbursement agreement (TR 2022/D1) and Draft Practical Compliance Guideline PCG 2022/D1 - Section 100A reimbursement agreements - ATO compliance approach (PCG 2022/D1).
The Commissioner has also released Taxpayer Alert TA 2022/1 - Parents benefitting from the trust entitlements of their children over 18 years of age (TA 2022/1), which outlines arrangements that it considers may be shams or subject to section 100A or Part IVA.
These documents are not an easy read, but all private wealth tax advisors need to understand section 100A and the Commissioner’s attitude, so they can protect their clients and themselves. In particular, some of the arrangements that are classed by the Commissioner as being medium risk, and potentially subject to review, would be considered by many to be regular, ‘plain vanilla’ tax planning.
There are still a number of unknowns and we don’t have any greater understanding of the actual scope of section 100A than we did a week ago, but we at least have clarity on the Commissioner’s views and proposed compliance approach. At the same time, we await further judicial guidance on section 100A and its scope, while the decision of Logan J in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation  FCA 1619 (Guardian AIT) makes its way through the appeal process. This case is covered in detail in our previous article, ‘Long awaited guidance on s100A, but read with caution!’, and is currently subject to appeal.
Administrative guidance materials such as these do not have the force of law. Taxation Rulings merely provide the Commissioner’s view of the law, Practical Compliance Guidelines outline how the Commissioner will allocate ATO compliance resources according to assessments of risk, and Tax Alerts highlights the Commissioner’s concerns about new or emerging higher risk tax arrangements.
While it may turn out that the Commissioner’s position is circumscribed by further judicial guidance on section 100A, these are the key points we want advisors to keep in mind when reading these documents:
- Since 2010, section 100A has experienced a ‘renaissance’ and been a central focus in the review and audit of many privately-owned and middle-market taxpayers. With the issue of these guidance materials, advisors and taxpayers are on notice of which arrangements in particular will be reviewed. If your clients set up an arrangement that is deemed medium or high risk under PCG 2022/D1, they can expect some unwanted attention from the ATO.
- If a taxpayer’s affairs are structured in a manner that is deemed medium or high risk under PCG 2022/D1, the Commissioner may well look to argue that the taxpayer or their advisors have an ‘aggressive’ tax attitude and apply penalties commensurately.
- Advisors need to be aware of the Commissioner’s position in section 100A to fully apprising the client of the risks inherent in their arrangements (either new or existing) and the heightened risk of ATO scrutiny and penalties.
- Section 100A reviews are very much a ‘forensic’ exercise. It is about the facts and what the objective facts reveal about subjective intentions. If your client becomes embroiled in a section 100A review, you should expect the Commissioner will deploy his expansive information gathering powers to discover the facts and documents that are relevant to his determination of the matter. In the matters we have been involved in, the taxpayers and their advisors have been called in for interviews with the ATO (with the ATO represented by counsel) and have been required to furnish documents and past advice – keeping in mind that the ‘accountants’ concession’ is not the same as legal professional privilege.
Draft Taxation Ruling TR 2022/D1
TR 2022/D1, which is proposed to have retrospective application, sets out the Commissioner’s views on what constitutes a reimbursement agreement, including:
- what is the purpose of eliminating or reducing income tax; and
- what is an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing.
It is a lengthy and complicated document. What is of particular interest is the scope of the ‘ordinary family or commercial dealing’ exception, what it was intended to cover when it was introduced, and what it’s said to cover now.
There is also an inherent difficulty in defining what is ‘ordinary’, as that is a purely subjective concept and it depends very much on context and the particular facts that are under review: what looks ‘ordinary’ to you may look ‘extraordinary’ to the next person (or, the Commissioner) and what is ‘ordinary’ in one set of circumstances may be ‘extraordinary’ in a different set of circumstances. In this way, any attempt to define ‘ordinary’ in a way that would have universal application is doomed to fail.
What is clear is that the Commissioner appears to be narrowing the exception. What we all need to keep in mind is that arrangements that would be really complex when section 100A was introduced may well be considered ordinary today. The commercial landscape has shifted and we need to ensure that the scope of the exception reflects present realities.
