ATO Changes Rules On Trust Distributions

The ATO has released 4 tax rulings that will stop commonly used trust distributions to family members. It’s one of the most significant developments in the taxation of trusts in over two decades.

As a result of these ATO rulings:

• Your options to spread your trust income across your family members may be vastly limited; and
• Your family group’s overall tax payable will probably increase.

We want to let you know about this now so that you can plan for the extra tax payments that you may need to make.

Making trust distributions to family members

For many years, it has been common practice by all business owners and investors who use Family (Discretionary) Trusts to look to spread trust income across family member beneficiaries.

Trust distributions are often made to adult children for asset protection and estate planning purposes.

Sometimes, the adult children in a family may have lower tax rates than their parents, so the overall tax rate % for the family group is lower as a result of the spread of these trust distributions.

However, on 23 February 2022, the ATO issued Taxpayer Alert TA 2022/1 ”Parents benefitting from the trust entitlements of their children over 18 years of age”.

This is a game changer.

It states that the ATO believes that parents who make trust distributions to their adult children and then arrange for their children to give the distribution back to them are only doing this to reduce tax. The ATO plans to invalidate the trust distribution and tax the trustee of the trust at 47% on the amount of the distribution.

These new guidelines may affect trust distributions for the current income year, as well as retrospectively. The ATO has stated that they can go back as far as the 2015 tax year to review trust distributions.

It goes against what has been commonly done for many years and may vastly restrict how your trust distributes profits in the future.

What is the value to you? 

Tax laws change all the time, and it is our role as your accountants and advisors to keep you alert to important changes that affect you.

There are different levels of risk associated with different tax planning strategies that involve trust distributions.

The ATO has classified these risks as white zone, green zone, blue zone, and red zone. The ATO will be investigating all red zone risks and some white zone risks and will not investigate white zone or green zone risks.

We can help you to understand how these ATO tax law changes affect you, discuss new strategies that you might be able to use, and estimate your tax payable for 2022 and 2023 so you can carefully plan for it.

The Risk Zones

The ATO’s guidance sets out four ‘risk zones’ – referred to as the white, green, blue, and red zones. The risk zone for a particular arrangement will determine the ATO’s response:

• White zone - This is aimed at pre-1 July 2014 arrangements. The ATO will not look into these arrangements unless it is part of an ongoing investigation, for arrangements that continue after this date, or where the trust and beneficiaries failed to lodge tax returns by 1 July 2017. 
• Green zone - Green zone arrangements are low-risk arrangements and are unlikely to be reviewed by the ATO, assuming the arrangement is properly documented. For example, the ATO suggests that when a trust appoints income to an individual but the funds are paid into a joint bank account that the individual holds with their spouse then this would ordinarily be a low-risk scenario. Or, where parents pay for the deposit on an adult child’s mortgage using their trust distribution and this is a one-off arrangement.
• Blue zone - Arrangements in the blue zone might be reviewed by the ATO. The blue zone is basically the default zone and covers arrangements that don’t fall within one of the other risk zones. The blue zone is likely to include scenarios where funds are retained by the trustee, but the arrangement doesn’t fall within the scope of the specific scenarios covered in the green zone. Section 100A does not automatically apply to blue zone arrangements, it just means that the ATO will need to be satisfied that the arrangement is not subject to section 100A.
• Red zone - Red zone arrangements will be reviewed in detail. These are arrangements the ATO suspects are designed to deliberately reduce tax, or where an individual or entity other than the beneficiary is benefiting

High on the ATO’s list for the red zone are arrangements where an adult child’s entitlement to trust income is paid to a parent or other caregiver to reimburse them for expenses incurred before the adult child turned 18. For example, school fees at a private school. Or, where a loan (debit balance account) is provided by the trust to the adult child for expenses they incurred before they were 18 and the entitlement is used to pay off the loan. These arrangements will be looked at closely and if the ATO determines that section 100A applies, tax will be applied at the top marginal rate to the relevant amount and this could apply across a number of income years.

How we can help you?

These new guidelines are a concern because they reflect a direct attack on many common trust arrangements, which may result in your circumstances being considered a higher risk from an audit perspective. 

If you're concerned about the effects this will have on you, please contact us as a matter of priority, so that we can:

1. Explain what these new rules are and what they will mean for your family group. 
2. Undertake a review of your estimated tax position for the 2022 income year, the entire family group, including any companies and trusts you have. We may need to reconsider our tax planning strategies for your group as the new guidelines may change the way you wish to distribute trust income. 
3. Undertake a risk assessment of trust distributions made in prior years.
4. Provide you with an “Estimated Tax Payable” report with trust distributions just in the “green zone”, without breaching any of the new ATO rulings.
5. Meet with you to discuss your options for 2022 tax planning.

We urge you to reach out and start this process sooner rather than later.