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Basic Concept-Section 100A and Reimbursement Agreement

Basic Concept-Section 100A and Reimbursement Agreement

Basic Concept

Section 100A is an anti-avoidance rule that can apply where a beneficiary’s trust entitlement arose from a reimbursement agreement. Broadly, a reimbursement agreement involves an arrangement under which a beneficiary is made presently entitled to trust income and:

  • someone other than that beneficiary receives a benefit in connection with the arrangement
  • at least one of the parties enters into the agreement for a purpose of reducing tax.

Exclusions from reimbursement agreements

There is no reimbursement agreement in any of the following circumstances:

  • an arrangement simply involves a beneficiary receiving and using their trust entitlement
  • the agreement has been entered into in the course of ordinary family or commercial dealing
  • the presently entitled beneficiary is under 18 years of age or otherwise under a legal disability.

Consequences of a reimbursement agreement

To the extent a beneficiary’s entitlement arises out of a reimbursement agreement, section 100A disregards it. This means that the net income that would otherwise have been assessed to the beneficiary (or trustee on their behalf) is instead assessed to the trustee at the top marginal tax rate.

High Risk Example- trust income distributed to a loss entity outside the family group

The Banksia Trust carries on a property development business. Alexi is the trustee of the Banksia Trust and the beneficiaries include Alexi, his family and any entity he controls. The trust income of the Banksia Trust for the 2022–23 income year is $250,000 (the net income is also $250,000).

During the 2022–23 income year, Alexi is introduced to Mr Herschel by his accountant. Mr Herschel controls Herschel Pty Ltd, a company with $1,000,000 in available tax losses. Alexi and Mr Herschel agree that the Banksia Trust will distribute $200,000 to Herschel Pty Ltd to utilise tax losses and that Herschel Pty Ltd will be paid $20,000 and not call for the payment of the balance of its entitlement to trust income.

The trust deed of the Banksia Trust is amended on 31 March 2023 to include Herschel Pty Ltd as a beneficiary of the trust. On 30 June 2023, the Banksia Trust makes Herschel Pty Ltd presently entitled to $200,000 of the trust income and the balance of $50,000 to Alexi.

Herschel Pty Ltd receives $20,000 and the balance of its entitlement remains unpaid. The balance of the trust entitlement is used by the trustee to make loans to Alexi.

This is a high risk arrangement because the distribution was made:

  • to a beneficiary outside of the family group
  • for the purpose of reducing tax
  • to someone other than the presently entitled beneficiary received a benefit.

High Risk Example- beneficiary gifts their entitlement to another party

Thomas is the controller and trustee of Thomas Trust. During the year Thomas uses trust funds to pay for his personal living expenses.

Tracey is Thomas’ adult daughter who is a student with no income other than her trust entitlement. Thomas has other sources of income and pays tax at the highest marginal rate.

Thomas wants to avoid paying more tax so that he can maximise his ability to borrow funds and purchase more investments. Under an agreement between Tracey and Thomas, she agrees to gift her trust entitlement to Thomas (less an amount used to pay her income tax for the year).

The trustee of Thomas Trust then makes Tracey, presently entitled to all of the trust income for that income year.

The trustee reduces the loan owed to it by Thomas by the amount gifted from Tracey to Thomas. Thomas benefits from the trust income but is not assessed on any part of it.

Even though Thomas and Tracey share a close family relationship, with Tracey being financially dependant upon Thomas, it is high risk because the arrangement appears to be explained by the objective of reducing the tax that would otherwise have been payable had the trustee simply accumulated the income.

We would dedicate compliance resources to conduct further analysis on the facts and circumstances of the arrangement to consider if section 100A may apply.

High Risk Example- complex arrangement that is not ordinary family or commercial dealing

Andy and Gabriella are cousins who operate a hardware business through a discretionary trust. Andy, Gabriella and their families are beneficiaries of the trust. Andy and Gabriella’s families, other than co-owning the business, are not financially dependent on each other. There is an informal understanding between Andy and Gabriella that the profits of the business are to be shared equally between their respective families.

In the 2022–23 income year, Andy and Gabriella each draw a salary of $25,000 from the business. Andy’s only other source of income is from negatively geared rental properties he owns which have generated rental losses of $50,000 for the year. Gabriella’s only other source of income is from trading in cryptocurrency which has generated assessable income of $180,000.

The trust has $200,000 net income (after the payment of salaries). The trust deed defines income of the trust estate to equal the trust net income. Gabriella wants to avoid paying more tax so rather than distribute the income equally, Gabriella and Andy agree to distribute $200,000 to Andy and nil to Gabriella. They agree that Andy will pay $100,000 (less $25,000 used to pay tax on that $100,000) to Gabriella.

In earlier income years, Andy and Gabriella entered into similar agreements where Andy was made presently entitled to trust income to take advantage of his lower marginal tax rate.

Even though Andy and Gabriella are cousins and business partners, they have their own family units and are not financially dependent on each other. This arrangement was entered into to take advantage of Andy’s lower marginal tax rate. This is a high risk arrangement and we will devote compliance resources.

High Risk Example- trust income is returned to the trust by the beneficiary in the form of assessable income

A private group includes the Jones Trust and a private company Smith Pty Ltd. The company is wholly owned by the trustee of the Jones Trust.

The Jones Trust received an assessable insurance payment of $2 million in December 2015 which was included in its assessable income in the year ended 30 June 2016.

The trustee of the Jones Trust used $1.4 million of the $2 million insurance payment to purchase a holiday house in February 2016 for the personal use of Ms Jones-Smith who controls the trust.

On 30 June 2016, the trustee of the Jones Trust made Smith Pty Ltd presently entitled to the $2 million income of the Jones Trust.

The company’s taxable income for the year ended 30 June 2016 was $2 million which was wholly comprised of the net income of the Jones Trust.

During the year ended 30 June 2017, Smith Pty Ltd received $600,000 of its trust entitlement which was used to pay its income tax liability.

The trustee of the Jones Trust does not have liquid funds available to pay the $1.4 million unpaid entitlement of Smith Pty Ltd.

During the year ended 30 June 2017, Smith Pty Ltd paid a $1.4 million dividend that was fully franked to the Jones Trust. The distributable income of the trust for that year was $1.4 million and the net income of the Jones Trust was $2 million. The trustee made Smith Pty Ltd presently entitled to the $1.4 million franked dividend income of Jones Trust. The taxable income of Smith Pty Ltd was $2 million which is comprised of the $1.4 million dividend and $600,000 franking credits included in the $2 million net income of the Jones Trust.

The distribution between Jones Trust and Smith Pty Ltd is repeated in each subsequent income year. In effect, there is a circular distribution of the $1.4 million.

The arrangement concerning Smith Pty Ltd’s entitlement to income of the Jones Trust is high risk because the arrangement cannot be explained by any commercial objective and appears to be explained by the objective of reducing the tax that would otherwise have been payable had the trustee simply accumulated the income. We would dedicate compliance resources to conduct further analysis on the facts and circumstances of the arrangement to consider if section 100A may apply.

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