In the Guardian AIT case, Justice Logan provided some limited guidance as to what constitutes a reimbursement agreement. We understand that there is at least one more section 100A case on foot at the moment and another Federal Court decision should be handed down soon.
Absent further judicial guidance, we still do not have a solid understanding of exactly how to assess which matters come within the exception – TR 2022/D1 provides the Commissioner’s view of these matters, but does not have the force of law.
We hope that the cases currently before the Federal Court provide some much needed clarity.
The key takeaways from TR 2022/D1 are:
The ‘connection requirement’ must be met: broadly, this requires that the ‘present entitlement’ and the ‘reimbursement agreement’ must be connected, in terms of circumstances and in terms of time.
This means that the beneficiary is (in fact or otherwise deemed) presently entitled to a share of trust income and their present entitlement to that share arose out of a reimbursement agreement or by reason of any act, transaction or circumstance that occurred in connection with or as a result of a reimbursement agreement.
For this requirement to be satisfied, the conferral of the present entitlement must be legally effective (noting that often, a ‘present entitlement’ is not created, usually because the terms of the deed have not been strictly complied with) and a reimbursement agreement must exist.
A corollary to this is that if the relevant beneficiary is presently entitled to a share of trust income in their capacity as a trustee of another trust (the ‘interposed trust’), that income must not have flowed-through to another entity. That is, there must be income of the interposed trust attributable to that share to which no beneficiary of the interposed trust estate is presently entitled.
The ‘benefit to another requirement’ must be met: this suggests that in applying section 100A the Commissioner will look for a disconnect between the ‘present entitlement’ and where the financial benefit of the trust’s income is actually enjoyed.
The agreement must provide for the payment of money or the transfer of property to, or the provision of services or other benefits for, a person other than the presently entitled beneficiary.
The ‘tax reduction purpose’ requirement must be met: one or more of the parties to the agreement must have entered into it for a purpose of ensuring that a person would be liable to pay less tax in an income year than they otherwise would have.
Note the emphasis on the singular here: ‘a’ purpose and not the sole, dominant or primary purpose. Tax reduction may be one of a number of purposes behind entering into a particular arrangement (say, asset protection).
- As for the ‘ordinary family or commercial dealing’ exception, the Commissioner states:
- In construing the language of the ordinary dealing exception, and what is ‘ordinary’, adopting a dictionary meaning of the term is insufficient and you must take the words in their statutory context: that is, they are provided as an exception to an anti-avoidance provision.We consider the exception should be construed somewhat broadly such that section 100A is only to apply to arrangements that are clearly artificial or contrived. The ATO’s risk assessment in PCG 2022/D1, discussed below, appears to go beyond this.
- The essential feature of ordinary family or commercial dealing is that it is ordinary, and contains no element of artificiality. A dealing will be ordinary where a person can examine the acts and predicate that they can be explained by the familial and/or commercial objects they are apt to achieve without further explanation.
- Just because an arrangement is common does not make the arrangement 'ordinary'. The excuse of ‘but everyone around me was speeding’ will not fly. Similarly, a dealing can fail to be ordinary even where it is not artificial.
Draft Practical Compliance Guideline PCG 2022/D1
PCG 2022/D1 sets out the Commissioner’s proposed compliance approach to section 100A and reimbursement agreements in both future and past income years.
The PCG sets out how the Commissioner proposes to differentiate risk for a range of trust arrangements to which section 100A might apply and is designed to allow taxpayers and their advisers to assess the level of risk associated with their trust distribution arrangements.
Taxpayers are provided with a risk assessment framework, with different types of arrangements determined to fall within different coloured zones, against which they can assess the relative risk associated with their arrangements from a section 100A perspective.
Taxpayers are expected to self-assess their current arrangements and determine whether they fall within the White, Green, Blue or Red zones. This risk assessment framework is intended to provide taxpayers with some degree of certainty as to their taxation affairs. More importantly, the Commissioner uses these compliance frameworks to proactively ‘nudge’ taxpayers away from higher risk arrangements by messaging to the taxpaying public that if they enter into certain arrangements, they are playing with fire.
