On 31 May 2023, the ATO issued its updated resolutions checklist for trustee resolutions which is welcome. Practical guidance and can be accessed via their website. Special Counsel Saxon Rose and Partner Michael Patane from HopgoodGanim’s taxation practice explain more.
Variation of income resolutions guidance – 31 May 2023
In conjunction with the release of the resolutions checklist, to help trustees understand the legal complexity and tax consequences of using “variation of income resolutions” when distributing trust income, the ATO also released an Addendum to Taxation Determination TD 2012/22 Income tax: for the purposes of paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) is a beneficiary’s share of the net income of a trust estate worked out by reference to the proportion of the income of the trust estate to which the beneficiary is presently entitled?
Variation of income resolutions are sometimes used by trustees to direct which beneficiary bears the tax if there’s an adjustment to the net income of the trust after 30 June of a tax year, due to:
- a review or audit by the Commissioner; or
- an amendment made by the trustee.
The guidance includes an example which reflects the Federal Court decision in Lewski v Federal Commissioner of Taxation, highlighting the possible different tax outcomes depending on the legal effect of various trust resolutions.
The guidance notes variation of income resolutions can have a different effect to the outcome intended, which is often to avoid the trustee being taxed at 47% under section 99A on the additional income.
In the example provided, the Trustee first resolves to distribute 100% of the trust income to a named individual beneficiary (Andy), and then resolves that, should the Commissioner of Taxation disallow any amount as a deduction or include any amount in the assessable income of the trust, 100% of such amount or amounts are to be deemed to be distributed on 30 June 2023 to a corporate beneficiary, Bouquet Pty Ltd (Bouquet).
The Trust Deed provides that Edna Pty Ltd (Edna) is the default beneficiary who will be entitled to any trust income that the trustee has not dealt with effectively by 30 June each year.
The example then assumes:
- The trust tax return lodged by the trustee for the year ended 30 June 2023 shows the net income as $100,000 consisting of business income; and
- The ATO later determines that the income from the business carried on by the trustee was understated by $20,000. That is, the corrected net income of the trust was $120,000 and likewise the trust income as defined by the deed was $120,000.
Depending on whether the resolution is authorised by the trust deed and the legal effect of the trustee resolution, a variation of income resolution may give rise to a range of possible outcomes. The Guidance states there are three possible scenarios under which the variation of income resolution may be interpreted under trust law. These are that the resolution is:
- not authorised by the Trust Deed and cannot be severed from the other parts of the resolutions, therefore the income distribution resolution is wholly invalid;
- not authorised by the Trust Deed, but may be severed without invalidating the remaining income distribution resolutions, therefore the resolutions are partially valid;
- authorised by the Trust Deed and the income distribution resolutions are fully valid.
The table below summarises the range of tax outcomes that could follow the particular trust law interpretations which may be determined by a court if the matter were litigated.
The Guidance states that as neither the trustee nor the Commissioner can have certainty as to the interpretative outcome, then in these circumstances, the ATO could issue primary tax shortfall assessments and alternative assessments to Andy, Bouquet, the trustee, and Edna.
| Scenario 1 | Scenario 2 | Scenario 3 | |
| Possible outcome 1 | Edna assessed on $120,000 | Andy assessed on $120,000 | Andy assessed on $120,000 |
| Possible outcome 2 | Andy assessed on $100,000, Edna or Trustee assessed on $20,000 | Trustee assessed on $120,000 | |
| Possible outcome 3 | Andy assessed on $100,000, with Bouquet or Trustee assessed on $20,000 |
The ATO has noted it will not devote compliance resources to examining the effect of variation of income resolutions made before the Addendum to TD 2012/22 was released on 31 May 2023, provided:
- all net income has been declared; and
- there isn’t evidence of tax avoidance, evasion or fraud.
If you are unsure about how the above guidance applies to your circumstances, professional advice should be sought.
Section 100A and Division 7A guidance – 8 December 2022
In December 2022, the ATO finalised a suite of draft public advice and guidance (PAG) products relating to Section 100A reimbursement agreements and Division 7A of the Income Tax Assessment Act 1936.
This advice and guidance affects taxpayers, including high net wealth individuals, private businesses and family groups who use trusts to hold property, investments and business assets and use those trusts as conduits to distribute income to trust beneficiaries, often within a family group.
It is fair to say that the guidance has been met with a degree of alarm by members of the tax and accounting profession, professional bodies and taxpayers.
As 30 June rapidly approaches, the task of determining what amounts can be effectively distributed to trust beneficiaries has become more challenging and requires a strong familiarity with the December 2022 guidance and the decisions in FCT v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 and BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112.
Operation of Section 100A
Generally, where a beneficiary is presently entitled to a share of trust income and isn't under a legal disability, that share of the trust's net income is assessed (taxed) to the beneficiary.
However, to the extent a beneficiary’s entitlement arises out of a “reimbursement agreement”, section 100A of the ITAA 1936 disregards it. The result is the net income which would otherwise have been assessed to the beneficiary (or trustee on their behalf) is assessed to the trustee at the top marginal tax rate (currently 47%).
Unlike the general four-year amendment period, the ATO has an unlimited period within which to reassess under Section 100A.
A “reimbursement agreement”, generally involves making someone presently entitled to trust income in circumstances where:
- someone other than the presently entitled beneficiary actually benefits from that income, and
- at least one party enters into the agreement for purposes that include getting a tax benefit.
Even where there is a reimbursement agreement, Section 100A will not apply:
- where such agreement arose after the beneficiary was made presently entitled to the income; or
- the agreement was entered into in the course of an ordinary family or commercial dealing.
Perhaps not surprisingly, the ATO takes a quite restrictive view of what is an “ordinary family or commercial dealing”.
As such, perhaps the best way to mitigate risk in relation to Section 100A is to ensure there is no reimbursement agreement prior to income being appointed to a beneficiary – the manner of making distributions and identity of those beneficiaries then becomes less important from a tax integrity viewpoint!
Ultimately, if trustees and their accountants are unsure as to the implications of distribution decisions, professional advice should be sought.
For more information, contact our Taxation team.