Pitcher Partners Advisors Proprietary Ltd ABN 80 052 920 206
Level 13, 664 Collins Street Docklands VIC 3008
Level 1, 80 Monash Drive Dandenong South VIC 3175
Postal Address GPO Box 5193 Melbourne VIC 3001 p. +61 3 8610 5000
Justin Dearness & Christopher Ryan Australian Taxation Office
By Email: justin.dearness@ato.gov.au; christopher.ryan@ato.gov.auDear Justin & Christopher
TR 2022/D1 & PCG 2022/D1 - SECTION 100A REIMBURSEMENT AGREEMENTS AND THE ATO COMPLIANCE APPROACH
1. Thank you for the opportunity to provide comments on the ATO’s Draft Taxation Ruling TR 2022/D1 (“Draft TR”) and Draft Practical Compliance Guideline PCG 2022/D1 (“Draft PCG”) in relation to section 100A1 reimbursement agreements.
2. Pitcher Partners specialises in advising taxpayers in what is commonly referred to as the middle market. Accordingly, we service many taxpayers who operate through trusts that are affected by the ATO’s interpretation of section 100A.
3. Our submission contains detailed comments covering both the Draft TR and Draft PCG which are set out in Appendix 1. Broadly, we believe the Draft PCG does not meet its goal of providing practical compliance guidance to taxpayers. The Draft PCG provides limited examples of arrangements that would be considered to be within the green zone, with the majority of trust distributions being categorised as either blue zone arrangements or red zone arrangements. Due to the serious consequences of section 100A applying, this is be an undesirable outcome as smaller taxpayers would be required to obtain advice on the risk of section 100A applying to historical arrangements and distributions on an annual basis.
4. We have highlighted in Appendix 1 a number of suggestions to expand the green zone scenarios to common arrangements that should be considered ordinary dealings or low risk from a section 100A perspective. Additionally, we believe it is critical that further clarity is required regarding the status of the section 100A guidance first published on the ATO’s website in July 2014 (“Fact Sheet”) so that taxpayers better understand their
1 Income Tax Assessment Act 1936 (“ITAA36”). All legislative references in this submission are to the ITAA36 unless otherwise specified.
Adelaide Brisbane Melbourne Newcastle Perth Sydney
Pitcher Partners is an association of independent firms. Liability limited by a scheme approved under Professional Standards Legislation. Pitcher Partners is a member of the global network of Baker Tilly International Limited, the members of which are separate and independent legal entities. pitcher.com.au
risk status for past arrangements. In particular, we believe that section 100A should not be applied retrospectively unless the taxpayer’s circumstances fell into one of the specific examples that the Fact Sheet stated section 100A should apply to, or otherwise were not consistent with the broad objects of the Fact Sheet.
5. In addition to our submission, we have included a case study in Appendix 2 outlining a basic scenario that commonly arises for small businesses. On our reading of the Draft PCG, the arrangements described in the case study appear to result in red zone categorisation, give rise to Division 7A implications and potential double taxation. We note that, in our view, the case study demonstrates a low-risk scenario as there is no tax mischief. We request that the ATO consider this case study separately and ensure the final guidance products enable taxpayers to correctly assess whether their arrangements are low risk from a section 100A perspective. At present, in our opinion, it is very difficult to apply the Draft PCG with confidence to such a common arrangement.
6. We believe it is critical that taxpayers and advisers are able to determine how section 100A applies to what we consider to be ordinary arrangements to properly manage their tax affairs with confidence. The current guidance documents released by the ATO would result in significant uncertainty and complexity in the middle market, making the trust taxation laws difficult to administer from both an advisor and ATO perspective.
7. Finally, given that section 100A has an unlimited amendment period, the ATO needs to consider providing guidance on record keeping obligations for the purposes of finalising the PCG. For example, the ATO needs to consider whether taxpayers are required to retain accounts, tax returns, distribution minutes and other documents indefinitely in order to support a ‘low risk’ position.
We would be happy to discuss any aspect of this submission. Furthermore, we believe that it would be of great benefit if the ATO would be willing to discuss these issues in person and also to workshop various examples. Please contact either Leo Gouzenfiter on (03) 8612 9674 or me on (03) 8610 5170 to discuss this further or to organise a meeting to further discuss this with us.
Yours sincerely A M KOKKINOS Executive DirectorAPPENDIX 1 – DETAILED COMMENTS
PART A – COMMENTS ON THE DRAFT TR
8. As an overall observation, we believe the Draft TR provides a good overall legal analysis of the principles underpinning section 100A. However, we set out below some comments on specific parts of the Draft TR where we do not agree with the ATO view or where we believe further guidance is required.
Tax purpose requirement
9. The recent decision in Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT [2021] FCA 1619 (“Guardian”) adopted the comments Hill J in East Finchley Pty Ltd v FCT [1989] FCA 720 in relation to the tax purpose exclusion in subsection 100A(8).
10. The analysis in paragraphs 157 - 166 of Guardian appears to support a view that one must postulate a counterfactual in order to determine whether the subsection 100A(8) exclusion applies. For example, paragraph 163 refers to “the required prediction in subsection 100A(8)”. This is consistent with the Draft TR’s analysis in paragraphs 156159 which considers the alternative view that only an “annihilation” approach can be applied.
11. The observations in Guardian endorse a reconstruction or alternate postulate type approach. As such, the analysis of the tax reduction purpose in paragraphs 70 - 75 of the Draft TR should be expanded to expressly state that a counterfactual or alternate postulate type analysis is required to determine whether this critical element of section 100A is satisfied.
12. Additionally, the Draft TR and Draft PCG examples should be expanded to explicitly state the relevant counterfactual that would result in a greater amount of income tax being paid. It would be particularly useful to understand whether the ATO believes the counterfactual involves a conferral of a present entitlement to some other entity (and if so, which entity) or an accumulation of income by the trust and why the identified counterfactual is a reasonable one.
Dominant purpose
13. We note that the ATO state at paragraphs 16 and 71 of the Draft TR that there is no “dominant purpose” test contained in section 100A(8). We highlight that this position is contrary to other similarly drafted provisions in the income tax law, for example, section 177E, which deals with dividend stripping.
14. Section 177E does not have an explicit purpose test. However, the High Court in FCT v Consolidated Press Holdings Ltd [2001] HCA 32 appeared to have no trouble in concluding that one must apply a dominant purpose test when considering whether there had been tax avoidance.
[133] Hill J and the full court found that there was no purpose of avoiding tax on distributions of profits. For the reasons already given, it is dominant purpose which matters. There was a corporate reorganisation, entered into for reasons related to the United Kingdom tax treatment of future earnings, and a desire to avoid double taxation. The disposal of shares involved in the reorganisation attracted liability in
Australia to capital gains tax. A number of the characteristics common to schemes that have been regarded as typical dividend stripping schemes were absent. Above all, there was an absence of the particular taxation purpose which is the hallmark of such a scheme, and which is the reason why such schemes were intended to be covered by Pt IVA of the ITAA 1936.
