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  • Trust taxation – reimbursement agreement

    Find out when a reimbursement agreement may result in trust net income being assessed to the trustee under section 100A.

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    Present entitlement and section 100A

    When a beneficiary’s trust entitlement arises out of a reimbursement agreement, their corresponding share of net income may be assessed to the trustee at the highest marginal rate instead of being assessed to the beneficiary under section 100A of the Income Tax Assessment Act 1936 (ITAA 1936).

    When a beneficiary is presently entitled to a share of trust income and is not under a legal disability, a corresponding share of the trust's net income is generally assessed (taxed) to either:

    • the beneficiary, if they are an Australian resident, or
    • the trustee, if the beneficiary is a foreign resident (but only to the extent to which that proportion of the trust's net income is from Australian sources).

    Special rules apply to franked distributions and capital gains.

    However, to the extent a beneficiary’s entitlement arises out of a reimbursement agreement, section 100A disregards it. This means that the net income that would otherwise have been assessed to the beneficiary (or trustee on their behalf) is instead assessed to the trustee at the top marginal tax rate.

    Draft Taxation Ruling TR 2022/D1 Income tax: section 100A reimbursement agreements sets out the Commissioner of Taxation's view on when the entitlement of a beneficiary (not under a legal disability) to trust income arises out of a reimbursement agreement.

    We have an unlimited period in which to make or amend an assessment under section 100A.

    Reimbursement agreement

    A reimbursement agreement generally involves making someone presently entitled to trust income in circumstances where both:

    • someone other than the presently entitled beneficiary actually benefits from that income
    • at least one party enters into the agreement for purposes that include getting a tax benefit.

    Meaning of terms

    'Benefit' includes the:

    • payment or loan of money, the transfer of property, the provision of services or other benefits
    • release, abandonment, failure to demand payment, or postponed payment, of a debt.

    ‘Agreement’ is defined widely to include arrangements and understandings that can be informal, express or implied. An agreement can comprise a series of steps or transactions. An agreement need not be enforceable or even intended to be enforceable.

    'Tax benefit' is where a person would be liable to pay less income tax for an income year or where a person's tax liability would be deferred to a later income year.

    Example: reimbursement agreement

    The trustee of a trust estate makes a beneficiary entitled to trust income.

    Under an agreement, instead of paying the amount of trust income to the beneficiary, the trustee gives, or lends on interest-free terms, the money to another person. The other person benefits from the trust income but is not assessed on any part of it.

     Instead of making a distribution payment to the presently entitled beneficiary, the trustee gives or lends the money interest free to a third party under a reimbursement agreement.
    Subject to the arrangement being an ordinary commercial or family dealing, this would generally constitute a reimbursement agreement if it was intended that the beneficiary who was made presently entitled to the trust income pays a lower amount of tax than would have been payable by the person who actually benefitted from that income.

    End of example

    Agreement can predate trust

    The trust does not have to exist at the time the reimbursement agreement is entered into.

    In Commissioner of Taxation v. Prestige Motors Pty Ltd 98 ATC 4241; 38 ATR 568, the court held that there was no reason why the present entitlement of a beneficiary to trust income cannot be said to arise out of an act or transaction that occurred as a result of a reimbursement agreement, merely because the agreement predated the creation of the trust.

    Beneficiary does not have to be party to agreement

    The beneficiary entitled to trust income does not have to be a party to the reimbursement agreement.

    In Idlecroft Pty Ltd v. Commissioner of Taxation 2005 ATC 4647; 60 ATR 224 , the court held that the requirement that the agreement must be ‘in relation to a beneficiary’ does not require the beneficiary to be a party to the agreement. In that case, the beneficiaries’ entitlements arose by operation of the trust deed, but section 100A was held to apply because the relevant provisions in the deed were triggered as a result of the reimbursement agreement.

    Ordinary family or commercial dealing and other exclusions

    Section 100A does not apply where:

    • an agreement has been entered into in the course of an ordinary family or commercial dealing
    • the presently entitled beneficiary is under a legal disability (such as a minor).

    Section 100A may also not apply where the presently entitled beneficiary is the trustee of another trust.

    Ordinary family or commercial dealing

    Broadly, for an arrangement to be entered in the course of ordinary family or commercial dealing, the purpose of the arrangement should be to achieve normal family or commercial objectives.

