On 31 July, the ATO released draft guidance in relation to Section 99B of the Income Tax Assessment Act 1936, including:

• Draft Taxation Determination TD 2024/D2 (Draft TD) – outlining the Commissioner’s views on certain factors relevant in determining when section 99B will apply.
• Draft Practical Compliance Guideline PCG 2024/D1 (draft PCG) – outlining the Commissioner’s proposed compliance approach to section 99B.

Comments on both releases are due on 28 August 2024.

What is section 99B?

Section 99B is a provision that was originally introduced to treat the provision of certain distributions and benefits provided by a non-resident trust to a resident beneficiary as taxable, where such amounts would not otherwise be taxable.

The provision is a ‘catch-all’ or residual provision, meaning unless a particular exception applies, amounts paid to the beneficiary’s benefit are subject to tax.

The main exceptions are:

• amounts representing the corpus of the trust estate, provided that if a ‘hypothetical’ resident taxpayer derived the funds represented by that corpus, the amount would not have been assessable.
• amounts that, had they been derived by a hypothetical resident taxpayer, would not be included in the hypothetical taxpayer’s assessable income for the year, and
• amounts that are assessable to the beneficiary through the application of another provision.

Whilst section 99B has been law since 1979, there has been minimal judicial or administrative guidance on its breadth and application. The wording of the provision is broad and ambiguous, and some commentators have expressed concern that it may apply to arrangements involving resident trusts as well as and non-resident trusts.

Draft Taxation Determination TD 2024/D2

The draft TD has a relatively narrow focus, as it only deals with the exceptions to section 99B relating to the ‘hypothetical resident’ taxpayer concept. The draft TD does not specifically state that section 99B only applies to non-resident trusts, however, the only scenarios discussed and examples used in the draft TD relate to non-resident trusts.  There is some comfort in that the draft TD gives no indication that the Commissioner will depart from the previous position that section 99B applies to distributions from non-resident trusts.

The draft TD states:

• the hypothetical taxpayer must be an Australian resident. Concessions only available to specific classes of taxpayers, such as the CGT discount, do not apply to amounts assessed under section 99B.Thus, the amount assessed under section 99B cannot be reduced by the CGT discount.
• the circumstances that resulted in the trust estate receiving the amount distributed to an Australian resident beneficiary are relevant to consider. The draft TD notes that where proceeds from the disposal of a CGT asset are distributed, the date of acquisition of the asset and its cost base are relevant considerations – for example:
  • if the amount distributed to a beneficiary represents proceeds from the disposal of a pre-CGT asset, the proceeds would (absent unusual circumstances) not be assessable under section 99B, and
  • for post-CGT assets, the asset’s cost base and relevant provisions are considered. For example, the CGT rules relating to death and deceased estates modifying the cost base of the CGT asset and the date of acquisition are assessed, where the distribution or benefit is provided by a non-resident deceased estate.

Draft Practical Compliance Guideline PCG 2024/D1

The draft PCG provides guidance on practical issues for the application of section 99B, clarifying:

• common scenarios where section 99B may need to be considered
• the practical aspects or record-keeping needed to prove that an exception applies
• the ATO’s compliance approach to distributions and benefits that are seen as low risk by the ATO.

Similar to the draft determination, the draft PCG onlydiscusses issues on non-resident trusts despite not asserting that section 99B only applies to non-resident.

Common scenarios where 99B may apply

Several potential Section 99B scenarios are in the draft PCG, illustrating distributions from a non-resident trust estate and other situations where Section 99B might apply. This includes where:

• a resident beneficiary receives a loan from a non-resident trust
• the trustee of a non-resident trust allows a resident to use trust property and
• a resident beneficiary receives an amount from a non-resident deceased estate.

When a taxpayer relies on one of the exclusions in section 99B, the onus will be on the resident beneficiary taxpayer to provide the ATO with documentation evidencing the exception.

Record keeping for reliance on the exceptions

The draft PCG details the required documentation to prove an exception, providing examples of records that must be provided to the ATO and emphasises that the resident beneficiary must secure sufficient records. One example highlights that a trust resolution stating an amount is out of corpus is not sufficient.

Low risk arrangements

The draft PCG illustrates low risk arrangements, indicating the ATO will not further review these arrangements. Examples include:

• arrangements on commercial terms with supporting evidence. The Commissioner’s comments are welcomed, with one of the many challenges of section 99B is that it can apply to loan arrangements and there is no express exception provided for loans on commercial terms, and
• where property is received from a non-resident deceased estate within 24 months of the date of death, with a value of less than $2m and evidentiary requirements are met. This is a sensible and positive administrative concession simplifying Australian issues for beneficiaries of a deceased estate of a non-resident.

How SW can help

Please reach out to your SW contact to discuss the application of section 99B and any aspect of the ATO draft releases.

SW will continue to monitor and provide commentaries to inform clients of any developments as they occur.

Contributors

Ian Kearney

Ned Galloway

Maxwell Pratt

The post Section 99B and trust distributions | New ATO draft guidance appeared first on SW Accountants & Advisors.

The contents of these pronouncements are both voluminous and complex and are still being digested, but essentially relate to the Commissioner’s views on the operation of two integrity measures – section 100A and Division 7A. 