[134] The conclusion of Hill J and the full court on this issue was correct. (emphasis added)
15. Accordingly, rather than being simply a dichotomy of an arrangement being either stamped as either a “tax avoidance arrangement” or one being “entered into the course of ordinary family or commercial dealings”, this approach would alternatively allow an arrangement to have multiple purposes (including a tax purpose) without the present entitlement being caught by section 100A. The exclusion in section 100A(13) is clearly intended to remove those transactions that are considered to be entered into in the course of ordinary family or commercial dealing. However, to the extent that an arrangement is not one ordinarily entered into, the commerciality of the arrangement may still be examined in applying the purpose test. An arrangement may have dual purposes, but in our view should generally not fall within section 100A if it cannot be shown that the dominant purpose is that of paying less income tax.
16. The above approach therefore allows ordinary transactions to be excluded from section 100A (such that the exclusion can be applied in the majority of cases). In addition, to the extent that transactions are not ordinary (such that they would generally be entered into in the course of ordinary dealing), they would need to be considered to determine whether they have a requisite purpose of tax avoidance due to the extraordinary nature of the transaction. Specific entitlement
17. We do not agree with the conclusion in paragraph 37 of the Draft TR that the effect of section 100A is to create a fictional state of affairs where the receipt or entitlement to financial benefits does not arise. This is taking the deeming rules in subsections 100A(1) and (2), which are to be construed narrowly in accordance with FCT v Comber [1986] FCA 92, too far. For section 100A purposes, the deeming of no present entitlement does not go beyond switching off the mechanism by which sections 97 and 98 operate to assess beneficiaries and trustees on an appropriate share of the net income of a trust estate.
18. Furthermore, on a literal reading of section 100A, it simply cannot apply to situations where a beneficiary has a specific entitlement to a capital gain or franked distribution under sections 115-228 or 207-58 of the Income Tax Assessment Act 1997 (“ITAA97”) but no present entitlement to any income of the trust estate. For example, section 115228 can be applied where the beneficiary is “reasonably expected to receive” an amount in the future. This requirement in section 115-228 is independent to a requirement of there being a present entitlement and does not rely on that concept.
19. Sections 100A(1)(a) and (2)(a) require that the beneficiary “is presently entitled to a share of the income of a trust estate”. Where this condition is not satisfied, the section simply has no application and there is no further need to consider what the actual effect of the deeming of no present entitlement does more broadly. Accordingly, turning off the present entitlement would have no effect on a beneficiary that is simply reasonably expected to receive an amount of a particular financial benefit.
20. This is reinforced by the enactment of the Trust Recoupment Tax Assessment Act 1985 and Taxation Ruling IT 2329. These deal with arrangements involving subsection 95A(2) and vested and indefeasible interests in trust income but no present entitlement. The Explanatory Memorandum to this legislation highlights that it was introduced to deal with “new generation trust stripping schemes”. Evidently, section 100A was not able to deal with these arrangements because they simply do not involve the conferral of a present entitlement to income of a trust estate.
Relief from double taxation for distributions to corporate beneficiaries
21. The ATO should not be seeking to apply section 100A in a way that results in more than the top marginal rate of tax being paid on trust net income. This can occur where a distribution is made to a corporate beneficiary. Where section 100A is applied, the trustee may pay tax at the top marginal rate (i.e. 47%) on the net income of the trust. In addition, as the corporate beneficiary will have received profits through the legal distribution (untaxed), the shareholders may be taxed on the same income at the top marginal rate when the dividend is paid from the company as an unfranked dividend (47%).
22. We note that the ATO’s view at paragraph 37 of the Draft TR is that the effect of section 100A is to “create a statutory fiction where that receipt or distribution did not arise”.
23. In this scenario, the ATO should be clear that they would apply this principle to ensure no additional tax is payable for distributions to corporate beneficiaries subject to section 100A.
24. That is, the statutory fiction would mean that the relevant company had not received the distribution, and thus would not have derived profits relating to the relevant present entitlement and could thus not have distributed the amounts as dividends (as it never received under the fictional state of affairs). Furthermore, if the unpaid entitlement is forgiven, it should not be subject to Division 7A (as the UPE would not be taken to exist for the purposes of applying the entire Act).
25. As such, any distribution of those underlying profits should not give rise to assessable dividends to shareholders, be subject to dividend withholding tax, not give rise to any deemed dividends under Division 7A (e.g. where the UPE gives rise to the provision of financial accommodation), nor give rise to a debit in the franking account of the corporate beneficiary as any purported allocation of franking credits would not have been made to a frankable distribution (i.e. there would be no distribution within the meaning in section 960-120 of the ITAA97). We believe this would be a sensible approach to administering the provisions consistently with the ATO’s comments in paragraph 37 as they relate to the statutory fiction created by the application of section 100A. As we are aware that the ATO has sought to double tax arrangements in some cases, we believe it is critical for the ATO to ensure that this does not occur in the administration of these provisions.
Indirect benefits
26. The ATO should explain the implications of its reference in paragraph 67 of the Draft TR to benefits being able to be provided indirectly (e.g. to those that hold equity interests in the presently entitled beneficiary).
27. This has potential for an extremely broad application of section 100A. For example, where a trust distributes to a corporate beneficiary or a unit trust beneficiary, does the ATO consider that section 100A can apply even where that beneficiary promptly receives the underlying cash and uses the funds for investment or business purposes? Would the ATO seek to argue that there has been an indirect benefit provided to some entity other than the presently entitled beneficiary (e.g. the unitholder or shareholder) and that a tax purpose exists as more tax would have been paid had the trust distributed directly to the equity holder who may have used the funds to inject equity into the presently entitled beneficiary?
PART B – COMMENTS ON THE DRAFT PCG
General comments
28. Our overall observation is that the Draft PCG does not meet its goal in providing practical guidance to the majority of taxpayers that will need to consider its application on a day-to-day basis.
29. At the outset, we highlight that there are over 900,000 operational trusts, with a significant proportion of these trusts being considered ‘micro’ or ‘small’. This group of taxpayers are unlikely to understand the technical content of the Draft TR and thus will likely be using the Draft PCG as a guide for complying with and reducing risk in respect of section 100A.
30. We therefore see the Draft PCG as being the most important document that will be utilised by the majority of trust taxpayers in the smaller end of town. Accordingly, we believe it is absolutely critical that unsophisticated taxpayers are able to apply the Draft PCG in a manner that provides them with sufficient guidance and certainty on common transactions.
