Edited version of private advice

Authorisation Number: 1052123547268

Date of advice: 29 May 2023

Ruling

Subject: Application of section 100A to unpaid present entitlements

Question

Does section 100A apply with the result that the Trustee, Y Pty Ltd is liable to be assessed to tax on the net income of the Z Trust pursuant to section 99A?

Answer

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Z Trust was established by Deed of Settlement dated X July 20XX between Person A, as Settlor, and Y Pty Ltd, as Trustee.

The beneficiaries of the Z Trust are:

• Person B, the Specified Beneficiary;
• Any child of the Specified Beneficiary; and
• Any other person (other than an Ineligible Appointee) nominated by the Trustee. No additional beneficiaries have been nominated.

The Z Trust was established for the purpose of participating in the development of residential apartments on a property in State of XXX (the X development project). Title to the property had been acquired by W Pty Ltd as trustee of the V Unit Trust in or about 20XX.

The Z Trust acquired 49% of the issued shares in W Pty Ltd and was issued with units representing 49% of the total issued units in the V Unit Trust. The remaining shares and units are held by an unrelated entity U Pty Ltd in its capacity as trustee of the T Family Trust controlled by an unrelated third party.

The Z Trust is part of a broader group of companies and trusts (S Group) established in Australia by the C family, Person B, her husband Person D and their adult child. The reasons Z Trust was established are varied including:

• A desire to isolate the other assets and entities comprising S Group from the risks entailed with a property development project of the scale of the X development project.
• The desire to be free of the restrictions on dealings with third parties that other trusts associated with S Group are subject to as a result of the making of Family Trust Elections.

The Senior Facility Agreement governing loans to be made by the Z Trust to the V Unit Trust provides that interest compounds periodically. The interest for an accrual period is capitalised and added to the outstanding loan balance with interest in subsequent accrual periods calculated on the principal amount plus capitalised interest. The reason why the interest is being capitalised is because no material revenue is expected to be earned from the X development project until 20YY following its completion and the sale of the units.

The Z Trust is currently funded by a series of loans from R Trust. R Trust is a non- resident trust. It is currently planned that the Z Trust will repay its outstanding loans to the R Trust and the UPEs to Person B upon refinancing of the Senior Facility Agreement before 30 June 20YY.

The accrual period is generally monthly. Interest accrued and capitalised on the loans to the V Unit Trust was included in the income of the Z Trust for the 20XX income year.

Y Pty Ltd in its capacity as trustee of the Z Trust resolved that Person B be presently entitled to all of the income of the Z Trust. Person B's entitlement to the income of the Z Trust will necessarily remain unpaid until cash is available from the sale of the units, or refinancing of the loans, and is paid over by the trustee of the V Unit Trust in accordance with the terms on which the funds have been provided to the trustee of the V Unit Trust.

Until such time as the X development project becomes sufficiently cash-flow positive, or the loans are refinanced, interest on the loans made to the V Unit Trust will continue to be capitalised. The capitalised interest under the Senior Facility Agreement will continue to be recorded as income derived in the relevant year.

Person B, Person D and their adult daughter moved to the Country A in October 20ZZ.

Person B is not subject to a legal disability.

Assumptions

Person B and Person D and their adult child were not residents of Australia for tax purposes in the income years ending 30 June 20XX and 30 June 20XY. They will not be residents of Australia for tax purposes for any of the income years this ruling applies to.

The Z Trust will repay its outstanding loans to the funding trust and the UPEs to Person B before 30 June 20YY.

There are no further steps in the arrangement, beyond those listed in the facts and circumstances, prior to or subsequent to, the arrangement that would form part of the reimbursement agreement.

Relevant legislative provisions

Section 100A Income Tax Assessment Act 1936

Reasons for decision

Issue 1, Question 1

Summary

Section 100A of the Income Tax Assessment Act 1936 (ITAA 1936) does not apply to the arrangement as the proposed delay in paying the present entitlement, in this case, would not be considered as entered into or carried out for a purpose of securing a reduction in liability to income tax in respect of a year of income for the Trustee or the beneficiaries or other parties.

Detailed reasoning

Section 100A is an anti-avoidance provision that was enacted in 1979. Broadly, and subject to the exception for an agreement entered into in the course of ordinary family or commercial dealing, section 100A applies in cases in which a beneficiary has become presently entitled to trust income where it has been agreed that another person will benefit, and that agreement is made by any of its parties with a purpose that some person will pay less or no income tax as a result. Unlike the general anti-avoidance provisions in Part IVA, section 100A does not require the making of a determination by the Commissioner; it is a self-executing provision which operates according to its terms.

According to the Explanatory Memorandum, section 100A:

... look[s] to the existence of an agreement or arrangement that is entered into otherwise than in the course of ordinary family or commercial dealing and under which present entitlement to a share of trust income is conferred on a beneficiary in return for the payment of money or the provision of benefits to some other person, company or trust. ...

