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  • What attracts our attention

    Trust issues that attract our attention include:

    Circular trust distributions

    A circular trust distribution exists where a trust (the first trust) makes a distribution to a second trust. Then all or part of that distribution goes back to the first trust as a distribution from either the second or another trust.

    We want to make sure that the trustees have complied with their obligations to trustee beneficiary non-disclosure tax. This includes trustees of family trusts for income years starting on or after 1 July 2019.

    We focus on those circular trust distributions if tax has not been paid on some or all of the distribution because:

    • one or more beneficiaries understate the trust amounts included in the beneficiary’s assessable income
    • there is an unbroken circular trust distribution between two or more trusts.

    See also:

    Differences between distributable and net income

    We focus on tax-preferred beneficiaries, including private companies, where their distributable income is significantly less than the net income.

    Whether or not this behaviour is considered tax avoidance depends on the case.

    Situations that attract our attention include where:

    • a trust has  
      • a small amount of distributable income and a large amount of net income
      • supposedly made a tax-preferred beneficiary entitled to that distributable income
      • a difference between distributable income and net income which was either retained in the trust or extracted from the trust in a tax-concessional form
    • steps have been taken to create or increase the difference between distributable and net income, or to include the tax-preferred entity as a beneficiary
    • the trust deed has not been followed when calculating distributable income or assigning distributable income to beneficiaries
    • the income of the trust includes franked dividends from a private company.

    See also:

    • TA 2013/1 Arrangements to exploit mismatches between trust and taxable income
    • TA 2016/12 Trust income reduction arrangements
    • TD 2018/13 Income tax: Division 7A: can section 109T of the Income Tax Assessment Act 1936 apply to a payment or loan made by a private company to another entity (the 'first interposed entity') where that payment or loan is an ordinary commercial transaction?
    • Tax issues for trusts – tips and traps

    Distributions to complying superannuation funds

    We focus on distributions from trusts to complying superannuation funds, including self-managed super funds (SMSFs). Any non-arm’s length income should be taxed in the superannuation fund at the top marginal tax rate.

    We look for complying superannuation funds (generally SMSFs) that receive income distributions from a trust, where the distributions result from:

    • the exercise of a discretion of the trustee
    • a fixed entitlement with one or more of the following features  
      • the fixed entitlement was not acquired on arm's length terms
      • the fixed entitlement was acquired using a loan from a related lender who is not on arm's length terms
      • the acquisition of assets within the trust was facilitated by loans between related parties which are not on arm's length terms
      • the rate of return received from the investments of the superannuation fund is not consistent with an arm's length return. 

    See also:

    • Non-arm’s length income
    • Self-managed super fund limited recourse borrowing arrangements interest rates
    • TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income
    • TD 2016/16 Income tax: will the ordinary or statutory income of a self-managed superannuation fund be non-arm's length income under subsection 295-550(1) of the Income Tax Assessment Act 1997 (ITAA 1997) when the parties to a scheme have entered into a limited recourse borrowing arrangement on terms which are not at arm's length?

    Distributions to tax-preferred beneficiaries

    We focus on distributions to tax-preferred beneficiaries that may have been used by trustees to attempt to reduce the amount of tax paid on the trust's net income (as calculated under section 95 of the ITAA 1936).

    Tax-preferred beneficiaries include:

    • tax-exempt entities
    • entities that deduct excess deductions and tax losses against their share of the trust's net income
    • entities that apply capital losses or carried forward net capital losses against their share of the trust's capital gains
    • entities that pay lower or nil rates of tax
    • entities that lack the financial means to pay tax
    • non-resident beneficiaries that are either entitled to trust amounts that are subject to withholding tax or whose share of trust income is attributed to sources outside Australia.

    Situations that attract our attention include where:

    • a tax-preferred beneficiary becomes entitled to an amount that is favourably taxed because of their characteristics
    • the entitlement of the tax-preferred beneficiary is not paid to them or is applied to someone else
    • the tax-preferred beneficiary has been recently introduced into the trust, or has a weak social or economic connection with the persons controlling the trust
    • steps were taken to change the character of the trust income so that the income of the tax-preferred beneficiary is favourably taxed
    • the tax-preferred beneficiary is not able to pay the tax due on the trust entitlement
    • the tax-preferred beneficiary is tax-exempt, whether or not the requirements in sections 100AA and 100AB of the ITAA 1936 have been met.

    See also:

    Family trust distributions tax

    We focus on:

    • a trust that has a family trust election in place (family trust) which is distributing outside their family group
    • distributions to entities outside the family group by a trust, partnership or company which has made an interposed entity election (IEE) to be included in the family group of a family trust
    • instances where an individual beneficiary incorrectly returned an amount on which family trust distributions tax (FTDT) has been paid.