This is not an uncommon approach for the Commissioner: we have seen this before in PCG 2017/4, PCG 2019/1, PCG 2019/8 and PCG 2020/7. Taxpayers are told to swim between the flags set by the Commissioner – which are becoming increasingly narrow – with the alternative the risk of a protracted and costly ATO audit.
In 2009 there were suggestions that in addition to Division 7A, section 100A may also be applied to unpaid present entitlements (UPEs) to corporate beneficiaries, but that idea was shot down at the time. As is clear from PCG 2022/D1, the Commissioner has now back-flipped on this issue. This comes as no surprise: it was always something that was in contemplation by some guiding minds at the ATO and, from the Commissioner’s perspective, there is no harm in having more than one arrow in his quiver!
Curiously the Commissioner has now replaced their existing Division 7A guidance materials, TR 2010/3 and PSLA 2010/4, with a Taxation Determination, TD 2022/D1. It appears that the Commissioner is taking a clear (retrospective) position in relation to the application of section 100A to UPEs to corporates, but then only changing his view on the related Division 7A issue prospectively from 1 July 2022. Further discussion of TD 2022/D1 is provided in our article TD 2022/D1 – Is this the Commissioner’s answer to the lack of targeted amendments to Division 7A?.
Red zone (high risk):
This zone captures the arrangements that are squarely in the Commissioner’s sights as being subject to section 100A. The Commissioner is actively targeting these arrangements, with a number of taxpayers already in the middle of protracted audits in relation to these arrangements.
Red zone arrangements are those where:
- the beneficiaries’ respective entitlements appear to be motivated by sheltering the trust's (taxable) net income from higher rates of tax; and
- the arrangement involves contrived elements directed at enabling someone other than the presently entitled beneficiary to have use and enjoyment of the economic benefits referable to the trust’s net income.
Some example Red zone scenarios include:
- Arrangements where the presently entitled beneficiary lends or gifts some or all of their entitlement to another party, including where funds that represent the entitlement are paid to their parent in connection with expenses incurred by the parent or the caregiver before the beneficiary turned 18 years of age (a claw back of the childhood allowance and school fees, if you will), or the beneficiary is a non-resident and the funds that represent the entitlement are made available to another party by way of loan or gift.
- A typical ‘washing machine’ arrangement. That is, an arrangement where a trust makes a distribution of income to a corporate beneficiary, owned by the trust, that subsequently distributes a dividend back to the trust. This type of arrangement was considered in the recent Guardian AIT
- Arrangements where the trustee sets off a beneficiary's UPE against an amount the trustee is owed by the beneficiary, being the subscription price for the acquisition of units, and either:
- the subscription price of the units is greater than their market value; or
- the trust deed provides the trustee with a unilateral right to issue new units in satisfaction of a UPE.
- Arrangements where the share of net income included in a beneficiary's assessable income is significantly more than the beneficiary's entitlement and all of the following apply:
- the difference is the result of contrivance;
- some or all of the amount reflecting that difference has accrued to, or been retained by, an entity other than the beneficiary; and
- the tax paid by the beneficiary on their share of the trust net income is significantly less than the tax that would have been paid by the entity who accrues or retains the amount, had they been assessed on it.
- Arrangements where a beneficiary is made entitled so their deductions or capital losses could be utilised against the trust net income (including trust capital gains) and the economic benefit associated with that trust net income is utilised by the trustee or an entity other than the beneficiary.
- Arrangements subject to a Taxpayer Alert, including TA 2016/12 - Trust income reduction arrangements.
If you’re in this zone, you should expect a knock at the door, and soon.
Blue zone (medium risk)
This zone is a ‘catch all’. It captures anything that is not a White, Green or Red zone arrangement.
In particular, the PCG notes that the Blue zone captures arrangements whereby a trust entitlement is withheld by the trustee and may otherwise be in the Green zone, but for the fact they exhibit certain risky features including:
- The beneficiary makes a gift of their trust entitlement.
- The beneficiary disclaims their entitlement or forgives or releases the trustee from its obligation to pay the entitlement.
