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This article was originally published in CCH iKnow.
Tax is always changing, and over the last year there have been monumental shifts in trust tax law that changes the way practitioners have understood the law for many years.
The key with all of the following changes to our understanding of trust tax law is that they impact trustee resolutions and beneficiary decisions that need to be made pre-30 June.
Treatment of capital gains distributed from Australian resident trust to foreign tax resident
In February 2022, the taxpayers in Peter Greensill Family Co Pty Ltd (as trustee) v FC of T; Nicholas Martin & Anor v FC of T 2021 ATC ¶20-794; [2021] FCAFC 99 were refused their special leave application to have the Full Court decision appeal to the High Court. This cemented the decision made by the Full Court, changing the way practitioners understand the application of s 98 of the Income Tax Assessment Act 1936and s 855-10 of the Income Tax Assessment Act 1997.
The two cases (heard separately in the Federal Court, but together in the Full Court), considered the issue of whether a trustee could be assessable on a capital gain that resulted from non-Taxable Australian Property (“non-TAP”) where the gain was distributed to a foreign resident beneficiary of the Australian resident trust. Unlike the situation for fixed trusts (like unit trusts), the decision was that a foreign resident beneficiary is not exempt from Australian tax on a foreign-sourced (i.e. non-TAP) capital gain.
This decision impacts non-fixed trusts – which is a common investment vehicle for high wealth family groups. Many advisors are advocating for legislative change to address this perceived mismatch.
Mismatch between tax and accounting income
Ever since Bamford v FC of T [2010] HCA 10 clarified the definitions of “income of the trust estate” and “share” the ATO has been concerned about “income tax shuffles”. In 2013, Taxpayer Alert TA 2013/1 was issued which focused on arrangements that exploited the difference between trust income and taxable income. This is commonly seen by the ATO where trust income is smaller than taxable income – without a reasonable explanation. The common situation includes the use of “bucket” companies or loss-making entities to “shuffle” the tax liability. Recent ATO statements about trust risks have raised this area of trust taxation as a continuing tension point for practitioners and their clients.
With 30 June fast approaching, practitioners are rushing to prepare trustee resolutions for distributions before midnight on 30 June. It is key that practitioners revisit the “proportionate” method described in Bamford and ensure that their clients’ trust deeds are reviewed to ensure that trust income is calculated correctly and that trust resolutions are drafted appropriately to deal with such perceived “mismatches”.
Beneficiary ability to disclaim AFTER 30 June tested in Carter
Surprising many, the High Court decision in FCT v Carter [2022] HCA 10 changes the practical issue of a beneficiary disclaiming entitlement to trust assets.
The High Court considered s 97 of Income Tax Assessment Act 1936 and the case law on disclaimer by beneficiaries. In a practical sense, practitioners know that accounts aren’t generally prepared before 30 June and working out the exact quantum figure for distributions is nearly impossible in many circumstances.
Despite the ATO’s views to the contrary (see ATO provides clarity following Commissioner of Taxation v Carter), this decision may conflict with many trust deeds’ requirements that a trust resolution is made just prior to 30 June. However, the decision is clear that a beneficiary who disclaims their interest after 30 June cannot thus change the tax consequences as at 30 June – so they remain taxable on that distribution. In effect, this will make it practically impossible for most beneficiaries to disclaim their interest in the relevant trust – even where this results in manifest injustice. This will be a further consideration (complication in our opinion) for practitioners preparing trust resolutions for their trust clients this year. Again, this is an area where many are advocating a need for urgent [retrospective] law change to prevent such injustices.
PCG 2021/4 – Impact on service trusts
As tax specialists, practitioners usually set themselves up in the most tax effective vehicle for their business and personal investments. However, this is not without potential drama along the way – first it was Personal Services Income, then the introduction of Everett Assignments, and now the finalised guidance from the ATO on allocation of professional firm profits.
Whilst there is a period of leeway to get your structure into an ATO-approved status, many practitioners and their professional services clients will otherwise be impacted by the ATO’s current guidance. Service trusts (commonly used in the modern business world) are contemplated in one generic example that achieve a “green zone” result. However, given that many service trusts result in distributions to lower-taxed associates of the firm’s principals, which would likely run afoul of the wider risk model used in those guidelines.
Another common pre-30 June activity is restructuring structures – and so if you are considering changing your structure to comply with the current PCG 2021/4 – read through the guidance carefully and engage with the ATO early (if you are risk averse).
PCG 2022/D1 - Update to section 100A guidance on reimbursement agreements
Practitioners have been focusing on the undefined phrase of “ordinary family and commercial dealings”. To many, the release of PCG 2022/D1was seen as a direct threat by the ATO to many “ordinary family and commercial dealings”. The ATO has said in communication since the release of the PCG that the application will be focused on the more egregious arrangements – however the examples provided in the PCG are still concerning many practitioners.
When preparing your 30 June trustee resolutions, this is one more thing to keep in mind – is that distribution to an adult child that the trust doesn’t have the money to pay an “ordinary family dealing” or is it an arrangement covered by the new PCG?
TD 2022/D1 – Change to ATO treatment of UPEs
Since 2010, when PS LA 2010/4 was issued, there has been a continuous concern about sub-trust arrangements. In 2017, PCG 2017/13 was released which was supposed to end sub-trust arrangements after 30 June 2022. Luckily, on 7 June 2022 (perhaps cutting it a bit fine and unduly worrying practitioners), the ATO extended the application of PCG 2017/3 for sub-trust arrangements that arose on or before 30 June 2022.
The new draft guidance (which has been a further complication for practitioners this year) complicates the trustee resolution process and trust entitlement.
How can Tax Controversy Partners help you?
Obtaining legal advice is important, as experienced tax lawyers we can guide you through the stressful process and inform you of your obligations, especially coming into the new financial year, with all these new changes to how we understand trust law.
At Tax Controversy Partners, our experienced lawyers can represent your best interests in disputes, objection and providing proactive advice on a proposed transaction. We can help you to minimise administrative penalties that may be imposed if things haven't gone to plan.
Please contact us to help using our online contact form, via email at admin@taxcontroverypartners.com.auor by phone at 02 8513 3813.
Bruce Collins, Founder and Principal Solicitor at Tax Controversy Partners Pty Ltd will be running a webinar “Recent Developments in the Taxation of Trusts” with CCH Learning on Wednesday 22 June at 1pm. Please join the discussion by registering here.