Section 100A: The great unknown
The Commissioner’s guidance, or lack thereof, on the operation of section 100A of the ITAA 1936 continues to create great uncertainty for tax professionals.
Section 100A was introduced into the Act in 1978 to deal with blatant trust stripping arrangements. However, it has found a new lease of life with the Commissioner in recent years, and we have seen increased audit activity where the application of section 100A is being alleged. Further, the ordinary 2 or 4-year amendment periods do not apply where the Commissioner seeks to apply section 100A, and instead the Commissioner can go back as many years as he likes where a breach of section 100A is being alleged.
What is section 100A?
Section 100A is a broad anti-avoidance provision that allows the Commissioner to disregard trust distributions that form part of a ‘reimbursement agreement’ and to instead impose tax on the trustee at the top marginal tax rate (currently 47% including the Medicare levy).
Broadly, there will be a ‘reimbursement agreement’ in place where:
- a beneficiary who is not under any legal disability is presently entitled to a share of the income of the trust estate;
- the beneficiary is presently entitled to such income of the trust estate by way of a ‘reimbursement agreement’;
- as part of the arrangement, there is a payment or transfer of money or property to a person other than the beneficiary presently entitled; and
- the agreement was entered into to secure the reduction or elimination of tax paid in the relevant year.
Ordinary family or commercial dealing
The most contentious element of section 100A is the carve-out provided for arrangements entered into in the course of an ‘ordinary family or commercial dealing’. To maintain the mystique of this already vague phrase, the legislation does not define what an ‘ordinary family or commercial dealing’ is, nor does the case law provide a clear meaning in the context of section 100A.
The few cases on section 100A have dealt with blatant trust stripping schemes and are largely unhelpful when applying section 100A to more common place tax planning arrangements (e.g. distributions to adult children). If we go searching through the casebooks, we can find some judicial consideration on the meaning of the expression ordinary family dealing in the context of the former general anti-avoidance provision, section 260 of the ITAA 1936 (the predecessor to Part IVA).
The judgment of Lord Denning in Newton’s case is a leading example. In that judgment Lord Denning drew a distinction between transactions “capable of explanation by reference to ordinary business or family dealing” and arrangements “implemented in [a] particular way so as to avoid tax”:
In order to bring the arrangement within the section you must be able to predicate – by looking at the overt acts by which it was implemented – that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.
Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div. 7 tax… Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax…
To what extent the judicial comments on ordinary family dealings in the context of section 260 will inform the meaning of that phrase in the context of section 100A is an unknown.
Draft ATO ruling
As many tax professionals will be aware, the ATO has indicated for a number of years that it will be releasing a draft taxation ruling on section 100A. That ruling will set out the Commissioner’s preliminary views on the exclusions from a ‘reimbursement agreement’ for:
- agreements not entered into with a purpose of eliminating or reducing someone’s income tax; and
- agreements entered into in the course of ordinary family or commercial dealings.
The latest guidance on the ATO website suggests the release of that ruling is imminent with consultation expected to be completed this month (although, the ATO’s “Advice under development – trust specific issues” page still has an expected completion date of July 2021 for the release of the draft ruling).
Whenever the draft ruling is released, we’ll be covering it in detail in the Birchstone Brief and other forums so stayed tuned for our analysis and insights, and please get in touch with us in the meantime if you have any section 100A issues.
East Finchley Pty Ltd v FCT  FCA 720
Continuing on with the theme from last week, and in anticipation of the ATO releasing their ruling on section 100A, over the next several weeks we will look at the key judicial decisions that shape our current understanding of how section 100A works. If you missed last week’s introduction to section 100A, you can read it here.
They say that the beginning is a good place to start, so let us delve into the first case that considered section 100A in detail: East Finchley. While many of the findings of Justice Hill of the Federal Court have been overturned by subsequent section 100A cases (cases that we’ll look at in the coming weeks), it is still a useful case to revisit as it provides an example of the type of conduct that section 100A was intended to address (even though the arrangement in the case was ultimately found to be ineffective without needing to resort to section 100A).
The facts of this case can be summarised as follows:
- At a meeting of the directors of East Finchley (the trustee of the Thomas Family Trust) on 23 June 1983, the trustee purported to distribute the income of the trust for the 1983 income year to three named beneficiaries and the remainder (which was substantial) to “non residents” who were relatives (of the controllers of the trust) who lived in India. In total, 126 non-resident beneficiaries were distributed $585 each, this amount being the tax-free threshold for non-residents in that income year.