Section 100A

What is it?

Section 100A is an anti-avoidance provision that has the potential of imposing a penal tax outcome where one person (beneficiary) is made presently entitled to trust income, but another person effectively receives the benefit of the income.  The provision was originally introduced (way back in 1979) to attack aggressive tax avoidance arrangements, but it is worded so broadly that it can technically apply to much more commonplace circumstances.

If it applies, the relevant trust income is generally subject to tax within the trust under section 99A at the top marginal rate of tax (currently 47%).

Historically, many taxpayers and their advisers have taken comfort from the rule in section 100A that ‘ordinary family or commercial dealings’ are excluded from the operation of section 100A.

What is changing?   

In recent years, it has become evident that the Commissioner has been looking to apply section 100A to circumstances well beyond its originally intended targets, and yesterday made public his detailed (preliminary) views on this troublesome provision in the form of:

• Draft Taxation Ruling 2022/D1 – Income tax: section 100A reimbursement agreements
• Taxpayer Alert TA 2022/1 – Parents benefitting from the trust entitlements of their children over 18 years of age
• Draft Practical Compliance Guideline 2022/D1 – Section 100A reimbursement agreements – ATO compliance approach

Whilst administrative guidance on this difficult subject is welcomed from a clarity perspective, the preliminary views expressed will present challenges to many and could fundamentally change the tax planning considerations for trusts and beneficiaries.

What does this mean?  

Whilst the detail of these lengthy and complex draft pronouncements is still being digested, we note the following key points:

• the Commissioner has expressed a very broad view of circumstances to which section 100A could apply
• the Commissioner has expressed a very narrow view of when the ‘ordinary family or commercial dealing’ exception is likely to apply.

The Commissioner has indicated that section 100A could apply to the following circumstances, including:

• gifts from individual trust beneficiaries on low marginal tax rates to other family members with a higher marginal tax rate – for example, gifts or reallocations from adult children that have unpaid trust distributions to their parents.
• a pattern of behaviour involving continuous gifts from beneficiaries back to the trust or even circumstances involving accumulation of unpaid trust distributions with the funds being retained in the trust
• non-commercial loans between family members funded by income distributions from a trust
• manipulation of income of the trust estate and net income.

The examples referred to above have far reaching implications for trusts and their beneficiaries (including corporate beneficiaries).  The approach that Commissioner proposes to adopt represents a significant departure from arrangements that many family groups will have adopted in the past.

The Taxpayer Alert TA 2022/1 specifically identifies circumstances which the Commissioner regards as high risk in relation to distributions to children of parents who control a discretionary trust.  The TA not only addresses 100A, but indicates the distributions may be legally ineffective or subject to Part IVA.

When will this new approach apply from?

The draft ruling indicates that the approach will apply retrospectively as well as prospectively, subject to some concessions set out in Draft Practice Compliance Guideline PCG 2022/D1.  This is significant, as section 100A (being originally intended for aggressive tax avoidance measures) is not subject to any statutory time limits – it can be applied retrospectively indefinitely, without the usual limitations upon the Commissioner.

Unfortunately, the draft PCG only provides limited concessions for arrangements entered into prior to the release of the pronouncements referred to above.  In very broad terms, certain pre-existing arrangements that are regarded as relatively benign will not be reviewed by the ATO. The limits to these concessions is one of the elements of the new suite of drafts that we believe is worthy of further dialogue and submissions in an effort to seek an outcome that is less harsh.

The PCG also provides something of a ‘heat map’ for taxpayers and advisers to rate the risks of arrangements under section 100A.

Division 7A – complying subtrusts no longer permitted

In addition to the section 100A developments, the Commissioner has also issued a draft determination in relation to Division 7A (TD 2022/D1: when will an unpaid present entitlement or amount held on sub-trust become the provision of financial accommodation). Whilst this TD is quite lengthy, the essence of it is that the Commissioner has announced a prospective (from 1 July 2022) change to his previous approach under which he allowed unpaid trust distributions owing to a company beneficiary to be put on interest-only terms for a 7 or 10 year period (depending on the interest rate).  The new approach will be more challenging for taxpayers in that such unpaid entitlements will need to be put on complying Division 7A loan terms, which broadly require both interest and principal repayments annually.   

Next steps

Section 100A in particular is a very technical and difficult provision and there is much to digest in the pronouncements referred to above.  SW will be considering the draft guidance in detail and propose to make submissions to the ATO prior to the finalisation of these pronouncements. 

Another factor to bear in mind (which is also referred to by the Commissioner in the draft ruling) is that the recent Guardian case concerning the operation of section 100A (refer to SW summary here: Guardian case – section 100A win for the taxpayer (sw-au.com), which was decided in favour of the taxpayer, is subject to appeal.  The draft views expressed appear to have been formed without any major regard to this decision, so the outcome of this appeal will be particularly relevant in this context. 

In addition to making submissions to the ATO in respect of these drafts, SW will be closely monitoring developments in this area and will keep its clients well informed as circumstances evolve.

Contributors

Ophelia Katrivessis

Ned Galloway

The post Trust distributions – the game has changed appeared first on SW Accountants & Advisors.