Family discretionary trusts – avoiding the risk of ATO action

For many years, the use of family discretionary trusts has been broadly embraced due to the potential asset protection and tax benefits these entities could provide. In fact, according to the Australian Financial Review, there are “about 928,000 family trusts managing assets worth nearly $2.2 trillion.”[1]

There are several benefits of using family discretionary trusts including having the flexibility to make distributions to various beneficiaries at the discretion of the trustee, which can help to cater for the changing needs of a family group over time. They also create a separate ownership vehicle, which can help preserve intergenerational wealth by accumulating and protecting assets, as well as realising tax benefits, including capital gains tax concessions.

Recent significant developments

The high level of uptake has put family discretionary trusts squarely in the ATO’s spotlight. There have also been some significant recent developments in this space, including funding for an additional 200 ATO staff to monitor tax avoidance across wealthy families, large companies and associated subsidiaries.

The ATO recently issued guidance on s100A of the Income Tax Assessment Act 1936 (Cth), an anti-avoidance rule that can apply where a beneficiary’s trust entitlement arose from a reimbursement agreement. In its guidance, the ATO raised concerns over arrangements involving beneficiaries receiving an entitlement to income of a trust, when the economic benefit of that income is instead provided to another taxpayer. For trustees, demonstrating that a beneficiary has received the true economic benefit of a distribution can be particularly problematic when beneficiary entitlement accounts remain unpaid for extended periods of time.

The release of the ATO’s guidance coincided with another significant development in trust tax law, being the Full Court of the Federal Court of Australia’s recent decision in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (Guardian). While this case was originally flagged as a test case for the application of s100A to trust distribution arrangements, it also highlights the broad reach of the general anti-avoidance rules of Part IVA of the Income Tax Assessment Act 1936 (Cth).

The Guardian case provided some clarification on the application of s100A, including that there must be a reimbursement agreement in place between at least two parties. However, the decision did not provide an explanation of what constituted an ordinary family dealing, which is a significant exclusion from the application of s100A.

In Guardian, the Court also considered when a ‘tax benefit’ arises and confirmed the onus is on the taxpayer to prove that a more reasonable alternative to the ATO’s position would have happened if the scheme did not exist. The Court also looked at the concept of ‘dominant purpose’ in the context of how the schemes were entered into. In Guardian, the Court found the dominant purpose in one of the assessed years was not for accumulating wealth, but rather for helping reduce the beneficiary’s tax liability. 

Getting ahead of the risks

Trustees should be mindful that making distributions of income from a trust conveys a legal obligation to pay that entitlement to a beneficiary when and if it is called upon. They should intend, when resolving to distribute to a beneficiary, to meet that obligation in a reasonable timeframe. In this regard, the process of allocating entitlements to beneficiaries should also include a consideration of how the arising obligation to those beneficiaries will be satisfied.

Where trusts have been in place for some time, it is prudent to undertake regular reviews of the arrangements to identify any potential risks and ensure future strategies reflect the current ATO views.
In these reviews, trustees should ensure they comply with their obligations around acting in the best interests of the beneficiaries and ensuring the trust is operating in line with the purpose it was set up for under its deed.
It can also be useful to regularly review:

• individual distributions and the communications regarding entitlements and intentions for payment;

• the eligibility of beneficiaries, including considering whether any beneficiaries have moved, or are likely to move, overseas;

• intergenerational wealth management plans, and

• the terms of the deed, to ensure they are still fit-for-purpose.

Moore Australia’s tax advisors have extensive experience in advising on family discretionary trusts and associated issues. To arrange a meeting to discuss a trust review or any concerns you might have about the management of trusts or distribution strategies, contact a member of our team.