What is S.100A?

Section 100A (S.100A) constitutes a provision within the Income Tax Assessment Act of 1936 and operates as an anti-avoidance measure. It becomes applicable in situations where an individual receives a benefit from a trust, yet another person is concurrently entitled to income and subsequently evaluated. The activation of this rule occurs when the present entitlement is linked to an agreement, arrangement, or understanding, involving the provision of a benefit to a different party, with the intent of diminishing or postponing income tax for at least one party.

In instances where section 100A is applied, the entitlement of the beneficiary is disregarded. Instead, the trustee is subjected to assessment on the beneficiary's share of the trust's taxable income at the highest marginal rate.

Trust distributions to adult children and grandparents

When trust distributions directly benefit family members, such as adult children ('Green Zone Scenario 1'), or are received and enjoyed within two years ('Green Zone Scenario 2'), and when they are retained by the trustee ('Green Zone Scenario 3'), complexities arise, as indicated in the Income Tax Assessment Act.

Trust distributions to adult children and grandparents face challenges in meeting the low-risk criteria of the Green Zone, especially concerning family members and economic benefits.

If you want to know more about the Australian Taxation Office (ATO) compliance risk zones, read our article here.

In navigating these intricate scenarios, it is important to be mindful of various elements, including income tax implications, the nuances of reimbursement agreements, and the benefits accruing to relevant family members. Moreover, careful deliberation of prevalent tax planning strategies is crucial, involving skillful handling of trust income and a keen comprehension of their impact on tax liabilities.

The Australian Taxation Office's stance on commercial dealings and taxpayer alerts adds a layer of intricacy. This highlights the vital need for careful deliberation and adherence to established guidelines to navigate potential issues that might arise in the administration of trusts. This is particularly crucial for trusts incorporating discretionary elements and featuring corporate beneficiaries within the framework of an ordinary family context.

Tax advisory: ATO is focusing on trust distributions to adult children

The Australian Taxation Office (ATO) has expressed specific concerns regarding trust distributions directed towards adult children of trust "controllers." The issue arises when these distributions fail to directly benefit the adult child, such as instances where trust funds are used to reimburse parents for private school expenses.

The ATO's concerns stems from the potential for adult children to be used in order to minimise tax liabilities on the trust's net taxable income. This risk materialises when the trust controllers, typically parents, distribute funds to an adult child whose income primarily relies on trust distributions, especially if they are engaged in study and part-time work.

Distributions that only benefit certain family members

The ATO states that S.100A won't be applied to invalidate a distribution paid to an individual beneficiary, like an adult child or grandparent, provided the funds are used to:

• Benefit the beneficiary, their spouse, and/or dependants
• Make personal contributions to a superannuation fund
• Make a donation to a deductible gift recipient

Tax caution: parents typically excluded as 'dependants'

In scenarios involving trust distributions to adult children or grandparents benefiting 'Mum or Dad' (the trust 'controllers'), the Green Zone Scenario isn't generally applicable. This is because the Green Zone only applies if Mum or Dad is considered a dependant of the presently entitled beneficiary. In most cases, Mum or Dad wouldn't qualify as a dependant for either their adult child or parent.

For these purposes, a 'dependant' includes a beneficiary's child or stepchild under 18 or a person financially dependent on the beneficiary.

Example: Adult child receives benefits from trust allocation

In this particular case, Olivia Anderson serves as the sole trustee of the Anderson Trust, with beneficiaries including Olivia herself and her 25-year-old son, Ethan.

On 8 July 2023, the trust's trustee decided to distribute $50,000 of trust income to Ethan.

Ethan's trust distribution was directed to Olivia as a repayment for a loan he extended to her during the year. Ethan used the loaned funds to purchase new furniture for his apartment.

Now, the question arises; would the ATO consider applying S.100A to nullify Ethan's trust distribution?

The ATO assessed this situation as low risk for S.100A purposes. The reasoning is that Ethan employed the distribution to settle a loan from Olivia, effectively benefiting from the trust entitlement by reducing his debt to her. The ATO further clarified that the outcome would remain unchanged, irrespective of how Ethan used the loan—whether for the purchase of new furniture or any other purpose.

Distributions enjoyed by presently entitled beneficiary within a two-year period

Trust distributions received and enjoyed by the presently entitled beneficiary within a two-year timeframe fall under the observation of the ATO, establishing parameters for their classification in the low-risk Green Zone for S.100A compliance, assuming the ordinary family or commercial dealings exclusion applies.

