The Section 100A

Section 100A of the tax law has a rule called “integrity rule” that applies when the income of a trust is supposed to go to a beneficiary, but the economic benefit of the distribution goes to another party.

For section 100A to apply, there must be a “reimbursement agreement” in place at or before the time the income is given to the beneficiary. Distributions to beneficiaries who are under a legal disability or are under the age of 18 are not affected by these rules.

If section 100A applies to trust distributions, the trustee is usually taxed on the income at penalty rates instead of the beneficiary who would be taxed at their own marginal tax rates.

Even though section 100A has been around since 1979, the ATO hasn’t had much direction on how to handle it until recently. This is no longer the case, and new advice from the ATO shows that trust distributions could be at risk in a number of situations.

For section 100A to apply, the following must be true:

1) The present entitlement (a person or entity is or becomes entitled to income from the trust) must be related to a reimbursement agreement;

2) The agreement must provide a benefit to someone other than the beneficiary who is currently entitled to the trust income; and

3) One or more of the parties to the agreement must want a person to pay less income tax for a year of income.

High risk areas

People used to rely on the exceptions to section 100A, which says that the rules don’t apply when the distribution is to a beneficiary who is legally unable to receive it (such as a minor) or when the arrangement is part of an ordinary family or business transaction (the “ordinary dealing” exception).

The ordinary dealing exception is what is getting a lot of attention right now.

For example, let’s say that a college student who is over 18 and doesn’t have any other sources of income is given $100,000 from a trust. The student agrees to give the money to their parents, less any taxes they need to pay to the ATO, to make up for costs they had to pay when the student was a minor. This is a high-risk situation if the student has a lower marginal tax rate than the parents, since the real benefit of the income goes to the parents.

The ATO is also worried about situations where distributions go in circles. For instance, this could happen when a trust gives money to a company that the trust owns. The company then sends dividends back to the trust, which gives some or all of the dividends back to the company. From a section 100A point of view, the ATO thinks that these arrangements are high risk.

If you wish to discuss the above in more detail, please contact us on 02 9957 4033.