The ATO is Going After Trust Distributions

Discretionary family trusts have been considered a tax effective structure for deriving income, given the trustees have the flexibility to distribute income to a wide range of beneficiaries.

However, the ATO has increased its focus on discretionary trusts in recent years, particularly targeting trust distributions.

As a trustee, you need to understand the fundamentals of making trust distributions:

• Your Family Trust Deed – who can receive distributions, what is defined as “trust income”, what’s a beneficiary’s tax liability when receiving distributions;

• Trustee income distribution resolution – determining trust income and how distribution is to be made in writing no later than 30 June in the relevant year, to make sure the distribution is valid;

ATO’s attack on trust distributions 

ATO has adopted a strict stance on enforcing Section 100A ITAA 1936, which invalidates trust distributions and makes the trustees liable for tax at the top marginal rate.

ATO has released “compliance guidelines” to allow trustees to assess the level of risk of S.100A applying to trust distributions. The level of risk is assessed via a “risk framework” which classifies certain trust distributions into colour risk zones:

• Low-risk green zone – any trust distributions falling within a green zone will not attract the application of S. 100A – under the distribution arrangement, the beneficiary genuinely benefits from a trust distribution in its entirety.

Note an arrangement does not fall within a green zone if it contains any “exclusion factors”, make sure:

• The trustee notifies the beneficiary of their entitlement to trust income before the due date for lodgement of the trust return or the actual date of lodgement;

• The presently entitled beneficiary (except minors) lodges their tax return for the relevant income year, and accurately declares their share of the net (taxable) income for that year;

• The beneficiary does not use their trust entitlement to pay excessive consideration for a transaction where the parties are not dealing in arm’s length;

• The beneficiary does not disclaim their entitlement or forgive or release the trustee from their obligations to pay their trust entitlement.

• High-risk red zone – the ATO will scrutinize a trust distribution that falls within the red zone, and potentially applies S.100A to the distribution:

• the beneficiary’s entitlements appear to be motivated by sheltering the trust taxable income from higher tax rates; 

eg: all distributions are made to beneficiaries at the lower marginal tax rate

• the arrangement enables someone other than the presently entitled beneficiary to have use or enjoyment of economic benefits of the trust net income;

eg: distribution made to an adult child (who’s on lower tax rate than parents) ultimately benefits the parents. 

Warning: The ATO has warned trustees about the practice of distributing income to an adult child (on lower tax rate) and using the distribution to pay off the purported debt owed by the child for the child’s schooling and upbringing expenses. These expenses are parental expenses, they are not legitimate expenses of the child, therefore the parents (not the adult child) benefit from the distribution. On the other hand, the ATO recognises university fees/debts are legitimate expenses of the child.

In broad terms, S.100A applies where a distribution has been made to a beneficiary, but another person partially or fully benefit from that distribution.

Note the ATO has unlimited amendment period when applying S.100A to invalidate a trust distribution.