Unless carefully managed, unpaid present entitlements (UPEs) and beneficiary accounts in family/discretionary trusts can give rise to significant tax risks.
Section 100A anti-avoidance provisions
Section 100A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) is an anti-avoidance provision that applies to arrangements where one person receives a benefit from a trust but another person is made presently entitled to and assessed on that income.
A typical scenario where s 100A may be applied is where a trust distributes income to adult children who are not aware of and who do not have access to their beneficiary accounts in the trust and the parents or others use the money for their own use and benefit rather than the money being distributed to or paid to the children.
Trustees should carefully manage UPEs to minimise the risk of s 100A being invoked. If s 100A is invoked, the trustee is assessed on the relevant income at the highest marginal rate of 45% plus the Medicare levy under s 99A of the ITAA 1936 and the beneficiary is deemed not to have been made presently entitled to that income for tax law purposes. Thus, it is important for trustees to appropriately manage and document UPEs.
Example showing significant tax saved using discretionary trust
Family/discretionary trusts over many years have been used as a means of splitting income between family members to leverage off the tax-free threshold and the progressive personal marginal tax rates of each individual family member. Significant tax can be saved by a family by splitting income via a trust to minimise the overall tax payable by the family.
The example in the Annexure shows that significant amount of tax is saved by a trust that, in addition to splitting income between mum and dad in FY2024, also distributes income between their two adult children. On $560,000 net income in FY2024, some $40,066 tax is saved by splitting $100,000 to each child and the balance of $360,000 equally between mum and dad (ie, $180,000 for each of mum and dad).
Common practice with managing UPEs
According to the ATO, the general practice with some family trusts has not been good as some adult children were supposedly entitled to distributions but the trustee (who were typically the parents as individual trustees or the directors of the corporate trustee) used the income distributed to the children for their own needs. Rarely did the children ever take any interest in what was happening in this regard.
However, the ATO has been increasing its review and compliance activities in recent years and is detecting more cases where the children or other beneficiaries have not received the benefit of the purported distributions made to them.
In particular, a failure by trustees to notify beneficiaries of their UPE may lead to the ATO applying s 100A to tax the trustee at 45% on any income that the beneficiary is not notified of or does not receive any benefit from. In paragraph [13] of PCG 2022/2, the ATO outlines the features of different risk zones, namely:
- white-low risk, for arrangements prior to 1 July 2014;
- green – low risk, for arrangements after 30 June 2014; and
- red – high risk,
arrangements in relation to the application of s 100A.
In relation to green zone arrangements, the ATO state:
We will not dedicate compliance resources to consider the application of section 100A to arrangements in the green zone, other than to confirm that the features of the relevant scenario are present in your circumstances.
However, at paragraph [32] the ATO state that an arrangement where the trustee has not notified a beneficiary of their entitlement to trust income by the trust’s relevant tax return lodgement date will be excluded from the green zone.
For example, for a distribution to beneficiaries made on 30 June 2023, the beneficiaries should have been notified of their entitlements by the earlier of 15 May 2024 or the date that the trust’s 2023 tax return was due to be lodged.
Thus, there is an increased prospect that the ATO will dedicate compliance resources in respect of a particular arrangement where a trustee does not notify a beneficiary of their trust entitlement in a timely manner. Where the ATO determines that s 100A should be applied to an arrangement, in addition to any primary tax and interest on late payment, significant penalties may also be applied.
There is no time limit on the ATO applying s 100A to prior income years. This provision works differently to the usual rule that the ATO cannot generally amend beyond a 4-year period from the date of an income tax assessment.
DBA documents for ‘managing UPEs and beneficiary accounts’
Given the increased ATO compliance activity, DBA Lawyers has prepared a suite of documents to inform and educate trustees to and to assist trustees to manage their UPEs and beneficiary accounts. These documents include:
- a covering letter and checklist;
- a suggested letter to the beneficiary notifying them of their UPE;
- draft trustee resolutions; and
- a detailed memo outlining the importance of managing beneficiary accounts in respect of s 100A of the ITAA 1936.
Our fee to prepare this suite of documents for a specific trust for one income year is $440 (inc GST). Naturally, we can also be engaged to provide consulting advice in relation to the above.
To view our range of popular trust related services please click here. One service we also offer is to undertake a review of the trust deed to provide a report on some key factors that may need to be addressed to ensure the deed can undertake a number of important functions, eg, tax streaming, succession to key roles and having up to date powers to invest, etc.
Related information
For related information and articles:
- ATO checklist for trust distributions
- Why should you order trusts from DBA Lawyers?
- Discretionary trusts – variations and issues
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licensed financial adviser under the Corporations Act 2001 (Cth).
Note: DBA Lawyers presents monthly online SMSF training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
By Fraser Stead ([email protected]) Lawyer,
Shaun Backhaus ([email protected]), Senior Associate, and
Daniel Butler ([email protected]) Director, DBA Lawyers.
DBA LAWYERS
17 May 2024
| ANNEXURE | ||||||
| Example – showing $44,066 tax saved with two children: | ||||||
| The M&D Family Trust derives $560,000 of net income for FY2024. | ||||||
| A. Trust income split between 2 family members: | ||||||
| The trust distributes only to mum and dad in FY2024: | ||||||
| Mum | Dad | Total | ||||
| Net income | 280,000 | 280,000 | 560,000 | |||
| Tax | 96,667 | 96,667 | 193,334 | |||
| Net income | 183,333 | 183,333 | 366,666 | |||
| B. Trust income split between 4 family members: | ||||||
| The trust distributes to mum and dad and their two adult children in FY2024: | ||||||
| Mum | Dad | Diane | Oscar | Total | ||
| Net income | 180,000 | 180,000 | 100000 | 100,000 | 560,000 | |
| Tax | 51,667 | 51,667 | 22967 | 22,967 | 149,268 | |
| Net income | 128,333 | 128,333 | 77,033 | 77,033 | 410,732 | |
| Option A – 2 | Option B- 4 | Differences | ||||
| Total income | 560,000 | 560,000 | – | |||
| Total tax | 193,334 | 149,268 | 44,066 | |||
| Net | 366,666 | 410,732 | – 44,066 | |||
| Tax saved | 44,066 | |||||
| Assumptions: | ||||||
| – Medicare levy of 2% is ignored. | ||||||
| – Each person has no other income. | ||||||
| – There are no net capital gains, nor CGT discount amounts. | ||||||
