trusts distributing to children - new ato alert

Taxpayer Alert

TA 2022/1

Parents benefitting from the trust entitlements of their children over 18 years of age

https://www.ato.gov.au/law/view/document?docid=TPA/TA20221/NAT/ATO/00001

 

Perfect example of when physical payment of trust entitlements is wise. Just finishing one as I read this and its the text book of what to do. A prepayment occurs just prior to 30 June and when all matters are completed the balancing amount is paid. None is regifted or dubious and the trustee actually prepares well considered resolutions prior to 30 June.

Albo plans for trusts should assist to minimise this. I am also not fan of the practice of distributing trivial $416 amounts to minors. It exceptionally contrived. Often I see this executed badly so $416 is distributed for accounting purposes but with franking gross up its a problem. Or no family trust elections when needed etc

 

s100A is a focus this year I hear

 

same ive never recommended distributing the 416 to minors. tax savings are soo insignificant yet the myriad of issues that arise from it open an entire can of worms.

 

Read paragraph 29 of the taxpayer alert and compare that to example 2…

 

This seems to be a new direction the ATO are heading on this issue isn't it? As opposed to say, just cracking down on something that was more clearly in breach?

 

The ato are saying it is just clarifying an existing position. It is not new.

I am helping to write the lobby and position papers on this with the Tax Institute.

 

Its no change in law, but they must be seeing more of this happening and want to scare taxpayers into stopping it

 

It also seems to suggest a way to not be seen as suspicious, right: just pay the distributions to the adult child's bank account.

 

Its the adult child's income so the parent has no right to it. The child can come back to sue the trust to recover it. If it is an unpaid present entitlement the limitations act doesn't apply to it like it would with a loan, so can be be recoverable many years later and this often comes up in family law property disputes.

Example
Lisa has been recieving $50,000 per year on paper from a discretionary trust controlled by her dad, Homer. Lisa never sees this money but pays tax on it, with her father reimbursing her for the tax.

Lisa and her lover Millhouse later separate and as part of the property settlement Millhouse analysis the tax returns and bank statements and finds out that 20 years of repayments have not been received so the trust basically owes Lisa $1mil. This is now property of the marriage for family law purposes and Millhouse might be able to recover some of that as part of the property settlement.

Also who would do this to their own kids anyway - you are basically stealing from them.

 

I suspect the reason for this alert is a major emerging trend in the past 2 years as share markets have rebounded from their 2008 lows (between 2018-2021) that there has been a LOT of new disc trusts formed where the prevailing tax benefit is distributions to low tax rate parties within a family. The typical taxpayer wants to invest a bit of $$$ from a offset, savings or even borrowed and onlend to the trustee in ETFs. Typical taxpayer seeks to distribute to minors (doesnt really work), adult low income kids and also aged parents. I imagine some enterprising advisers have then sought to expand this arrangement across the area of education trusts which have been previously noted as a concern often spanning grandparents and kids (uni etc) Education trusts set up under testamentary wills are slightly different however could also be misused.

To counter the alert issues follows a approach I have been recommending for a long time.
1. The beneficiary should be paid their distribution entitlements.
2. No round robin of funds
3. Then they should only loan these back to the trustee under a legal written agreement OR regift under a Deed of Gift. However the legal issues Terry raises concerning gifting is a profound concern and why regifting is not necessarily wise. Legal advice on the loan recourse should always be obtained as the beneficiary could demand repayment.
The Tax Payer alert is specifically focussed on the concerns where "the parents who exercise control over and enjoy the economic benefit of the income." rather than that of the trust receiving the after tax cash proceeds to enable accumulation of wealth. Where the economic benefits of the income are reinvested no concern should arise. The benefical entitlement is also not a unpaid presnet entitlement.

I am curious why the ATO Alert is confined to those over 18. I would consider those under 18 are equally (or even more) a concern.

 

Doesn't the wording seem to imply that it is more reasonable for parents to be responsible for the expenses of minors, so the alert is confined to beneficiaries over 18?

 

If the trust deed allows, the trustee can make children presently entitled and for the trustee to meet their obligations to the beneficiary by paying the money to the legal guardian of the child and the guardian can then use the funds for the living expenses of the child.

 

I don't get the greed.

 

I've never liked the reimbursement agreements, it looks like straight out tax avoidance to me. If a trustee distributes to a beneficiary, those funds should be paid, or where necessary, a loan agreement entered in to.

I would agree that the ATO are seeing more of it, from an increase investment trusts and earnings, and more children living at home earning low amounts during Covid times.

 

How are the parents benefiting? Isn’t it the Trust that’s benefiting? Having more funds to invest with, which is of benefit to all beneficiaries? Depositing funds into 18 year old’s bank account at interest rate of SFA seems to be a bad move financially.

 

Its often not. It a sense of entitlement. They see the trust money as theirs. Often based on simplistic views. Hence the Taxpayer Alert
Its very common like many see a company as them. as dont see the distinction no matter how many times its explained.

 

In the TA the arrangement sees the beneficiary surrender their income to others (parents) who untimately benefit. Charging costs like tuition fees is a excuse.

 

Usually this type of scenario results in the parents paying less tax.

 

People relocate kids to a tax haven and then send franked dividends to the kid resident in the tax haven. The kid then lives their for say 5 years and relocates.

The cash on relocation back to Australia is tax free.

think of doing this with a 50m franked dividend. You save 12.5m of tip up tax and it costs 300k a year (ish) to keep the kid occupied for 5 years.

And guys are doing this using the ordinary family dealings arrangement. If you can combine this strategy by using the base rate entity tax rate you have generated a serious tax saving - plus your kid can get a masters degree

Other variations include paying interest to an offshore child as well.

And the cash is paid. Simply “paying the cash” doesn’t solve the ATO problem - it is the focus on an ordinary family dealing.

Sadly what is ordinary to me (say $150 at Christmas) is not ordinary to our wealthiest families - so the ordinary family dealing provision in the law actively helps the wealthy.

Lobby efforts have been made in this area. Ideally a de minimus exemption should be applied so Uber wealthy can use but that is problematic. Anecdotally the ATO are looking at very small amounts in this area - say $10k as a form of avoidance.