- On July 1983, one of the directors of the trustee travelled to India to give to each of the non-resident beneficiaries a letter notifying them of their entitlement to their $585 income distribution, and to get them to sign a pro-forma letter authorising the trustee to credit the distribution to a loan account in the beneficiary’s name in the trust’s accounts. Under this arrangement, no money actually changed hands and no tax was paid by the trustee or the beneficiaries.
- In August 1988, in the midst of an ATO investigation, the trustee eventually paid the non-resident beneficiaries their entitlements.
The Federal Court ultimately didn’t rule on whether section 100A applied in this case. This was because there were factual issues that required the case to be remitted back to the Tribunal to be reconsidered. In particular, there was a real question of whether the resolution of the directors of the trustee at the 23 June 1983 meeting had been effective to create present entitlements in the non-resident beneficiaries.
On rehearing the matter, the Tribunal decided that there wasn’t sufficient evidence to prove that the trustee made an effective resolution by 30 June 1983 to create present entitlements in the non-resident beneficiaries. As a result, the balance of the income was assessable to the default beneficiaries which, as the default beneficiaries were minors, resulted in the trustee being liable to pay tax.
While the Federal Court ultimately remitted the matter back to the Tribunal, Justice Hill made findings on certain aspects of section 100A which were raised in the appeal. Many of those findings (such as whether the beneficiary needs to be a party to the reimbursement arrangement) have been overturned in subsequent cases. However, one finding has remained unchallenged.
Justice Hill found that by the beneficiaries acknowledging their entitlements and authorising the trustee to credit the distribution to a loan account in their name, this resulted in the trustee’s obligation to pay the distribution being satisfied and replaced by a loan back from the beneficiary to the trustee of the trust. It was held that this offset was a “payment of money” which could form part of a reimbursement arrangement and be sufficient to enliven section 100A.
Those familiar with the ATO’s view on the Division 7A treatment of UPEs to corporate beneficiaries, may recognise that East Finchley is one of the cases that the ATO relies upon in TR 2010/4 that support the view that a UPE can be converted to an ordinary loan by setoff (i.e. the UPE becomes a ‘section two’ loan).
FCT v Prestige Motors Pty Ltd  FCA 221
This week we consider what is regarded as the leading case on section 100A: FCT v Prestige Motors Pty Ltd.
This matter involved a complex series of transactions which can be split into the ‘RLAV arrangement‘ and the ‘NMLA arrangement‘:
- Prestige Motors Pty Ltd (Prestige Motors) sold its profitable business to a unit trust (Unit Trust);
- 93% of the units in the Unit Trust were owned by Ronald Lyons Australia (Vic) Pty Ltd (RLAV);
- RLAV had significant losses and came under control of the controllers of Prestige Motors prior to the allotment of units by the Unit Trust;
- Prestige Motors became the trustee of the Unit Trust;
- the Unit Trust, RLAV and Prestige Motors arranged for loans to be made to RLAV by Cholmondeley (a newly formed Singaporean company, the directors of which would act in the interests of the parties who arranged the loan);
- the Unit Trust distributed profits to RLAV to be offset against its losses; and
- interest payments were made by RLAV to Cholmondeley, with only 10% interest withholding tax payable on these amounts.
- The Unit Trust issued units to a tax-exempt entity, National Mutual Life Association Ltd (NMLA);
- the deed of the Unit Trust was varied to allow income distributions to NMLA; and
- the deed of the Unit Trust was amended to divert capital benefits to other beneficiaries.
The Court held that the RLVA arrangement and NMLA arrangement both separately constituted reimbursement agreements under section 100A.
In relation to the RLAV arrangement, the Court said that the elaborate documentation and series of steps outlined reflected an understanding or arrangement to which a number of companies and persons were parties. Further, in relation to the requirement under section 100A(7) for there to be a payment of money or transfer of property, it was said that:
…it would seem that a number of payments or transfers answer the statutory description. Most obviously, the reimbursement agreement contemplated that the parties to it intended that RLAV (the beneficiary that became presently entitled to income) would pay very large amounts of interest to Cholmondeley.
The Court also held that it was not necessary for the Unit Trust to be in existence at the time that a reimbursement agreement was entered, and that there was no commercial motivation for the sale of the business.