31. In our view, we believe that very few examples in practice will fall squarely within the white or green zones, and that the majority of examples would fall within the red or blue zone. We highlight that there are simply too many nuances in taxpayers’ arrangements for them to be “relevantly identical” to the examples and conditions outline in the Draft PCG and Draft TR.
32. As outlined below, it is imperative that the scope of white zone / transitional arrangements and the scope of the green zone provide appropriate guidance for lowrisk common arrangements (and that they are not contained in the blue zone).
33. Following are our specific comments on particular aspects of the Draft PCG.
Record-keeping expectations and unlimited period of review
34. Paragraph 15 of the Draft PCG recommends that taxpayers who choose to rely on it should document how their circumstances meet their requirements for the green zone.
35. The PCG should provide further details about what this entails. For example, would the ATO expect financial statements, trust resolutions, bank statements, correspondence, etc to be kept supporting a taxpayer’s position and for how long. As section 100A has an unlimited period of review, does the ATO expect that such records and documents are to be kept indefinitely and well beyond that statutory record-keeping requirements?
White zone and transitional arrangements
Fact Sheet
36. The retrospective nature of the Draft PCG (as outlined in paragraph 47) is unfair as it will be seen to take a “U-turn” on how the ATO has administered section 100A prior to the release of the recent guidance. This is despite what was contained in the somewhat obscure and somewhat vague Fact Sheet published in 2014.
37. From our experience, the reality is that the ATO has not sought to investigate and apply section 100A consistently with the Fact Sheet since its publication other than in
extreme examples such as a “washing machine” arrangement. In over 40 years, we are not aware of any circumstance which is contrary to this in an ATO audit or review.
38. Para 47 of the Draft PCG is drafted in the following manner:
47. When finalised, this Guideline is proposed to apply to present entitlements to income of a trust estate conferred before or after its date of issue. However, for entitlements conferred before 1 July 2022, the Commissioner will stand by any administrative position reflected in Trust taxation - reimbursement agreement, which was first published on our website in July 2014 to the extent it is more favourable to the taxpayer's circumstances than this Guideline. [emphasis added]
39. It is unclear what it means to have an ‘administrative position reflected’ in the Fact Sheet as the examples and commentary in the Fact Sheet were very fact and case specific. Some examples only dealt with high-risk cases of section 100A. Other examples included facts which (in most cases) would be different to an actual taxpayer’s circumstances. This is demonstrated in the table below.
Example Comment
Example 1 – Interestfree loan
Example 2 – PS LA 2010/4 arrangements
The example cannot be used for transitional relief as it concludes that section 100A would likely apply.
The example states that the funds are used for ”working capital for the business”. This example does not technically apply to a taxpayer in almost all cases. For example:
• The trust does not carry on a business (e.g. it invests in passive assets such as rental properties and listed shares).
• The trust uses the money to repay a loan that funded the business premises. Per the decision in Kidston Goldmines v FCT [1991] FCA 351, there may be technical uncertainty as to whether this amount has been used in ‘working capital’ as it is traceable to a specific use.
• The trust has made a loan to an individual (a small loan, say equal to 5% of the UPE) and that loan is also on Division 7A terms (as required by section 109D, 109T or 109XA). The loan is not working capital of the business. Note this also does not fall into Example 4 of the Fact Sheet as there is a corporate beneficiary in this example.
• The Fact Sheet states a requirement that there be “annual repayments made” in respect of the PS LA 2010/4 arrangement. The PS LA does not actually require annual repayments; it only requires annual interest to be paid with a repayment due at the end of the agreement. This means that most PS LA arrangements may not be technically consistent with the comments in the Fact Sheet.
• A family asset is acquired by the trust (e.g. holiday home) either wholly or partly through the use of the UPE that is on Division 7A or PS LA 2010/4 terms.
Example 3 –Arrangements under a will
The example requires the income to be used to invest in incomeproducing assets. The example does not specifically apply where the
Example Comment
assets are capital appreciating assets that do not produce income. For example: gold; spec shares; crypto assets etc.
Example 4 –Commercial loan
The Fact Sheet only covers amounts being distributed to individuals. If the amounts are distributed to a company (and put on Division 7A terms with the company) and loans are made to Charlene by the trust on commercial terms, this may not be covered by the Fact Sheet nor under Green Zone Scenario 3 (which presently would require that the loan made to Charlene was also specifically made on section 109N terms and that Charlene uses the money for investment or for working capital but not for private purposes).
Note that under TD 2011/16, the loan made by the trust to Charlene does not have to be on section 109N terms for no deemed dividend to arise in accordance with sections 109T and 109W.
The Fact Sheet therefore does not provide any relief for arrangements involving corporate beneficiaries where the trust lends out on “commercial terms” other than Division 7A terms or for private purposes.
Example 5 – Washing machine
The example cannot be used for transitional relief as it concludes that section 100A would likely apply.
40. Additionally, there are some contradictory comments made in the Fact Sheet regarding interest-free loans. Example 1 involves an interest-free loan by the trustee to a person other than the presently entitled beneficiary and concludes that this would generally constitute a reimbursement agreement. However, in the next section of the Fact Sheet the ATO state that money lent by a trustee to a family member on principal only (i.e. interest-free) terms could still indicate an ordinary family dealing.
41. Finally, the Fact Sheet has been silent on the utilisation of tax losses between members of the same family group and the application (or potential application) of section 100A. Instead, the Fact Sheet simply refers to Division 175 of the ITAA 1997 and Division 271 in Schedule 2F to ITAA 1936 as “other integrity provisions that may apply to an arrangement”. Many, rightly or wrongly, have implied that this meant that the ATO were not as concerned with the utilisation of tax losses where in the situation where a family trust election was in place (by virtue of the reference to those provisions).
42. Accordingly, it will be difficult for taxpayers to determine whether their case would be one that is covered by an ‘administrative position reflected’ in Fact Sheet. We believe that more certainty needs to be provided with respect to historical arrangements, as outlined in our recommendations below.
White zone arrangements
43. Both paragraph 47 (which references the Fact Sheet) and the white zone deal with transitional arrangements. This is likely to be confusing for taxpayers.
44. The white zone covers pre-2014 arrangements (in particular circumstances) and paragraph 47 covers pre-2022 arrangements (where the arrangement is covered by an administrative position reflected in Fact Sheet).
45. We believe that further clarity should be provided so that it is simple for taxpayers to assess their historical arrangements to determine whether their historic arrangements would be classified as low risk.
