In brief - This was the issue considered by the Federal Court in Guardian AIT Pty Ltd as trustee for Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619

The decision is relevant to trustees of discretionary trusts who are considering distributions of trust income to a company, particularly where the shares in the company are held by the trustee.

Application of section 100A of the Income Tax Assessment Act

Section 100A of the Income Tax Assessment Act 1936 (Cth) is a longstanding anti-avoidance provision that was introduced to counter trust stripping. The arrangements that it was intended to counter involved the distribution of income of a trust to a new beneficiary with particular tax attributes so that no or reduced tax was paid by that beneficiary, while the benefit of the trust income was enjoyed by another person in a tax free form. 

However, section 100A applies to a wider range of arrangements. Broadly, it applies where:

  • a beneficiary that is not subject to a legal disability is presently entitled to the income of a trust, and

  • the present entitlement arose out of a reimbursement agreement.

A reimbursement agreement is an agreement that provides for the payment of money, the transfer of property or the provision of services or other benefits, to a person other than the beneficiary.

The agreement must be entered into to reduce or eliminate the income tax liability of a person, in other words, there must be a tax avoidance purpose present.

A reimbursement agreement does not include an agreement entered into in the course of ordinary family or commercial dealing.

If section 100A applies, the beneficiary is taken not to be presently entitled to the income of the trust. Instead, the trustee is liable to pay tax at the top marginal rate in respect of that income on the basis that no beneficiary is presently entitled to the income. 

The matter was heard by Justice Logan who found that on the facts section 100A did not apply.

What were the facts of the case in Guardian AIT Pty Ltd as trustee for Australian Investment Trust v Commissioner of Taxation?

Guardian AIT Pty Ltd (Guardian) was the trustee of a discretionary trust called the Australian Investment Trust (AIT). The shares in Guardian were owned by Mr Springer and he was also the principal under the trust deed.

By the time the relevant transactions were implemented, Mr Springer had transitioned to retirement. During his working life, Mr Springer carried on numerous businesses through companies that he controlled. Most, but not all, the businesses were successful.

The transactions took place in the 2012, 2013 and 2014 income years and involved:

  • the appointment of a new company called AIT Corporate Services Pty Ltd (AITCS) as a beneficiary of the AIT. The sole shareholder of AITCS was Guardian as trustee of the AIT

  • the appointment of part of the net income of the AIT to AITCS

  • the creation of an unpaid present entitlement in favour of AITCS because the amount of net income appointed was not paid to AITCS

  • AITCS drawing on the balance of the unpaid present entitlement to pay income tax

  • the declaration of fully franked dividends by AITCS to Guardian as trustee of the AIT, which further reduced the balance of the unpaid present entitlement (this only occurred in the 2013 and 2014 income years)

  • the appointment of the fully franked dividend income to Mr Springer, who in the relevant income years was a non-resident

  • the entry into a compliant Division 7A loan agreement by AITCS and Guardian as trustee of the AIT in relation to the balance of the unpaid present entitlement

  • the repayment of the balance of the unpaid present entitlement.

The Commissioner assessed Guardian under section 100A and Mr Springer under the general anti-avoidance provisions in Part IVA of the Act. The Commissioner also imposed penalties of 50% of the tax payable on the basis that there was no reasonably arguable position.

There was evidence that Mr Springer undertook a plan to gradually wind down the business activities, relocate to Vanuatu, reduce his involvement in the businesses and to convert Guardian to a passive investor. 

As part of this plan, AITCS was incorporated shortly before the end of the 2012 year to receive distributions of the trust income from the AIT. Mr Springer decided to incorporate a new company, rather than use a company that had previously carried on business, because he was concerned about claims arising from the business activities. It was not part of the plan to pay dividends from AITCS to Guardian, this decision was made later.

Prior to the 2012 income year, there were no plans for the distribution of income from the AIT. Distributions were made on an as-needs basis. Mr Springer operated the businesses in a similar way, there were no formal cash flow budgets and he met expenses from funds available within the various businesses.

Section 100A findings of the Federal Court

Justice Logan found that section 100A did not apply because:

  • there was no reimbursement agreement that preceded the distributions to AITCS or the declaration of the dividends, as the decision to declare each dividend was only made after the distributions had been made, or on an ad hoc basis from year to year

  • the object of the dividend was to reduce the balance of the unpaid present entitlement payable to AITCS 

  • the agreement was restricted to the incorporation of AITCS, the appointment of AITCS as a beneficiary of the AIT and the resolution of Guardian to appoint part of the net income of the AIT to AITCS

  • the agreement was entered into in the course of ordinary family or commercial dealing because:

    • the object of the agreement was to minimise risk during Mr Springer's retirement and to have a new separate legal entity to receive trust distributions, which could be used for passive investment and wealth accumulation

    • AITCS did not have any special tax status or any carried forward tax losses

    • the agreement avoided large trust distributions being made to Mr Springer or another individual beneficiary

  • the agreement did not provide for the payment of money to a person other than the beneficiary, it only provided for the payment of money to AITCS

  • there was no tax avoidance purpose as the only reasonable counterfactuals were either that AITCS would have received and retained in full its unpaid present entitlement, or it would have entered into a Division 7A loan agreement with Guardian

  • the counterfactual proposed by the Commissioner that Mr Springer would have received the trust income instead of AITCS was unreasonable as:

  • it was inconsistent with Mr Springer's decision to minimise risk

  • Mr Springer did not need the trust distribution for his retirement as he already had substantial wealth

  • the evidence of Mr Springer's accountant was that he would have never recommended a trust distribution be made to Mr Springer.

Part IVA findings of the Federal Court

Justice Logan found that Part IVA did not apply because the dominant purpose of the scheme was the minimisation of risk to Mr Springer in retirement and the formation of a new corporate beneficiary to receive trust distributions, which could be a vehicle for passive investment and wealth creation. The payment of dividends was not a dominant purpose of the scheme.

The Commissioner's proposed counterfactual that Mr Springer would have received the trust distributions instead of AITCS was not something that would have been reasonably expected to have occurred. There was no tax benefit.

We can see why the Commissioner took an adverse view of the transactions because the outcome was that the net income that was distributed to AITCS only attracted tax at the corporate rate as it ultimately found its way to Mr Springer in the form of a fully franked dividend while he was a non-resident. 

The Commissioner also does not like arrangements where trust income is distributed back to the trust in the form of a franked dividend.

The outcome in this case may have been different had the evidence established that the declaration of the dividends was a part of the plan at the outset.     

This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2022.

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