- The income of the trust is less than the net income as a result of the trustee exercising a power, or the deed being amended, to affect the quantum of income of the trust estate.
- The beneficiary's trust entitlement is satisfied by payments that are sourced from that beneficiary, or the entitlement has been made subject to a loan agreement and the repayments of that loan are sourced from payments or loans from the beneficiary.
- The arrangement involves one or more features that may be explicable by a tax avoidance purpose.
These arrangements are on the Commissioner’s radar and may still be reviewed, but they are not classified as high risk and are not a current priority for ATO compliance activity.
Green zone (low risk)
This zone captures your squeaky clean ‘ideal world’ arrangements from the Commissioner’s perspective. These examples are provided by way of a ‘guiding light’ for taxpayers on how they should be structuring their affairs in order to avoid an ATO audit.
Interestingly, Green zone scenario 3 ties in with Draft Taxation Determination TD 2022/D1, which provides the Commissioner’s view on when an unpaid present entitlement or an amount held on sub-trust will become the provision of 'financial accommodation' for the purposes of Division 7A.
Like many practitioners, the Commissioner has probably got sick of waiting for guidance from the Government about the potential application of Division 7A to UPEs in favour of a corporate beneficiary. The Board of Taxation provided its report and recommendations to the Government on these matters in 2014, and still we wait.
TD 2022/D1 does not amount to a U-turn as was alleged in 2009, but it does reflect the Commissioner’s apparent attitude that the scope of the law is what the Commissioner thinks it should be. One of the outcomes of the negotiated arrangements in 2009 was that there was to be a test case to clarify the scope of Division 7A and its potential application to UPEs: that plan was abandoned.
The Commissioner will not apply new compliance resources to review these arrangements. Keep in mind that the ATO is not precluded from reviewing these arrangements and current compliance activities will not cease for arrangements that may fall within this zone.
White zone (low risk)
This zone captures arrangements entered into prior to 1 July 2014, ie prior to the Commissioner’s original fact sheet being issued. Again, the Commissioner will not apply new compliance resources to review these arrangements.
Taxpayer Alert TA 2022/1
In TA 2022/1 the Commissioner highlights his concerns over arrangements designed to facilitate access to tax-free thresholds and lower marginal tax rates of family members, as opposed to those structured in accordance with ordinary familial considerations.
TA 2022/1 focuses on arrangements where trust income is distributed to adult children, while the parents enjoy or otherwise deal with the benefit of the income. This may include where the benefit of the income is not received by the children and instead applied by way of repayment to the parents of expenses incurred in relation to their upbringing (eg school fees) or the adult child is required to contribute to family costs (eg board or car expenses) in excess of what would be expected in their circumstances.
TA 2022/1 also flags that the Commissioner is concerned about similar arrangements involving other family members of controlling individuals who are subject to a lower marginal tax rate.
As noted above, these arrangements would come within the Red zone of PCG 2022/D1 and would be subject to ATO scrutiny. Importantly, the Commissioner has flagged that they may seek to apply the promoter penalty regime or refer to the Tax Practitioners Board advisors who facilitate these arrangements; and getting a ‘please explain’ letter can be an unpleasant experience.
This article was written with the assistance of Gabrielle Terliatan, Paralegal.
 Paragraphs 29-46 of PCG 2022/D1.
 Refer also to Tax Alert TA 2022/1 - Parents benefitting from the trust entitlements of their children over 18 years of age.
 Paragraphs 24-28 of PCG 2022/D1.
 Paragraphs 15-23 of PCG 2022/D1.
 Refer to our article TD 2022/D1 – Is this the Commissioner’s answer to the lack of targeted amendments to Division 7A? for further commentary on this point.
 Paragraphs 13-14 of PCG 2022/D1.
Last week, the Australian Taxation Office (ATO) released the final versions of its ruling (TR 2022/4 and Practical Compliance Guideline (PCG 2022/2) on Section 100A of the Income Tax Assessment Act 1936. The Hall & Wilcox Tax team invite you to attend a complimentary webinar on this critical issue for the private and SME market.
Virtually: via Zoom Webinar
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