Recommendation
46. The PCG should be clear and unambiguous with respect to how it treats transitional arrangements. In this regard, we make the following recommendations:
46.1. We recommend that reference to “an arrangement reflected in an administrative position of the Fact Sheet should be clearer.” We believe that greater certainty would be provided if it were stated that a taxpayer is covered by the Fact Sheet where: (a) their arrangement is broadly similar to an arrangement covered by the Fact Sheet or consistent with the broad objects of the Fact Sheet or where the Fact Sheet is relied on in good faith – for this purpose, the final PCG can provide a commentary regarding what the ATO view as the broad objects of the Fact Sheet; or (b) their arrangement covered the utilisation of tax losses within a family trust elected group and the use of tax losses did not involve a tax loss minimisation arrangement2
46.2. Paragraph 47 should be contained as a separate white zone arrangement rather than a transitional arrangement. This would eliminate dealing with two transitional provisions.
Green zone arrangements
47. The green zone arrangements in the Draft PCG are limited at present and should be significantly expanded to cover common arrangements that we view as low risk. It is somewhat of a concern that there are only three green zone scenarios in the Draft PCG. Further, green zone scenario 3 which deals with retention of funds is too narrowly drafted at present and should be expanded to cover various other scenarios involving ordinary retention of funds arrangements entered into private groups.
48. To demonstrate this issue, we refer to the green zone example provided by the ATO in the presentation titled “Section 100A and Division 7A” which was presented by Mr Christopher Ryan on 29 April 2022, slide 14 (“the Green Zone Example”). In this example, the arrangement is stipulated as being within the green zone based on its simplistic fact pattern. However, we highlight that the following slight changes in facts would likely render the arrangement to be in the blue zone, in circumstances that do not involve a change in the risk profile of the arrangement.
2
The words used and accepted in PCG 2016/16 on trust loss provisions are that an arrangement has not been entered into which would result in (a) section 272-35 having application; (b) the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or (c) fraud or evasion.
Change to Example Potential implication Potential modification to deal with issue
Kaitlyn is employed by the business (she was a sheep shearer) and is not a manager. The services provide by Kaitlyn have a value of an at least equal to those provided in the Green Zone Example.
Instead of the distribution being made to individuals, the distribution is made to a corporate beneficiary where both the trust and the company are controlled by the family unit (e.g. husband, wife and daughter).
Kaitlyn would be outside of the green zone and would then be within the blue zone.
Distributions to family members that are employed in the business should not result in failure of the green zone.
The trust makes a single loan ($10,000) to Kaitlyn which is not put on Division 7A terms. There are no companies in this example.
The green zone allows the trust to be controlled by the two spouses (para 20, dot point 3(i)), while the company must be controlled by a single individual (para 20, dot point 4(i)). Joint control by the family unit would potentially be outside of the green zone and within the blue zone.
The concept should be consistent with Schedule 2F, such that the trust and / or company are within the same family trust elected group.
The trust used the unpaid entitlement to repay debt that funded an office building.
Para 21(iii) requires all loans to be placed on section 109N terms, even where this provides for an interest free component for the first 12 months.
Loans are placed on commercial terms
As outlined earlier, this may not technically constitute the payment of working capital and may therefore fall outside of the working capital requirement. It may also not be regarded as being used in acquiring, maintaining, or improving an investment asset.
The repayment of bona fide debts of the trust should be an acceptable use of the funds.
Change to Example Potential implication
Paul and Sharon receive a trust distribution ($10,000). As a part of year-end tax planning, Paul and Sharon instruct the trust to make a payment of $500 to their superannuation fund (on their behalf) and a tax-deductible donation of $1,000 (on their behalf). Paul and Sharon claim a tax deduction for the amounts. The trust also plans to use the cash retained in the trust to pay the beneficiary’s income tax liability.
There would be a question as to whether the arrangement satisfies the ‘retention of funds’ requirement of the green zone.
Potential modification to deal with issue
Using funds to pay bona fide expenses of the beneficiaries should be acceptable for the purposes of determining whether the arrangement is in the green zone.
49. The above table is not intended to be exhaustive and is used to demonstrate that the specific requirements of the green zone may make it very difficult for taxpayers to fall squarely within its realms. We believe that greater certainty is required for simple things such as those outlined in the examples above. The following sections provide further clarification on the limitations of green zone scenario 3 and our recommendations to provide greater certainty to taxpayers.
Expanding scenario 3 – Use of funds condition
50. Further clarity should be provided regarding the use of funds condition in paragraph 21 of the Draft PCG. In particular, what it means to “maintain” an investment asset.
51. It is not clear if this simply refer to costs of physical maintenance (e.g. of a rental property) or does it refer more broadly to maintaining the value of the trust fund. Specifically, it is not clear whether the use of funds by the trust to pay off debts used to finance its investments satisfies the use of funds condition. Where a passive trust increases its net asset position by paying off debts, this should not be viewed as any less of a commercial dealing than acquiring a new asset from a section 100A perspective.
52. Green zone scenario 3 should be expanded to state that repaying debts that were incurred or to acquire an asset is an acceptable use of funds for a trust that does not carry on a business. To avoid doubt, the PCG should state that a trustee repaying business debts (e.g. trade creditors) is considered to be the use of funds “in the working capital of a business”.
53. Additionally, paragraph 21(c) of the Draft PCG should be elaborated upon to address whether paying off debts to associates would result in the use of funds condition not being satisfied. It is not clear whether it is considered that the associate has “benefited” from that use of funds or merely replaced one asset (a receivable) with another asset (cash) at the prevailing market value.
54. As many private groups rationalise and simplify intra-group debts as part of trust distribution arrangements, such uses of funds (i.e. to repay intra-group debts or loans) should also expressly be stated to satisfy the use of funds condition in green zone scenario 3.
Expanding scenario 3 – Complying loan requirement
55. The ATO should re-consider the requirement in paragraph 21(b)(iii) of the Draft PCG which imposes a requirement for taxpayers to enter into section 109N loan arrangements even where no private company is involved. This is unnecessarily restrictive and the making of loans on any commercial terms should be an acceptable “use of funds” by the trustee.
56. Further, the ATO should remove the requirement that the associate that borrows the funds uses those funds in the working capital of a business or for investment purposes. So long as the trust generates a commercial return on the loan, it should not matter that the associate uses funds for private purposes. From the trust’s perspective, making a personal loan that provides for a commercial return should be considered to be the acquisition of an investment asset. The use of the borrowed funds by the associate may give rise to considerations regarding interest deductibility but should not give rise to the application of section 100A. This can be distinguished from the non-commercial use of property as that kind of arrangement reduces the commercial return that could have otherwise been achieved by the trust.
57. Lastly, green zone scenario 3 should not require that where the distribution is to a private company that the company’s entitlement is made available to the trust on section 109N terms as contained in paragraph 20(b) of the PCG). This unnecessarily imports Division 7A considerations into the application of section 100A. If it is permissible for a distribution to be made available to an individual on “at-call” terms from a section 100A perspective, then it should not be any different if the beneficiary is a private company. The parties may wish to put the entitlement on complying terms to ensure a deemed dividend does not arise. However, if the private company does not have a distributable surplus so that a complying loan agreement is not required, then there should be no reason for the PCG to impose an obligation for the parties to enter into a section 109N agreement in respect of the entitlement, in the same way it does not seek to do so for entitlements to individual beneficiaries where a complying loan agreement is not required.
