The ATO has a renewed interest in reimbursement agreements, confirmed in its list of ‘what attracts our attention’ dated 27 October 2015. This follows the ATO’s continued attention on reimbursement agreements set out in its guidance released in July 2014. However, this time around, the ATO is arguing that certain trust distributions, which may be construed as part of legitimate tax planning, actually fall within the scope of the reimbursement agreement provisions – with particularly harsh consequences.
What are reimbursement agreements?
In broad terms, a reimbursement agreement exists where:
- a trust distribution is made to a specified beneficiary;
- another person obtains the benefit of the distribution; and
- the arrangement is for the purpose of minimising income tax.
A common example is a trust distribution to a beneficiary who is either exempt or on preferential tax rates, but where the trust funds are used either by the trustee in carrying on the trust’s business or by beneficiaries on higher tax rates.
Are there any exclusions?
There are exclusions for where an arrangement is done as part of ‘ordinary family’ or ‘commercial’ dealings. The ATO has issued guidance on these issues, but that guidance provides examples on cases that are obviously:
- ‘ordinary family’ dealings – a trust under a Will for a beneficiary under the age of 18;
- ‘commercial’ dealings – an unpaid trust distribution that is converted to a complying Division 7A loan; or
- not ‘ordinary family or commercial dealings’ – a washing scheme designed to avoid income tax.
Importantly, in our audit experience, the fact that distributions are made to family members may not be sufficient to constitute ‘ordinary family’ dealings – where those family members are on preferential tax rates. This will be a particular concern for taxpayers distributing trust income to adult children on low marginal rates or non-resident family members.
An area of particular concern for advisers should be around clients who have adopted washing schemes. In the guidance provided by the ATO, the following diagram highlights a particular arrangement that the ATO considers to be a reimbursement agreement.
What are the risks of reimbursement agreements?
Section 100A is a deeming provision. It does not require the Commissioner to make a determination in the way Part IVA does.
There is also no limitation period, which increases both the number of years of assessment that the Commissioner can amend, with a corresponding increase in the effect of interest.
What practical steps can I take?
For historical trust distributions, advisers should review whether there is a risk that the reimbursement agreement provisions apply.
If there is a risk, then a decision will need to be taken on whether to collect evidence that the arrangement is excluded (hopefully while that evidence can still be obtained) or make a voluntary disclosure. The collection of evidence in these matters is particularly important, because, while the Commissioner has no limitation period, the taxpayer has the burden of proving its case.
For future trust distributions, advisers need to consider the ATO’s published position since 2014. Practically, this may mean considering whether the pattern of previous distributions that were made as part of a client’s tax planning strategy can be continued – or whether the risk of the ATO seeking to apply the reimbursement agreement provisions is too high.
Please contact Fletch Heinemann on +61 7 3231 2443 if you would like more information on this issue.