Significant uncertainty remains after Guardian appeal decision narrows application of Section 100A

On 24 January 2023, the Full Court of the Federal Court of Australia handed down its decision in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3, dismissing the Commissioner’s appeal from the Federal Court decision¹ insofar as it related to section 100A of the Income Tax Assessment Act 1936, but allowing that appeal on Part IVA for the 2013 income year (only).

The decision is significant for taxpayers with family trusts because the Commissioner has been applying section 100A more regularly and broadly. Subject to a possible appeal to the High Court, the decision will necessitate a rewrite by the ATO of certain aspects of TR 2022/4 and PCG 2022/2.   The Court did not elaborate on the purpose and scope of the ‘ordinary commercial or family dealing’ exception in section 100A, leaving significant residual uncertainty for taxpayers.

WHAT IS SECTION 100A?

Broadly, section 100A is a self-executing integrity provision that applies to situations where a beneficiary’s trust entitlement arises out of or in connection with a ‘reimbursement agreement - e.g., where a distribution is made to one beneficiary, but the economic benefit of the distribution flows to another party and a tax reduction purpose existed.

Section 100A generally operates in such circumstances to disregard the beneficiary’s present entitlement and instead render the trustee liable to tax in respect of the distribution at the top marginal rate (currently 47%).

Critically, section 100A will not apply where the ‘reimbursement agreement’ is entered into “in the course of ordinary family or commercial dealing”².

CASE FACTS

The key facts of the case were, broadly:

•    An unpaid present entitlement (UPE) between the Australian Investment Trust (AIT) and its corporate beneficiary AIT Corporate Services Pty Ltd (AITCS) relating to a distribution made by AIT in favour of AITCS presented a Division 7A problem;
•    Following the distribution, in late 2012, the taxpayers’ advisors proposed the following two alternatives to remediate the Division 7A problem: 
   
  •    Full payment of the UPE before lodgement of AIT’s 2012 income tax return; or
•    Execution of a seven-year investment agreement requiring payment by the AIT’s trustee of interest at the Division 7A benchmark interest rate.
•    After the controlling individual (Mr. Springer) rejected both alternatives on account of his discomfort regarding any transfer of money into an account over which he had no control, the following strategy was implemented during the 2013 income year: 
   
  •    AIT paying AITCS’ income tax;
  •    AITCS declaring a  corresponding fully franked dividend to AIT (its 100% shareholder), thereby extinguishing the UPE; and
  •    AIT distributed 100% of the fully franked dividend to Mr. Springer, who was a non-resident of Australia.

The foregoing strategy was repeated for the 2013 and 2014 income years. As a consequence, the distributions were treated as non-assessable non-exempt income of Mr. Springer. Whereas had Mr. Springer received the original distributions from AIT directly, at first instance, such distributions would have been subject to income tax at the highest marginal rate (with no tax-free threshold).

THE APPEAL JUDGMENT

The Full Federal Court held that section 100A could not apply because:

•    There was no ‘reimbursement agreement’, which included the payment of a dividend by AITCS to the trust, in existence at or prior to the date of the resolution by which AITCS was made presently entitled to the trust income;
•    The parties to an agreement must include the ultimate beneficiary (i.e., Mr. Springer) or at least a representative or controller thereof; and
•    There was no evidence that Mr. Springer had consented to or adopted a plan for a reimbursement that could be attributed from his tax advisers from any direct communication with them nor had he given any authority to his advisers to act on behalf of his entities.

Unfortunately, as the appeal judgment held there was no ‘reimbursement agreement’, the purpose and scope of the ‘ordinary commercial or family dealing’ exception were not tested (other than stating in obiter that mere inclusion of a corporate beneficiary will not jeopardise what is an ‘ordinary commercial or family dealing’), leaving significant uncertainty for taxpayers.

With respect to Part IVA, it was held there was a ‘tax benefit’ obtained by Mr. Springer in both the 2012 and 2013 income years. However, it was held that the ‘dominant purpose test’ (i.e., that one of the parties to the scheme entered into or carried out the scheme for the dominant purpose of enabling the taxpayer to obtain the tax benefit) was only satisfied in relation to the 2013 income year.

This was because the chronology of events referable to the 2012 income year (i.e., the payment of a dividend by AITCS to Mr. Springer being preceded by the creation of the present entitlement and Mr. Springer’s expression of concern about accumulating a cash balance in AITCS’ bank account) did not support the conclusion that the dominant purpose of any party to those steps was to enable Mr. Springer to obtain a tax benefit for the 2012 income year.  

IMPLICATIONS OF THE JUDGMENT

The Guardian decision narrows the application of section 100A and it will (subject to whether special leave to appeal is obtained) necessitate a re-write by the Commissioner of certain aspects of TR 2022/4 and PCG 2022/2, particularly those in relation to the so-called ‘connection requirement’.

For example, paragraph 68 of TR 2022/4 provides that the presently entitled beneficiary need not be a party or in existence at the time of a ‘reimbursement agreement’ being made, whereas Example 14 of PCG 2022/2 appears to assert the existence of a ‘reimbursement agreement’ without the knowledge or consent of the presently entitled beneficiary. 

Taxpayers with outstanding ATO reviews or assessments on section 100A matters should consider whether they have a defence if no reimbursement agreement existed prior to or at the time of the beneficiary’s present entitlement to the trust income.

Tax agents should not communicate with their clients or make plans with them about how a proposed present entitlement from a trust will be repaid until after the relevant year of income. Similarly, taxpayers should not consent to or adopt a plan conceived by their tax adviser about the repayment of a present entitlement from a trust until after the relevant year of income.

The judgment also affirmed the potential application of Part IVA to such arrangements.

Section 100A and Part IVA are inherently complex and becoming increasingly challenging for taxpayers to deal with. RSM Australia is well-equipped to deal with these challenges and would be pleased to assist you in this regard. Please contact your local RSM advisor for any support.

For more information

If you have concerns about any of the issues raised in this article, please reach out to your local RSM office.