A trust entitlement has to arise from a prior reimbursement agreement for the tax avoidance measure to apply, says a Melbourne specialist.
Agreement rule is ‘100A Achille’s heel’
Section 100A has an Achilles heel that offers a way to resolve this year’s trust distribution dilemmas, says one tax specialist.
Melbourne practitioner John Jeffreys said trusts could only be subject to the 100A tax avoidance provisions if a reimbursement agreement existed prior to entitlements arising.
“A beneficiary’s entitlement has to arise out of a reimbursement agreement,” he said on a webinar devoted to the subject last Friday (24 June). “And the courts have said that reimbursement agreement must occur prior to the present entitlement arising.
“It is the Achille’s heel of section 100A and the Tax Office has not made a lot of this in their rulings.”
The ATO’s draft ruling on 100A released in February created confusion among accountants, Mr Jeffreys told Accountants Daily last week, and a tax-time guide released on 20 June had done little to dispel it.
But in his webinar, Mr Jeffreys said detailed questions about unpaid present entitlements should come after the key issue of whether a prior reimbursement agreement existed.
“This point is important because this is how the taxpayer won the Guardian AIT case: there was no reimbursement prior to the present entitlement arising. Now, this is a very significant point, and it’s the Achilles heel of 100A,” Mr Jeffreys said.
“So if you had no reimbursement agreement, or the reimbursement agreement occurred after the present entitlement arose and you can prove it in court, you have no section 100A risk.”
The Guardian case is under appeal and a decision was not expected until late this year, Mr Jeffreys said.
It was also vital to remember that in tax cases, the onus of proof was on the taxpayer to prove their innocence.
“You have the problem of trying to prove that something did not happen, which is a much more difficult thing to prove than something did happen,” Mr Jeffreys said.
He said documentation was required and timing was crucial.
Mr Jeffreys said: “So you’ve got your distribution minutes prior to 30 June. You, the accountant, for example, has recommended to the trustee, ‘Why don’t you distribute like this’ and that can be for tax purposes – that’s all okay.
“Then soon after 30 June, the trustee writes to the beneficiary and says: ‘Dear beneficiary, as at 30 June I made you presently entitled to $150,000 of the distributable income of the XYZ trust. In 30 days (or some other time period), can you please reply to me in writing and state what you want done with that $150,000.’
“This has all got to be truly at arm’s length.”
He said the beneficiary could take advice from lawyers, accountants or even the trustee and then make up their mind about what they wanted to do. They could then write back: “‘Dear trustee, thank you for your $150,000. What I want you to do is to pay me $30,000 so I can live as I want to, and the other $120,000 I’d like you to hold that for me because in a few years, I’m going to buy a house (or something like that).’
“What this is trying to do is show that there was no reimbursement agreement prior to the distribution minute being completed.
“If you can do that and do it properly then you will have no section 100A risk.”
He said it was important that trustees did not discuss the distribution or potential distribution before they actually signed the minute.
One difficulty concerned whether the Tax Office might infer there was a reimbursement agreement from past behaviour, such as a repeated pattern of distribution to save tax.
It was crucial to tread carefully.
“Watch out what you put in your file notes. In the Guardian AIT case the court went through what Pitcher Partners in Brisbane had put in their file notes and it was squeaky clean. They did themselves a great service by not recording things that might have suggested there was a reimbursement agreement. So both you and your staff have got to be schooled on this,” Mr Jeffreys said.