    Whether a particular agreement constitutes an 'ordinary family or commercial dealing' (which is not defined), and is therefore not a reimbursement agreement for the purposes of section 100A, depends on all of the relevant facts. The courts have made it clear that the exclusion must be considered having regard to all of the steps comprising the reimbursement agreement – not merely components of it.

    An agreement will not necessarily be considered to have been entered into in the course of an ordinary family dealing merely because all of the entities involved are members of the same ‘family group’. Conversely, an arrangement can still achieve normal commercial objectives in the absence of dealing at arm's length or market value.

    Features indicating that a dealing is not an ordinary family or commercial dealing may include:

    • the presence of artificial or contrived features in an arrangement or part of the arrangement, taking into account the complexity or way in which it was carried out
    • circumstances or conduct that is inconsistent with the legal or economic consequences of the beneficiary's entitlement such that 
      • it appears unlikely that the beneficiaries will receive their entitlements when the 
        • assets or funds representing the entitlement are purportedly lent to others without any intention of being returned or repaid
        • funds representing the entitlement are invested in ways inconsistent with the entitlement
        • funds representing the entitlement are dealt with in a way that is inconsistent with the beneficiary’s right to demand the entitlement
      • beneficiaries are not compensated for being kept ‘out of the money’ (for example, by way of interest, although interest-free loans may, depending on the cultural and other family circumstances, qualify as ordinary dealings)
      • beneficiaries are not informed of their entitlements
      • where income entitlements have actually been paid to the beneficiary, amounts were subsequently returned, or other benefits or services were provided, by way of gift or otherwise to another person (such as the trustee, another beneficiary or an associate, whether by the beneficiary or the trustee either independently or under a power of attorney)
      • income entitlements have not been remitted to the beneficiary, and the reasons given are false having regard to the reasons given for the purported distribution
    • the proportion of the trust net income distributed to the beneficiary as compared to other beneficiaries
    • the relationship between the beneficiary, settlor, trustee and default beneficiaries.

    Entitlements from 1 July 2022

    Draft Practical Compliance Guideline PCG 2022/D1 Section 100A reimbursement agreements – ATO compliance approach sets out our proposed compliance approach in relation to beneficiary entitlements conferred on or after 1 July 2022.

    Entitlements before 1 July 2022

    For beneficiary entitlements conferred before 1 July 2022, the administrative position outlined in Trust taxation – reimbursement agreement (July 2014) will continue to apply.

    See further guidance for registered tax agents and trustees dealing with trust distributions in Managing section 100A for the 2021–22 income year.

    Other integrity provisions

    You might also need to consider whether the following integrity provisions apply to an arrangement, and their potential interaction with section 100A:

    • where the beneficiary is a tax-exempt entity – sections 100AA and 100AB or Division 9C of Part III of the ITAA 1936
    • where the beneficiary is both under a legal disability and a prescribed person, and the assessable income may be excepted trust income – section 102AG of the ITAA 1936 which deals with income of a beneficiary under 18 years old, subject to specific exceptions
    • where the beneficiary is a private company – Division 7A of Part III of the ITAA 1936
    • where the beneficiary has either tax losses or excessive deductions – Division 175 of the Income Tax Assessment Act 1997 (ITAA 1997) for corporate beneficiaries and Division 270 of Schedule 2F of the ITAA 1936 for trustee beneficiaries
    • where a present entitlement or distribution is made from a family trust or an interposed entity to someone outside the family group – Division 271 of Schedule 2F of the ITAA 1936
    • where the beneficiary is a superannuation entity – the non-arm’s length income rules in section 295-550 of the ITAA 1997
    • Part IVA of the ITAA 1936 (see Taxation Determination TD 2005/34, which outlines an arrangement where Part IVA rather than section 100A would apply). Similarly, Part IVA was applied in Hart v FCT [2018] FCAFC 61 to an arrangement involving the interposition of a series of trusts that appeared to serve no commercial purposes other than to avoid the application of section 100A
    • Trust Recoupment Tax Assessment Act 1985 – which applies to schemes designed to circumvent the operation of section 100A
    • Crimes (Taxation Offences) Act 1980 – which provides for certain offences in respect of transactions undertaken to secure the non-payment of tax by a trustee.
      Last modified: 22 Jun 2022QC 41167