    See also:

    Income recharacterisation arrangements

    We focus on trusts where revenue activities are mischaracterised or transactions are undertaken for the dominant purpose of changing the character of trust income in order to achieve lower rates of tax or to obtain access to benefits or concessions not ordinarily available to trusts.

    Situations that attract our attention include:

    • using special purpose trusts in an attempt to re-characterise ordinary income as discountable capital gains
    • changing the character of trust income in order to access the withholding tax provisions.

    See also:

    • TA 2014/1 Trusts mischaracterising property development receipts as capital gains

    Loss trust moved into group

    Trusts with significant revenue or capital losses that have recently been moved into a group attract our attention.

    We focus on the carrying forward and use of revenue losses by a trust, to ensure the trust loss measures restrictions are applied.

    In these situations, entities within the new group may attempt to take advantage by distributing capital gains to the capital loss trust.

    See also:

    1. a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') to be a dividend, and
    2. an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1)

    Non-lodgment

    If a trust has derived income, they will have to lodge a return, irrespective of the amount of income, unless exempted by the Commissioner.

    Prompt lodgment of trust returns is integral to the integrity of the tax system. We rely upon the details provided in trust and beneficiary tax returns to satisfy ourselves that the appropriate amount of tax has been paid through the undertaking of tax assurance activities.

    We focus on non-lodgment of trust and beneficiary tax returns. We use information matching techniques to identify returns that are overdue or where there is a potential mismatch.

    Non-residents' capital gains

    We focus on trust capital gains of trusts that are attributed to a foreign resident beneficiary's interest in the trust that have not been assessed to the trustee under section 98 of the ITAA 1936.

    Situations that attract our attention include trustees and foreign resident beneficiaries who rely on:

    • section 855-10 to disregard capital gains made by a resident trustee
    • section 855-40 where the trust is not a fixed trust
    • source rules in taking the position that capital gains made by a trustee outside of Australia are not assessed to the trustee under section 98.

    We focus on these situations because there is a higher risk that tax was avoided.

    See also:

    • TD 2019/D6 Income tax: does Subdivision 855-A (or subsection 768-915(1)) of the Income Tax Assessment Act 1997 disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3)?
    • TD 2019/D7 Income tax: is the source concept in Division 6 of Part III of the Income Tax Assessment Act 1936 relevant in determining whether a non-resident beneficiary of a resident trust (or trustee for them) is assessed on an amount of trust capital gain arising under Subdivision 115-C of the Income Tax Assessment Act 1997 ?

    Potential reimbursement agreements

    We focus on arrangements that may constitute reimbursement agreements. These agreements involve making distributions to lower taxed beneficiaries while the economic benefits are directed to another entity. The other entity is often a controller of a privately owned group, close relatives of the controller or an entity within such a group.

    We are concerned that some of these arrangements have been entered into in order to avoid tax.

    See also:

    Unitisation arrangements

    We focus on arrangements involving private companies acquiring units in a unit trust. These arrangements may involve either:

    • the company making a payment to the unit trust for the units
    • the unit trust issuing the units to satisfy a UPE, debt or other obligation owed to the company.

    We are concerned if the cost of the units is more than what would have been paid had the parties been dealing at arm's length.

    The funds representing the UPE are then either:

    • retained in the unit trust as working capital
    • used to make loans or payments to shareholders or associates of shareholders of the private company.

    These arrangements may involve the application of Division 7A, section 100A or Part IVA of the ITAA 1936.

    See also:

    Value extraction and corpus distributions

    Capital distributions, or entitlement to corpus, may involve extracting value from a trust in a non-assessable form (subject to the CGT events, section 99B and the specific entitlement rules in Subdivision 115-C of the ITAA1997).

    Situations that attract our attention include when the:

    • corpus entitlement is satisfied by  
      • an unrealised capital gain
      • using an unpaid income entitlement of a tax-preferred beneficiary
      • accessing value in another entity, such as a company or a superannuation entity
    • capital distribution is funded from, or causes, a difference between the trust's distributable and net income
    • transfer of assets occurs to another trustee who intends both  
      • to hold them as a separate trustee on the same trust under a trust splitting arrangement
      • that the transfer should not trigger CGT events E1 and E2
    • trustee has borrowed money to satisfy the corpus entitlement and is claiming deductions for the loan interest.

    See also:

    Find out about:

    What you should do

    If you're unsure about the full implications of trust or tax planning arrangements either in place or contemplated, we recommend you seek independent advice, review your arrangement or discuss your situation with us by emailing TrustRisk@ato.gov.au (mark all information 'sensitive').

    If you need to adjust a tax position you have previously taken you can make a voluntary disclosure.

    If you're aware of potential tax avoidance or evasion arrangements involving trusts proposed to you by other taxpayers and advisers, email TrustRisk@ato.gov.au

      Last modified: 08 Mar 2021QC 33917