In my blog post 100A trust reimbursement agreement not the tool to fix the bucket company dividend washing machine last month I looked at reimbursement agreements following Guardian AIT Pty Ltd ATF Australian Investment Trust v. Commissioner of Taxation  FCA 1619 (Guardian AIT).
The Commissioner acts
In the meantime the Commissioner has appealed Logan J.’s decision in Guardian AIT to the Full Federal Court. The Commissioner has also released a suite of “draft products” which set out the compliance approach of the Commissioner relating to reimbursement agreements under section 100A of the Income Tax Assessment Act (ITAA) 1936:
- Draft Taxation Ruling TR 2022/D1 Income tax: section 100A reimbursement agreements
- Draft Practical Compliance Guideline PCG 2022/D1 Section 100A reimbursement agreements – ATO compliance approach
- Draft Taxation Determination TD 2022/D1 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of ‘financial accommodation’?
- Taxpayer Alert TA 2022/1 Trusts: parents benefitting from the trust entitlements of their children over 18 years of age
Evolution of the draft products
The suite clearly evolves from a similar suite finalised nearly twelve years ago which included Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements and Practice Statement Law Administration PS LA 2010/4 Division 7A: trust entitlements which focused on unpaid present entitlements of private companies, deemed loans and sub trusts. The Commissioner now takes a tougher line, prospectively, on what is a financial accommodation and thus a deemed loan for the purposes of Division 7A of the ITAA 1936 in TD 2022/D1. A company will need to demand immediate payment when it becomes aware of and has an unpaid present entitlement (UPE) to income of a trust. There will still be a financial accommodation, despite arrangement to pay a commercial rate of interest, which will be enough to be deemed loan and potentially a deemed dividend. Section 109N of the ITAA 1936 complying loan terms are needed so that UPE will not trigger a deemed dividend under section 109D.
This does not appear to be a relevant matter in Full Federal Court appeal in Guardian AIT in relation to the the bucket company dividend washing machine (BCDWS) arrangement used in that case. Under that BCDWS a dividend was declared by the bucket company back to the Australian Investment Trust (AIT) in the window allowed for a private company debit loan before the income tax return for the bucket company was due. That declaration is a prompt if not immediate action to extinguish any financial accommodation by the bucket company to the AIT.
The dividend washing machine arrangement comes up as Red zone scenario 2 in paragraphs 33 to 36 of PCG 2022/D1 where red zone activity in PCG 2022/D1 is activity at high risk for ATO action with compliance resources. It is not expected that, even if the Commissioner is unsuccessful in the Full Federal Court case in Guardian AIT, the BCDWS will be reclassified out of the red zone and will become an acceptable tax practice.
Repercussions of Guardian AIT?
It remains to be seen whether section 100A risks addressed in the draft products will align with Guardian AIT following the Commissioner’s appeal. Will higher courts adopt Logan J.’s understanding of the facts which accepted the BCDWS as an ordinary family or commercial dealing?
Perhaps more problematic for the Commissioner will be to convince a higher court that there was a reimbursement agreement at all in Guardian AIT. Logan J.’s findings that there was no timely reimbursement agreement for the bucket company to pay dividends to the Australian Investment Trust, and no plausible counterfactual as to whom otherwise the trustee of the Australian Investment Trust would have distributed income of that trust had it not been distributed to the Australian Investment Trust, meant the Commissioner could not make out a reimbursement agreement to which section 100A could apply.
In running the appeal the Commissioner may run the risk that the Full Federal Court will establish authority that section 100A cannot readily apply where the impugned distributions to which the Commissioner seeks to apply section 100A is made to immediate family members such as Simon and Sam in Example 7 in paragraphs 85 to 92 of PCG 2022/D1.
Example 7 – amounts provided to the parent in respect of expenses incurred before the beneficiary turns 18 years of age
85. Brown Trust’s beneficiaries include the members of the Brown Family. Brown Co is the trustee of Brown Trust, and Bronwyn Brown is the sole shareholder and director of the trustee.
86. Bronwyn is the parent of three adult children; Sandra (aged 26), Simon (aged 21) and Sam (aged 19).
87. During the 2022-23 income year, Sandra is self-employed and has a taxable income of $90,000. Simon and Sam study full-time and derive no income during the income year. Bronwyn’s children live at home with her at all times throughout the income year.
88. During the 2022-23 income year, Brown Trust derives $240,000 in income (the trust’s net income is also $240,000). Throughout that year, Brown Co makes regular payments totalling $240,000 into Bronwyn’s bank account. Those payments are recorded as a ‘beneficiary loan’ in the accounts of Brown Trust. Bronwyn uses these amounts throughout the year to meet her personal living expenses and those of the household.
89. On 30 June 2023, Brown Co resolves to make Simon and Sam each presently entitled to $120,000 of the Brown Trust income.
90. Brown Co applies their entitlements against the beneficiary loan owed by Bronwyn. The entitlements of Simon and Sam are each recorded as having been fully paid in the accounts of Brown Trust. Bronwyn assists in the preparation of Simon and Sam’s tax returns and pays the tax liability arising in relation to their entitlements from her personal funds.
91. The entitlements of Simon and Sam are applied in this manner because they each purportedly have an outstanding debt owed to Bronwyn in respect of education expenses and their share of the Brown household expenses that Bronwyn paid before they each turned 18.
92. Diagram 10 of this Guideline illustrates the circumstances in this example.Example 7 in PCG 2022/D1
Under sub-section 100(8) an agreement is carved out from being a reimbursement agreement unless there is what the Commissioner refers to as the tax reduction purpose.
Even though a distribution in that Example 7 to Bronwyn was a “lawful possibility” why “would have” distributions made to Simon and Sam (assuming the distributions were real and genuine) who are equally family beneficiaries with Bronwyn have been made to Bronwyn? Isn’t the true issue that the trust distributions to Simon and Sam are a sham and that Simon and Sam did not have a real entitlement and so are not presently entitled to the distributions in the first place?
The Commissioner appears to be reliant on the Full Federal Court agreeing with the construction of sub-section 100A(8) expressed in paragraphs 156 to 158 of Draft Taxation Ruling TR 2022/D1 Income tax: section 100A reimbursement agreements rather than the construction of that sub-section preferred by Logan J.