Expanding scenario 3 – Retention of funds condition
58. Paragraph 21(a) refers to the trustee retaining funds “for a period of time”. In almost all cases, there will be some period of time during which there are outstanding UPEs to the beneficiary, even if that is merely the time it takes for the trustee to calculate the amount of the entitlement.
59. Section 100A should generally not apply where there has been a retention of funds for a relatively short period. The final PCG should contain a green zone scenario that involves a temporary retention of funds only (e.g. where the distributions are paid out by lodgment day of the trust’s tax return). This should automatically be in the green zone and not considered a relevant retention of funds.
Expanding scenario 3 – Controller of the trust and private company
Paragraph 20, dot point 3 of the Draft PCG refers to a trust being controlled by an individual and/or their spouse. Dot point 4 refers to a company being controlled by the individual (but does not mention their spouse). For consistency, the corporate beneficiary should also be able to be one that is controlled by the spouse of the controller of the trust.
In many cases, the trust and/or company may be jointly controlled by family members (e.g. two parents and their three adult children where each has a 20% interest with no one individual having a controlling vote). Green zone scenario 3 should be expanded or clarified so that it can apply to distributions made by trusts that are not controlled by a single individual. Take the example above further, if the trust is controlled jointly by five family members, it should be considered that each of the five family members relevantly “controls” the trust and the retention of funds condition should be satisfied where the beneficiary is any of those five family members (and/or their spouses) or a private company that is controlled by any of those five family members (and/or their spouses).
Expanding scenario 3 – Distributions to loss trusts
60. Green Zone 3 should be expanded to expressly include trustee beneficiaries with tax losses. Presently, it only covers distributions to individuals or companies.
61. Trust-to-trust distributions are extremely common, particularly in Schedule 2F family elected groups and there is a distinct lack of guidance on these in both the Draft PCG and Draft TR.
62. While subsections 100A(3A)-(3C) carve out certain trust-to-trust distributions, section 100A can still apply to the extent a distribution is made to a loss trust. Example 11 of the Draft PCG (which covers red zone scenario 5) is not a very useful example as it is an egregious scenario involving an outsider to a family trust to which section 100A unquestioningly applies and which may be subject to family trust distribution tax in any case.
63. It would be far more useful for taxpayers to understand what features involving distributions to loss trusts within family groups – which are facilitated by Division 270 of Schedule 2F – are of concern). Given the purpose of the income injection test in Division 270, the final PCG should consider expanding the green zone for distributions to loss trusts within family elected groups where the use of funds condition is also satisfied (e.g. reinvested into working capital or investment asset of the distributing trust).
64. Specifically, we recommend that trustee beneficiaries are expressly included in paragraph 20 where both the distributing trust and the trustee beneficiary are within the same “family group” as defined in Schedule 2F and the use of funds condition in paragraph 21 is satisfied.
65. By expanding this green zone to trustee beneficiaries, this will invariably involve distributions to loss trusts (i.e., as distributions to non-loss trusts are simply excluded under the law). Therefore, this gives rise to some overlap with red zone scenario 5.
66. As such, any arrangement that meets the conditions for green zone scenario 3 should be deemed not to be ones that involve the economic benefit associated with trust net income being utilised by the trustee or an entity other than the beneficiary for the purposes of red zone scenario 5.
67. We have provided further commentary below at paragraph 103 of this submission. This section uses the example provided by the ATO at the CPA presentation on loss entities that was highlighted as being potentially low risk. We believe it is critical for the ATO to provide for this type of example to fall within the green zone.
New Green Zone Arrangement – Funds used by presently entitled beneficiary for their benefit
68. The Draft PCG does not state anywhere that the most basic case of funds being paid to the presently entitled beneficiary and used for their own benefit is a low-risk arrangement. This basic case should be expressly covered by a green zone to avoid all doubt.
69. In particular, consistent with our comments in paragraph 54 above, where the beneficiary receives and uses the funds to repay their own debts (whether owed to related parties or unrelated entities), then this should be plainly in a green zone.
70. This must specifically include where the individual uses the funds to repay Division 7A loans to a related company (whether by physical repayment or via set-offs) especially where the trust distribution was sourced from a dividend from a private company.
71. As this is an extremely common arrangement and low-risk due to marginal rates of tax being paid with respect to the dividend, this should be expressly covered by a green zone.
New Green Zone - Dividend and set-off arrangements for Division 7A loans owed by trusts
72. Paragraph 26 of the Draft PCG states that arrangements involving dividends and setoffs by corporate beneficiaries are not considered green zone arrangements because the source of the funds that satisfies the beneficiary’s entitlement can be traced back to the beneficiary.
73. It is extremely common for a trust to owe a private company an amount of a trust entitlement which has been converted into Division 7A loan. Where the amount has been invested in the working capital of the trust (or in an investment asset), it is very difficult for the trust to fund repayments of the Division 7A loan. Accordingly, a common method of repaying the loan is for the company to pay a dividend to an individual (either directly or via a trust) which is then used to provide a loan to a trust in order for it to repay some or all of the Division 7A loan. Effectively, the loan owing to the company is refinanced with a loan owing to an individual, but marginal rates of tax have been paid to achieve that refinancing.
74. The satisfaction of Division 7A loans owed by a trust through a dividend and set-off (where the dividend is distributed through a trust) is common practice and in many cases is the only way in which taxpayers can fund the repayment of their Division 7A loans. Section 109R(3)(a) has always provided an exception for dividends used to repay Division 7A loans and accordingly it is common practice for this mechanism to be used. We submit there is no integrity risk in this case if an individual includes the dividend in their assessable income and pays tax at marginal rates on the amount used to repay the company’s loan.
75. Such arrangements (with no additional features such as the individual beneficiary not enjoying the economic benefit associated with the trust distribution) should be
considered green zone arrangements. If there are particular concerns or features in these kinds of arrangements, these should be clearly articulated in the final PCG and placed into a red zone scenario if appropriate.
76. For example, if the ATO believe such arrangements are part of a broader “washing machine” arrangement involving multiple corporate beneficiaries then it should state this. However, as dividend and set-offs are a common method of repaying Division 7A loans and involves no tax mischief, we believe it is imperative that the final PCG classify this type of arrangement as a specific green zone arrangement.