Green Zone Scenario 2 specifically addresses situations where funds are retained for less than two years. A trust distribution to an individual beneficiary, be it an adult child or grandparent, qualifies for the low-risk Green Zone Scenario 2 if both of the following conditions are met:

• The beneficiary 'receives their entitlement' within two years of becoming presently entitled
• The beneficiary 'uses the entitlement' once received

It's crucial to note these requirements are thoroughly discussed in the preceding context concerning trust distributions to a trust 'controller.'

Tax strategy: Leveraging the 'two-year window' for distributions

To comply with conditions, disburse the entitlement to the adult child or grandparent within two years, ensuring they derive economic benefit, such as covering car running costs. Trustees can use this window without restrictions on the recipient's marginal tax rate. This strategic approach aligns with efficient family wealth management, avoiding taxpayer alerts, and generating tax savings while reducing liabilities.

This planning also mitigates risks tied to unpaid present entitlements in family trusts, offering a subtle way to enhance family wealth within the framework of tax law and ordinary family trust structures.

Trust distributions held by the trustee for a duration of two years or longer

Green Zone Scenario 3A applies when a trustee retains a trust distribution for an individual beneficiary (adult child or grandparent) for two years or more.

This aligns with ordinary family trusts, optimising bank account funds for lower marginal tax rates. It addresses anti-avoidance provisions and teenage bank accounts, aiming for less tax with safeguards for unpaid trust distributions. It optimises benefits for household expenses in a discretionary trust, emphasising trust reimbursement agreements.

It also navigates the Income Tax Assessment Act, managing trust income for tax savings and handling tax liability while considering classic income splitting strategies. Importantly, it ensures economic benefits and relevant family members' benefits, steering clear of taxpayer alerts and addressing existing or historical risks. All these elements contribute to effective tax planning, ultimately contributing to the overarching goal of managing family wealth.

Tax alert – Caution on trust distributions to adult children or grandparents

Meeting specific conditions for trust income distributed to an adult child or grandparent, retained by the trustee for two years or more, may face challenges compared to distributions to a 'controller' of a trust. Notably, a trust distribution used for working capital, investment, or lending, while posing tax risks, can fall within the low-risk Green Zone if both apply to the beneficiary (adult child or grandparent):

• The beneficiary or their spouse is a trustee or controls the trustee
• The adult child is employed in the trustee's business

Acknowledging concerns of potential behavioral changes, like giving control to children for classification purposes, the ATO considers such practices high risk. Similar considerations apply to trust distributions retained for a grandparent.

If the low-risk Green Zone criteria aren't met, it doesn't automatically move to the high-risk red zone. Instead, a case-by-case S.100A risk assessment is necessary, considering impacts on tax payment across the group and recurring arrangements. This advice emphasises professional guidance for tax planning, especially when dealing with family wealth, family trusts, and various marginal tax rates.

If you think you might be in need of such a risk assessment, get in touch with us today.

Delaying trust distribution for home purchase – low-risk green zone

The ATO identifies a low-risk green zone scenario when a trust distribution is withheld for an adult child planning to use it for a home purchase. Note this doesn't apply to distributions to grandparents. In this scenario, the ATO deems it low risk when an adult child delays claiming their entitlement until they're ready to invest in a home, ensuring they retain the right to recover the amount.

Even if the adult child's tax-free threshold reduces overall tax on trust net income, this remains in the Green Zone. S.100A is unlikely to apply, as it involves a straightforward delay in receiving the original entitlement, aligning with typical family or commercial dealings.

Regarding the adult child's right to recovery, actions inconsistent with their eventual entitlement, such as interest-free loans to others, signal the loss of this right. This arrangement, ensuring an actual benefit to the adult child, falls within the Green Zone.

Seek professional advice for compliance and transparency, particularly when other family members may adopt similar approaches. This structured and transparent approach aligns with low marginal tax rates, making it suitable for most family groups and considers commercial dealing exclusions for tax return purposes.

Tax strategy: ATO softens its approach in final compliance guidelines

In the preliminary S.100A compliance guidelines, the ATO introduced an extra condition for the mentioned scenario to qualify for the Green Zone. This condition mandated setting aside funds representing the present entitlement in a separate sub-trust solely for the adult child's benefit. Notably, this requirement for establishing a sub-trust is no longer in effect.

However, it's crucial to exercise caution, as Item 39 of the compendium underscores that the trustee's use of funds and any indications that the entitlement might not be received are factors to consider regarding the potential applicability of S.100A.

Next Steps

Navigating Section 100A changes in the Income Tax Assessment Act poses challenges for trust distributions to adult children and grandparents alike. The Green Zone scenarios involve complexities in benefiting specific family members, enjoying distributions within two years, and retaining funds by the trustee. Mitigating risks requires careful consideration of tax planning, trust entitlements, and commercial dealings to ensure adherence to guidelines.