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The ATO’s position on trust distributions suggests a number of possible approaches but – in the second article on the matter – John Jeffreys says one approach stands out.
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How to adopt a risk-free approach to s100A
05 May 2023
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16 minute read
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To avoid putting clients into section 100A red zone scenarios, accountants need to make some key policy decisions in relation to their clients:
- Will I adopt the policy that beneficiaries should be paid their entitlements and the beneficiaries be instructed to spend that entitlement only on themselves?
- Will I adopt the policy that all of my clients will have arrangements that fit within the green zone as set out in PCG 2022/2 and TR 2022/4?
- Will I adopt the policy that most of the arrangements with my trust clients will not fall within either the green zone or the red zone as set out in PCG 2022/2 and just deal with ATO questions if they ever arise?
- Will I adopt the policy, where applicable, that there is no reimbursement agreement, therefore I will ignore PCG 2022/2?
I explain these four policy decisions below. First, I want to make clear how the ATO has approached dealing with s100A and why that approach has got accountants thinking the wrong way.
The ATO approach to s100A
The approach of the ATO with regard to administering s100A has been to get the accounting and legal profession to focus on what happens with distributions to which beneficiaries are presently entitled. The unstated assumption has been that the way in which those distributions are dealt with after year end indicates whether a reimbursement agreement existed prior to the trustee making its trust income distribution decisions for the particular income year. That is, you focus on what has happened with the distribution after the beneficiary has been made presently entitled, and then conclude from these facts whether there was a reimbursement agreement that was entered into before the present entitlement arose.
What the ATO has not done, or done only to a limited extent, is address whether a reimbursement agreement existed in the first place. This has caused thousands of accountants to focus on what they (purportedly) can or cannot do with distributions to beneficiaries. I have been repeatedly asked by accountants whether a particular way of dealing with a distribution would be acceptable to the ATO or not.
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This is not the correct legislative approach. It puts the cart before the horse and this point was well made in both the Federal Court and Full Federal Court decisions in the Guardian AIT case.
The first question that must always be asked with s100A is whether there is a reimbursement agreement. If there isn’t one, s100A cannot apply and PCG 2022/2 with its green, white and red zones is irrelevant.
I have been frequently asked questions like:
- Can I distribute to an adult child and have them lend money to their parents?
- Can beneficiaries make gifts of their distribution to another person?
- Can a corporate beneficiary make a dividend payment out of its trust distribution?
And so on …
These are the wrong questions to ask as a starting point. The first question is whether there is a reimbursement agreement out of which the beneficiary’s entitlement arose. If there is no reimbursement agreement, there is no s100A risk and PCG 2022/2 is irrelevant.
Having said that, let me now return to the policy decisions I set out above.
The policy of paying the beneficiary
If a client wants no risk at all, the best method in respect of s100A is to ensure the beneficiaries are fully paid their entitlements and those beneficiaries only spend it on themselves or invest the entitlement for their own benefit. If this is done, one of the prerequisites of s100A is not satisfied. This is that someone other than the beneficiary has, in some way, benefited from the entitlement.
I also say, if you want no risk whatsoever, the beneficiary should not even give away $1 of their entitlement nor purchase a gift for anyone. The entitlement must be spent on themselves.
The reason I say this is because PCG 2022/2 makes it quite clear that an arrangement can be excluded from the green zone if the beneficiary (who has received their entitlement) deals with it in a way that is potentially unacceptable to the ATO (see paragraph 32 of PCG 2022/2).
The policy of being in the green zone
If a trust arrangement is in the green zone of PCG 2022/2, the ATO states that it will not apply compliance resources to the arrangement except to ensure that the arrangement is within the green zone. Some accountants are adopting this policy because they think it is what the ATO wants and will result in no risk for their clients. On balance, that is probably correct.
However, let us be clear about what the ATO is saying and not saying.