77. We believe it should be fairly simple to articulate ‘green zone’ requirements that could encapsulate this type of arrangement. That is, the features of this arrangement involve: (1) a company paying a dividend that is distributed through one or more trusts (that are part of the FTE elected family group), where (2) the dividend is ultimately assessed that income year in the hands of an individual beneficiary and (3) no additional high risk features are present.
New Green Zone Arrangement – Distributions made to facilitate deductible payments
78. Many taxpayers enter into arrangements involving the distribution of trust income followed by a tax-deductible contribution to a complying superannuation fund or a charity.
79. Direct distributions to the super fund may result in the application of the non-arm’s length income provisions and distributions directly to a charity may invoke the application of sections 100AA and 100AB as well as give rise to issues relating to the rule against perpetuities.
80. Such arrangements should be considered as ordinary tax planning and expressly noted to be within the green zone in the final PCG.
Red zone arrangements
81. In addition to expanding the green zone scenarios to cover common arrangements that should be considered low risk, we submit that certain aspects of red zone scenarios need be clarified so as not to inappropriately capture ordinary arrangements that should be considered low risk.
Red zone scenario 1 – Gifts and loans
82. Red zone scenario 1 in the Draft PCG (as well as example 3 in the Draft TR) should consider factors other than the marginal tax rates of the individual family members involved in the arrangement when considering if an arrangement is high risk or low risk. In particular, other than the annual incomes, the assets and debts of the individuals involved may better explain why a family member lends or gifts amounts to another.
83. For example, while a working parent may be on a significantly higher tax rate then their adult child, they may also have significantly more debts and financial commitments (e.g. mortgage on the family home) than the adult child. Likewise, the grandparents may be retired with few debts and more assets than the parents despite deriving less taxable income. They may also have greater means if they derive tax-free income from drawing on a super fund pension, but a low marginal tax rate, nevertheless.
84. The PCG should specifically consider these additional factors and state when they would take taxpayers out of a red zone.
85. If the taxpayers can demonstrate that the arrangement was motivated by factors other than tax (i.e. the lower-taxed beneficiary had fewer financial needs than the other family member who received a gift or loan) then this should result in the arrangement not being in red zone scenario 1.
Red zone scenario 3 – Unit trust arrangements
86. We believe that the counterfactual analysis required to identify a tax reduction purpose may significantly call into question the conclusions stated in relation to certain unit trust arrangements.
87. In particular, example 7 in the Draft TR outlines an arrangement involving 20 unrelated unitholders that should not result in section 100A applying even if the loans made by the unitholders to the fixed unit trust were not made at a market rate of interest or some of the factors outlined in paragraph 132 were present. As a fixed unit trust with unrelated unitholders, there is no reasonable counterfactual that involves some person paying more income tax. If the amounts are lent back interest-free to the trust, gifted to the trust or simply not lent back at all, the same unitholders would be assessed under section 97 on the exact same amounts of trust net income under all of those counterfactuals.
88. Similarly, we believe the ATO should re-consider red zone scenario 3 in the Draft PCG. In particular, paragraph 37 is worded too broadly. While Example 9 in the Draft PCG focuses on a closely held and controlled hybrid trust, paragraph 37 is so broadly worded so as to have potential application to fixed unit trusts with 1,000 unrelated investors that are managed investment schemes.
89. The mere existence of a power in the deed of a unit trust providing a trustee with a unilateral right to issue new units in satisfaction of a UPE does not give rise to a reasonably counterfactual that involves some other entity paying more tax. Neither does a reinvestment of the entitlement at greater than market value. Something else is needed, such as the establishment of the unit trust itself being part of the reimbursement agreement, for section 100A to be enlivened. The mere decision by a unitholder to use their entitlement in a non-commercial way or the trustee exercising a right against the unitholder (with that right being part of the bargain at the establishment of the trust vehicle) does not give rise to any identifiable tax reduction purpose.
90. It is hard to see how section 100A can apply to these kinds of unit trust arrangements. The ATO should reconsider these examples or at the very least add a detailed explanation of what it believes to be the relevant counterfactual.
91. More broadly, widely held collective investment vehicles, such as the trust in example 7 of the Draft TR, should not be subject to section 100A except in the rarest circumstances. Any such unit trust is likely to be a managed investment scheme regulated under the Corporations Act 2001 and therefore any arrangement relating to distributions should be presumed to be entered into in the course of an ordinary commercial dealing. The ATO should adopt a practice to treat such unit trusts as being at low risk of section 100A applying.
92. We note that Attribution Managed Investment Trusts (“AMITs”) are out of scope of section 100A pursuant to section 95AAD. Where a trust is eligible to be an AMIT but
does not elect to become an AMIT, it remains taxed under Division 6 of Part III. The ATO should similarly treat these at low risk.
93. Additionally, the red zone scenario 3 arrangement in the Draft PCG appears to undermine aspects of the Collective Corporate Investment Vehicle (“CCIV”) regime, to which section 100A can apply when a CCIV sub-fund trust is not an AMIT. CCIV subfund trusts that are to be taxed under Division 6 are required to declare their entire accounting profit for the year as a dividend payable within 3 months of year-end to ensure its taxable net income flows through to its investors (being the shareholders in the CCIV sub-fund).
94. Paragraphs 13.104-13.105 of the Explanatory Memorandum to the Corporate Collective Investment Vehicle Framework and Other Measures Bill 2021 suggests that dividends can be dealt with in any way on behalf of beneficiaries (such as being reinvested back into the sub-fund) and that this will satisfy the requirement that the dividend was declared as payable. Such an arrangement, encouraged by the legislation, appears to be considered high risk of section 100A applying according to the Draft PCG. The ATO should consider how red zone scenario 3 would apply to CCIVs and consider treating this as low risk given CCIVs are highly regulated and would generally only be used in commercial dealings.
Red zone scenario 4 – Consistency with TA 2016/12
95. Example 10 in the Draft PCG and Example 8 in the Draft TR both involve the trustee taking steps to reduce the distributable income of the trust for the relevant year by amending the trust deed.
96. Paragraph 40 of the Draft PCG only states that the ATO will not treat an arrangement as being the result of a contrivance if the difference between taxable income and distributable income is merely due to franking credits.
97. However, the Draft PCG should be clear that it is necessary that steps taken to artificially cause the difference between distributable income and taxable net income for the arrangement is a critical element for the arrangement to be considered high risk and in a red zone scenario.
98. The statement in paragraph 40 should be expanded to be consistent with Taxpayer Alert TA 2016/12 (“TA 2016/12”) which covers similar trust income reduction arrangements. TA 2016/12 states that the ATO is not concerned where the differences result from amounts not traditionally regarded as trust income (e.g. capital gains) or are a result of proper accounting. The final PCG should adopt these same exclusions from red zone scenario 4.