In relation to the NMLA arrangement, the Court said that the issue of units to NMLA and the subsequent dealings were the product of an antecedent agreement or arrangement, with the effect of the agreement being that the future distribution of the bulk of the Unit Trust’s income was made to NMLA rather than RLAV. The Court held that no commercial reason for raising capital outside the Perron group was demonstrated.
While the arrangements described above were complicated, it is quite easy to see that the arrangements “crossed the line”, giving us little general guidance on where that line does sit. However, one finding of the Full Federal Court in this case that is of some general application was that a reimbursement agreement does not need to be legally enforceable for section 100A to apply to agreement.
Idlecroft v FCT  FCAFC 141
Third in our series of section 100A cases and relevant to the findings in the first case we considered, East Finchley, this week we touch on the decision in Idlecroft Pty Ltd v FCT  FCAFC 141.
This matter related to a joint venture agreement formed between three discretionary trusts (Trusts) to develop property in South Australia. The Trusts each appointed Westside Commerce Centre Pty Ltd as trustee for the Hendon Unit Trust (Unit Trust) as a beneficiary. The Unit Trust had significant tax losses, and the Trusts utilised these losses by distributing of all their income to the Unit Trust. The Unit Trust was only paid a small margin of the income it was appointed.
In determining that section 100A applied to this arrangement, the Court stated that:
The connecting circumstances between the entitlement of the default beneficiaries came about because the appointments of income designed to give effect to the reimbursement agreement were invalid. The appointments came into effect because of the existence of the reimbursement agreement.
It was argued by the Trusts that section 100A could not apply because the default beneficiaries were entitled to the trust income as the addition of the Unit Trust as a beneficiary was not valid. On this basis, the taxpayers argued that there was not a reimbursement agreement under section 100A, because as commented on by Hill J in East Finchley, this requires an agreement with the default beneficiaries. However, in overturning the findings made by Hill J, the Court held that the definition of ‘agreement’ contained within section 100A does not require the beneficiary to be a party to the agreement.
The Court also held that the beneficiary in question does not even need to be the object of the reimbursement agreement. The court adopted a ‘but for’ test to hold that section 100A applied – but for the existence of the reimbursement agreement (which did not included, either as a part to, or the subject of the agreement, the default beneficiaries), the (invalid) appointments to the Unit Trust would not have been made, and therefore the default beneficiaries would not have received their default entitlements.
While the Court did provide some useful clarification on how the definition of ‘agreement’ in section 100A operates, there is again little to no clarification on some of the more contentious parts of the section. This is not surprising given that the taxpayers conceded parts of the case.
To cap off our section 100A journey, this week we consider the decision in Raftland Pty Ltd as trustee of the Raftland Trust v FCT  HCA 21.
This matter involved a complex series of trust distributions which can be summarised as follows:
- The Raftland Trust (Trust) was established in 1995 with the E & M Unit Trust (Loss Trust) as the default beneficiary. Raftland Pty Ltd was the trustee and was controlled by the Heran brothers.
- The Loss Trust was unrelated to the Trust and the Heran brothers.
- The Trust made an income distribution of $250,000 to the Loss Trust, which had accumulated losses of approximately $4 million, to effectively purchase control of the Loss Trust. Raftland Pty was subsequently appointed as trustee for the Loss Trust.
- Over the following three years, the Trust made significant income distributions (largely consisting of income that other entities in the family group had made the Trust presently entitled to) to the Loss Trust to utilise the prior year tax losses. Aside from the $250,000 income distribution for control of the Loss Trust, none of these income distributions were actually paid from the Trust to the Loss Trust. The income was largely retained by the Trust and other entities within the family group.
The High Court reasoned that the income distributions from the Trust to the Loss Trust were shams because there was never an intention for these distributions to be legally effective. Rather, the High Court held that there was only ever an intention to make a distribution of $250,000 to the Loss Trust, which was the price to effectively purchase control of the Loss Trust. On this basis, the Heran brothers became presently entitled to these amounts as the default beneficiaries.
Although the High Court regarded the distributions as a sham, they held that section 100A still applied. In following the reasoning of Kiefel J in the first instance, the High Court held that section 100A applied because the entitlements of the default beneficiaries (the Heran Brothers) came about because the appointment of income was invalid. The High Court essentially applied a ‘but for’ test – but for the existence of the agreements the appointments would not have been made.
Based upon the reasoning of the High Court above, it is arguable that if the beneficiaries would have received the distributions regardless of the agreement, then section 100A would not apply.