Just because your client is in the green zone does not mean that the ATO won’t investigate the arrangement. It clearly states that it might, and you are expected to keep records that can be produced to the ATO that explains why the client’s arrangement is in the green zone.
Also, the ATO is not saying it will not apply s100A to the arrangement if the circumstances are in the green zone. Nowhere in the PCG is this statement made and you should not make this statement to your client. All you can say is that the ATO is unlikely to investigate the situation in any depth. Based on what is said in the PCG, this is all you can say to your client.
Of course, if you adopt the policy of having your clients’ affairs in the green zone, this necessarily means that you are well versed in all of the green zone scenarios. These are found in both TR 2022/4 and PCG 2022/2. You must be very familiar with all of the scenarios as this is the only way that you can say (and document) that your client is in the green zone.
Neither green nor red policy
It is my opinion that most trust arrangements will not fall in either the green zone or the red zone of PCG 2022/2. Do not fall into the trap of thinking all arrangements either fall within the green zone or the red zone. That is definitely not the case.
Most accountants will not deliberately put their clients into a red zone arrangement. Also, due to the narrow requirements of some of the green zone scenarios, accountants will often find it is just too difficult to have their clients come within the green zone. What then?
You then need to advise your client that they are in a type of no-man’s land. There is nothing you can say to the client about whether the ATO will or won’t pursue the arrangement. There is no basis on which you can make a statement to your client about this issue. You will simply have to inform them that it is impossible to say whether the ATO will attack the arrangement, or not.
Unless you want to seek a private ruling from the ATO, your advice will be that the client will just have to wait and see whether the ATO ever questions the arrangement. If it does, you will have to deal with the issue when it arises. This position has an unsatisfactory feel about it, but what is the alternative?
The no reimbursement agreement policy
This is the royal road to having no s100A problems. It is the approach that I have consistently advised accounting firms to try and adopt, if at all possible. If you can confidently say (with your client) that there is no reimbursement agreement, you can happily ignore PCG 2022/2. All of the zones mean nothing. You can distribute income in any manner you want. The beneficiaries can do whatever they want with their entitlements, if they receive them.
How do you get to the position where there is no reimbursement agreement? You must school your client and your staff to ensure that they do not do things that could create such an agreement. Everyone needs to be able to testify in court, if needed, that no agreement was reached before the trustee made its distribution decision that beneficiaries would receive entitlements or that any person would benefit from those entitlements.
This means that trustees must be instructed not to have discussions of any type before year end as to who is going to receive distributions and what beneficiaries are required to do with their entitlements. No discussions over Christmas dinner. No discussions at the family barbecue. No emails that discuss the issue. Nothing. Everyone must be able to put a hand on their heart and say that no such discussions or agreements occurred. This is how Guardian AIT won its case in the Full Federal Court in respect of s100A.
I appreciate that, with some clients, this may be difficult to achieve. Nevertheless, if you want to avoid all s100A problems, this is the best way to do it.
Also, documentation can be created that will support the view that no reimbursement agreement has been entered into. I will not explain that documentation here.
I add that there is nothing wrong with an accountant discussing with their trustee clients how distributions might be made. This is not a reimbursement agreement. There is nothing wrong with suggesting possible options to your clients and making recommendations, even if they are 100 per cent motivated by tax saving. The Guardian AIT Full Federal Court decision made it clear that for the accountant to be involved in making a reimbursement agreement, the accountant would need to be authorised to act on behalf of the client. This rarely occurs in most accountant/trustee relationships.
Finally, to all my fellow accountants, I wish you the best with your upcoming trust distribution decisions. You have been presented with a very difficult issue that, unfortunately, has fallen into your lap to solve. After all of the rulings, cases, discussions, webinars, seminars and so forth – it is now decision time. The buck stops with you.
John Jeffreys is director of John Jeffreys Tax Pty Ltd.
This is the second of two articles by John Jeffreys on how to deal with s100A. The first article ran on Friday 5 May.
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