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Beware of artificial trust arrangements to avoid tax

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On 12 August 2013, the ATO issued Taxpayer Alert TA 2013/1 warning taxpayers against artificial arrangements where a deliberate mismatch is created between the amounts beneficiaries are entitled to receive from a trust and the amounts they are actually taxed on.

Broadly, the ATO says these arrangements concern situations where a trust has generated a small amount of income and a large capital gain during the year. Trust distributions are then made in such a way that one beneficiary receives the funds generated from the capital gain, tax free, while another beneficiary (being a newly incorporated company) incurs the tax liability attached to that gain. According to the ATO, the newly incorporated company receives no funds from the capital gain to pay this tax liability, and is wound up to avoid payment of tax and specifically the large taxable capital gain.

In particular, the ATO notes that these arrangements may contain all or some of the following features:

  • a discretionary trust is involved where all the members are in the same family group and one member of the family controls the trust;

  • trust income in the trust deed is defined as the trust's taxable income, unless the trustee determines otherwise;

  • during the income year, the trustee sells a capital asset that results in a capital gain and the trust also derives a small amount of ordinary income;

  • a newly incorporated company is made a beneficiary of the trust and is controlled by a member of the family group;

  • the trustee then exercises its power under the trust deed to determine that the capital gain is excluded from trust income, and to distribute all of the remaining trust income to the newly incorporated company;

  • as a result, the newly incorporated company is entitled to receive the small amount of ordinary trust income, but is also assessed on the trust's entire taxable income (including the capital gain);

  • the company has no capacity to pay its tax liability and a liquidator is appointed to wind it up; and

  • in the following income year, the trustee makes a capital distribution that is equal to the capital gain to a family member.

The ATO says it is concerned that arrangements of this type may be a sham and may constitute a scheme to which the general anti-avoidance rules in Pt IVA of the Income Tax Assessment Act 1936 (ITAA 1936) may apply. It says taxpayers should also note that the income may be assessable to any entity involved in the arrangement and their associates under s 100A of Div 6 of the ITAA 1936. In addition, the ATO notes that any entity involved in the arrangement as a promoter may be subject to Div 290 of Sch 1 to the Taxation Administration Act 1953 (TAA), and may also face civil and criminal proceedings.

However, the ATO says that where taxpayers have already sought advice in the form of a private ruling on their trust arrangements, they may rely on the private ruling. The ATO does, however, remind taxpayers that private rulings only apply to the particular entity identified in the ruling, the particular scheme described, and the particular years identified.

Source: ATO Taxpayer Alert TA 2013/1, http://law.ato.gov.au/pdf/tpa/tpa1301.pdf.

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