Red zone scenario 5 – Concept of “economic benefit” and “utilised”
99. Paragraph 42 of the Draft PCG should be explained more clearly. In particular, what is meant by the economic benefit associated with trust net income being utilised by an entity other than the beneficiary should be expanded upon.
100. Similar to our comments in relation to the “use of funds condition” in green zone scenario 3, it is not immediately clear whether a beneficiary using funds to pay liabilities (including to associates) means that another entity has utilised the economic benefit associated with the trust net income.
101. On one view, any time the loss beneficiary uses the funds for any purpose whatsoever, this results in some other entity getting some economic benefit. For example, if the funds are used to purchase ASX listed shares, the person who sold the shares enjoys the economic benefit of the funds. However, this should not result in red zone scenario 5 applying to the arrangement. Likewise, where the loss beneficiary uses funds to pay off debts (including to an associate), from the creditor’s perspective, this is simply the use of cash at market value rather than the utilisation of an economic benefit associated with the trust distribution.
102. The Draft PCG should be clear as to what features of such an arrangement are of concern. The aforementioned arrangements can be distinguished from situations where a loss trust makes an interest-free loan or gift to an associate, which quite clearly transfer the benefit away from the trust to the associate.
103. Consistent with our comments in paragraph 54 above, where the beneficiary uses funds (i.e. in contrast to there being a retention of funds and use by the trustee) to repay debts, this should not be viewed as the beneficiary not enjoying the economic benefit associated with the trust net income regardless of whether those are third-party debts or related party debts. In either case the beneficiary enjoys the benefit as their net asset position is enhanced by the amount of the trust distribution. The same result also should occur where the amount of the distribution to the loss entity remains unpaid but is placed on commercial terms.
104. Where the distribution is made to a loss entity as part of a broader intra-group debt rationalisation (where debts between group entities are bona fide and are not artificial), the PCG should include this in a green zone and expressly not in red zone scenario 5.
105. To this end, the PCG could adopt the following example that was used in a CPA Australia webinar on section 100A and Division 7A3. The PCG should explain clearly that, inter alia, for the $50,000 of income distributed to Loss Coy, the beneficiary (rather than the creditor) has enjoyed the relevant $50,000 economic benefit:
APPENDIX 2:
APPLICATION OF SECTION 100A TO LOSS ENTITY
1. We have outlined below what we consider to be a very basic example that commonly arises for small businesses: a trust satisfying its related party liabilities through offset arrangements involving distribution entitlements. Despite its common occurrence, it is very difficult to apply the Draft PCG in its current form with any certainty to this example. We believe the example demonstrates a low-risk scenario, as there is no tax mischief, but risks being categorised as red, or, at best, blue, under the Draft PCG.
2. Consistent with our submission, we believe that a number of changes to the Draft PCG could provide appropriate clarity that would allow taxpayers to be able to properly reduce risk with respect to this type of arrangement. As this type of arrangement would be common, we believe it is imperative for the ATO to provide greater clarity on the items contained in this example.
3. To the extent that the ATO believes certain things should be done by taxpayers to ensure that section 100A is not applied or that the ATO do not apply Division 7A to the arrangement, it would be useful for the ATO to provide that clarity as part of finalising the draft documents.
Background facts
4. Trust A, Trust B and Trust C are part of a family group and each has made an FTE with respect of John Jones (“JJ”). Trust A runs a business and Trust B holds a rental property that is incurring losses from negative gearing. Trust C owns all of the shares in Aco.
5. The financial information, prior to trust distributions, for the operating entities for 30 June X1 is as follows.
Trust A Trust B Aco Profit / (loss) $100,000 ($50,000)Taxable income / (loss) $100,000 ($50,000) -
Cash $100 $100 $100 Debtors $100,000
Property (WDV) - $1,000,000Loans (bank) - ($500,000)Loans (JJ) - ($550,000)UPEs - -Settled sum ($100) ($100) ($100) Retained loss / (Retained earnings) ($100,000) $50,000 -
Trust distribution
The deeds of each of Trust A and Trust B define income with reference to taxable income.
At 30 June X1:
Trust A resolves to distribute $20,000 of income to Aco with 100% of the remaining income to Trust B.
Trust B resolves to distribute 100% of its income to Aco.
8. The accountants compile the financial information and process the distribution journals on 31 August 20X1. The dollar amounts of the entitlements are journalised as at 30 June 20X1.
Trust A Trust B
Profit / (loss)
Aco
$100,000 ($50,000) -
Taxable income / (loss) $100,000 ($50,000) -
Distributions in $80,000 50,000
Distributions out ($100,000) ($30,000) Income tax expense ($15,000)
Cash $100 $100 $100
Debtors $100,000 - -
Property (WDV) - $1,000,000Loans (bank) - ($500,000)Loans (JJ) - ($550,000) -
UPE Trust A to Trust B ($80,000) $80,000
UPE Trust A to Aco ($20,000) $20,000
UPE Trust B to Aco ($30,000) $30,000 Tax payable ($15,000)
Settled sum ($100) ($100) ($100)
Retained loss / (Retained earnings) - - ($35,000)
Transaction 1
9. On the 30 September 20X1, Trust A collects $100,000 in cash from the outstanding debts. Trust A transfers $85,000 to JJ. The parties agree to these offsets, however there are no formal documents outlining the flow of these funds (i.e. no formal offset agreements). When preparing the subsequent financial statements, the accountants post the following journal entry.
Trust A Dr Cr
UPE Trust A to Trust B $80,000 Loan (Trust A to Trust B) $5,000 Cash $85,000
Trust B Dr Cr
UPE Trust A to Trust B $80,000 Loan (JJ) $85,000 Loan (Trust A to Trust B) $5,000
Transaction 2
10. Trust A also pays the income tax liability of Aco and uses that payment as a reduction of the UPE outstanding between Trust A and Aco.
Trust A Dr Cr
UPE Trust A and Aco $15,000 Cash $15,000
Aco Dr Cr
UPE Trust A and Aco $15,000 Income tax liability $15,000
11. Aco declares a dividend of $5,000 to Trust C. The dividend is distributed by Trust C to JJ. The accountants offset this against the UPE that Aco has with Trust A, offset this against the loan Trust A has with Trust B and then reduce the loan JJ has with Trust B. Other than the dividend declaration, there is no other formal document or offset agreements.