Sub-section (8) will effectively exclude from the scope of section 100A any agreement that was not entered into or carried out for a purpose of securing for any person a reduction in that person's liability to income tax in respect of a year of income, i.e., section 100A is only concerned with tax avoidance arrangements

As set out in paragraph 5 of TR 2022/4 - Income Tax: section 100A reimbursement agreements, there are 4 basic requirements for the operation of section 100A:

•         the connection requirement (see paragraphs 57 to 76 of the Ruling)

•         the benefits to another requirement (see paragraphs 77 to 82 of the Ruling)

•         the tax reduction purpose requirement (see paragraphs 83 to 89 of the Ruling), and

•         the ordinary dealing exception (see paragraphs 90 to 113 of the Ruling).

The consequences of section 100A applying are that the trustee (and not the beneficiary) will be liable for income tax on amounts that would generally otherwise be included in the assessable income of the beneficiary in respect of the beneficiary's present entitlement (or the amount of income paid or applied for their benefit).

The Connection Requirement

To satisfy the connection requirement, there needs to be a relevant connection between:

•         all or part of a beneficiary's present entitlement, or all or part of the income paid to or applied for the beneficiary, and

•         an agreement (that meets the requirements to be a reimbursement agreement).

For subsection 100A(1) to apply, it must be the case that the present entitlement:

... arose out of a reimbursement agreement or arose by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement ....

The arrangement in this case involved the agreement with a relevant connection to the beneficiary's present entitlement. This was to leave the interest income in the V Unit Trust and also to leave Person B's entitlement to the income of the Z Trust unpaid (as an unpaid present entitlement or UPE) until the development moves to positive cashflow or the existing financing by the Z Trust is refinanced.

The Benefits to Another Requirement

For an agreement to be a reimbursement agreement, it must provide for the payment of money (including via loans or the release, abandonment, failure to demand payment of or the postponing of the payment of a debt), transfer of property to or provision of services or other benefits for one or more persons other than the beneficiary alone.

A reimbursement agreement must satisfy the conditions in subsection 100A(7):

Subject to subsection (8), a reference in this section, in relation to a beneficiary of a trust estate, to a reimbursement agreement shall be read as a reference to an agreement, whether entered into before or after the commencement of this section, that provides for the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or persons.

The reference to 'persons other than the presently entitled beneficiary' can be anyone, including the trustee, another beneficiary of the trust or any other person

The meaning of 'payment of money' is extended by subsections 100A(10) and (12) to include a payment by way of loan and to the release, abandonment, failure to demand payment or postponement of payment of a debt. It follows that there is a payment of money where a beneficiary loans the amount of their entitlement to the trustee. The inclusion of the words 'or other benefits' means that condition could be satisfied in the case of an agreement where funds are not distributed but retained in the trust.

The arrangement in this case meets the benefits to another requirement. This was to leave the interest income in the V Unit Trust and also to leave Person B's entitlement to the income of the Z Trust unpaid (as an unpaid present entitlement or UPE) until the development moves to positive cashflow or the existing financing by the Z Trust is refinanced.

The Tax Reduction Purpose

For an agreement to be a reimbursement agreement, one or more of the parties to the agreement must have entered into it for a purpose (which need not be a sole, dominant or continuing purpose) of securing that a person would be liable to pay less tax in an income year than they otherwise would have been liable to pay in respect of that income year (a tax reduction purpose).

Subsection 100A(8) provides that:

A reference in subsection (7) to an agreement shall be read as not including a reference to an agreement that was not entered into for the purpose, or for purposes that included the purpose, of securing that a person who, if the agreement had not been entered into, would have been liable to pay income tax in respect of a year of income would not be liable to pay income tax in respect of that year of income or would be liable to pay less income tax in respect of that year of income than that person would have been liable to pay if the agreement had not been entered into.

The proposed delay in paying out the present entitlement, on the specific facts in this case, would not be considered as entered into or carried out for a purpose of securing a reduction in liability to income tax in respect of a year of income for the Trustee or the beneficiaries or other parties. In particular:

•         The UPEs to Person B relating to interest income earned by the Z Trust remain unpaid only for a short time and only until such time as the X development project becomes sufficiently cash-flow positive or is refinanced. In the interim, interest on the loans made to the V Unit Trust will continue to be capitalised. Such capitalised interest will continue to be recorded as income derived in the relevant year.

•         The Z Trust will repay its outstanding loans to the funding trust and the UPEs to Person B before 30 June 20YY upon the development becoming cash-flow positive or refinancing of the Senior Facility Agreement.

•         The Senior Facility Agreement interest rates payable to the Z Trust are consistent with interest rates paid under third parting financing arrangements prior to refinancing under the Senior Facility Agreement.

•         Withholding tax is paid by the Z Trust in respect of the interest income in the year the UPEs are created.

The Ordinary Dealing Exception

Agreements entered into in the course of ordinary family or commercial dealing are not reimbursement agreements. This 'ordinary dealing' test is an objective test applied, at least principally, from the perspective of the persons whose purposes are relevant to the operation of section 100A

The exception to the operation of section 100A is contained in subsection 100A(13):

agreement ... does not include an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing.

The exception is satisfied where the relevant agreement is entered into in the course of ordinary family or commercial dealing. While it can be relevant to consider whether individual steps were entered into in the course of an ordinary family or commercial dealing, that is not the statutory test. It is the whole of the agreement, not those individual steps, that must be characterised as having been entered into in the course of ordinary family or commercial dealing.

On the specific facts in this case it is not necessary to consider the ordinary dealing exception as the tax reduction purpose has not been met.