Aco Dr Cr Retained earnings $5,000 UPE Trust A and Aco $5,000
Trust A Dr Cr Loan (Trust A and Trust B) $5,000 UPE Trust A and Aco $5,000
Trust B Dr Cr Loan (Trust A and Trust B) $5,000 Loan (JJ) $5,000
12. The financial statements for the relevant entities (after posting the journal entries) are as follows.
Trust A Trust B Aco Cash $100 $100 $100
Debtors - -Property (WDV) - $1,000,000Loans (bank) - ($500,000)Loans (Trust A and Trust B) -Loans (JJ) - ($470,000) -
UPE Trust A and Trust B - $UPE Trust A and Aco -UPE Trust B and Aco ($30,000) $30,000 Settled sum ($100) ($100) ($100) Retained loss / (Retained earnings) - - ($30,000)
Application of section 100A to the background facts
13. In our view, section 100A should not apply to the above scenario and the transactions should be regarded as low risk under the PCG. There is a clear commercial driver underpinning the arrangement, enabling Trust B to reduce its debts and to remain solvent. All debts within the example are bona fide debts between the related parties.
14. However, we consider that there is a technical risk that the ATO could seek to apply section 100A based on the ATO’s view of the provision as outlined in the Draft Ruling and Draft PCG.
15. Section 100A has potential application in respect of three entitlements:
15.1. The $20,000 distribution from Trust A to ACo.
15.2. $50,000 of the $80,000 distribution from Trust A to Trust B.
15.3. The $30,000 distribution from Trust B to ACo.
16. For completeness, there is a technical risk of Division 7A applying to the $30,000 outstanding UPE from Trust B to ACo. This would need to be put on complying loan terms in accordance with section 109N.
Tax purpose
17. The Draft Ruling sets out the ATO’s view that, for there to be a reimbursement agreement, there need only be a purpose of obtaining a tax benefit. That is, that there is no requirement that the tax reduction purpose be the sole or dominant purpose, or even a not incidental purpose. The breadth such an view gives to subsection 100A(8) makes it almost impossible to identify an arrangement that would not fall within scope of the provision, other than one where trust income is taxed at the top marginal tax rate.
18. While there is an overall reduction of tax paid on trust income in the above scenario, there is no ‘tax mischief’ found in the arrangement. Instead, losses within the family group are simply used and the loss entity is enabled to repay group debt. All parties benefit on an arms’ length basis from the income, and there is no benefit to any party outside of the family group.
19. The commercial driver underpinning the arrangement is clear – if Trust A did not distribute to Trust B, it would be left with insufficient assets to clear its debts. Therefore, the purpose of the distribution is not to achieve a tax benefit, but rather to restore the balance sheet.
20. The only risk is in relation to the choice to use a corporate beneficiary. However, the $30,000 that remains unpaid from Trust B to ACo would be placed on Division 7A complying loan terms with the result that the principal would be repaid to the corporate beneficiary.
Proposed clarification required by ATO guidance
Reasonable time to pay the UPE
21. On its face, the three months (until 30 September 20X1) in which the UPE remains outstanding from Trust A to Trust B could be considered a benefit for the purposes of subsection 100A(7), as Trust A retained the use of the funds. However, we consider that it would be inappropriate to apply section 100A in this manner, and the ATO should provide specific statements that allow a trustee a reasonable amount of time to pay out the UPEs. We would submit that a reasonable time would be by lodgment day (to align with Division 7A administrative requirements).
Red zone scenario 5 – loss beneficiaries
22. Red zone scenario 5 (paragraph 42) is directed at situations where the presently entitled beneficiary has a loss. It applies where the “economic benefit associated with that trust net income is utilised by the trustee or an entity other than the beneficiary”. It is not clear what the ATO means when it refers to an “economic benefit”. On one view, any time the loss beneficiary (in this case, Trust B) uses the funds for any purpose whatsoever, this results in some other entity getting some economic benefit. In light of the views expressed in paragraph 67 of the Draft Ruling, the payment to JJ could breach this condition.
23. However, Trust B (the beneficiary) has received economic benefits (in that it has paid down its debts owed to JJ). For the creditor (JJ), this is simply an exchange of one valuable right for cash at value, rather than any unilateral economic benefit associated with the trust distribution, such as an interest free loan or gift. That the creditor in this case is an associate, rather than a third party, should be of no consequence as long as the debt was at value and bona fide.
24. If the Draft PCG were amended to clarify that the payment of beneficiary’s liabilities provides a benefit to the beneficiary personally, notwithstanding that the creditor is also benefited, then the arrangement would not fall within the red zone (in respect of the $50,000 entitlement from Trust A to Trust B).
25. We note, however, that without corresponding changes to green zone scenario 3 (outlined below), this would still leave the arrangement in the blue zone. The circumstances outlined in this example are driven by commercial objectives and provide no tax mischief. As outlined in
our submission, we believe it is important for this type of arrangement to be capable of falling within a green zone.
Blue zone – Dividend and set off
26. In this arrangement, the $5,000 dividend declared by ACo to Trust C is ultimately set off against the loan owing by Trust B to Trust A.
27. Setting off mutual obligations is a common and legally effective means of satisfying obligations and should not, in and of itself, bring an arrangement within the scope of section 100A. As outlined in our submission, this type of arrangement should fall within the green zone. We have proposed some wording or requirements that could be considered to allow for a very specific exclusion where dividend entitlements (through one or more trusts) are used to repay some or all of a Division 7A loan
Green zone 3 – retention of funds by the trustee
28. Assuming ACo was controlled by an individual that also controlled the trust, it is unclear whether the retention by Trust B of funds underlying the distribution to ACo would satisfy the ‘use of funds’ conditions in green zone 3. Paragraph 21(b) requires that the trustee uses the funds “for the acquisition, maintenance or improvement of investment assets of the trustee”. If the acquisition of an investment asset (in this case, a property) is considered low-risk, then surely repaying debt used to acquire an investment asset should also be regarded as low-risk.
29. If the ‘use of funds’ condition in paragraph 21 were clarified to expressly include that the repayment of debt was an acceptable use of funds (where such debt is bona fide), it would help to clarify that this arrangement falls within green zone scenario 3, at least in respect of the $30,000 distribution from Trust B to ACo.
Double taxation
30. As we have highlighted in our detailed consideration, if the ATO were to apply section 100A to the above arrangement, there is a real risk of double taxation to the parties. The distribution (from Trust A and Trust B) would be taxed at the top marginal tax rate (47%). ACo, having already paid $15,000 in tax on its $50,000 entitlement, would be entitled to amend its return and claim a refund of the income tax. However, it is unclear whether the fictional state of affairs, where the company would be deemed not have been made presently entitled to the trust income, would be sufficient to unwind the dividend that was declared to Trust C.
31. The finalised Ruling should explicitly state the ATO would not seek to recover twice. That is, if section 100A applies to tax the trustee on the income at 47%, there is a risk that ACo will also be taken to have received profits through the legal distribution (untaxed), and therefore the beneficiaries of Trust C (as the sole shareholder) may be taxed on the same income at the top marginal rate when the dividend is paid from the company as an unfranked dividend.
32. In addition, ACo should be able to forgive the loan to Trust B in the future without triggering a deemed dividend for the purposes of Division 7A.