Trust taxation in Australia: Division 6 and section 100A explained

Division 6 in outline

Division 6 of the Income Tax Assessment Act 1936 establishes the fundamental principles governing how trusts are taxed in Australia. The core concept is that the income of a trust is taxed in the hands of the beneficiaries who are presently entitled to receive it. This means that each beneficiary is taxed on their share of the trust income at their individual income tax rates.

If no beneficiary is presently entitled to the trust income, the trustee becomes liable for tax purposes. Generally, the trustee is taxed at the highest marginal rate. However, there are exceptions to this rule, particularly relating to non-discretionary trusts, which are addressed under section 99.

Careful planning can allow for the streaming of capital gains and franked dividends. This is achievable if the trust deed and associated resolutions are appropriately drafted to ensure the desired outcome.

Section 100A — reimbursement agreements

Section 100A is an integrity provision that addresses situations where a beneficiary’s entitlement to trust income is affected by a ‘reimbursement agreement’. These agreements are arrangements where someone other than the beneficiary receives the economic benefit of the income. The rule operates to prevent beneficiaries from avoiding tax by diverting the economic benefit of trust income to another party.

When section 100A applies, the beneficiary’s present entitlement to the income is disregarded for tax purposes. Consequently, the trustee is assessed for tax on that income at the rate specified in section 99A. This means the trustee, rather than the intended recipient of the economic benefit, is responsible for paying the tax.

This provision has been in place since 1979, but has recently received increased attention from the Australian Taxation Office, particularly following the release of Taxation Ruling TR 2022/4 and associated Practical Compliance Guidelines.

ATO guidance

The Australian Taxation Office (ATO) provides guidance on Division 6 and section 100A through various publications. Taxation Ruling TR 2022/4 details the ATO’s interpretation of how section 100A operates. This ruling assists in understanding the application of the rules relating to trust distributions and potential reimbursement agreements.

Practical Compliance Guideline PCG 2022/2 outlines the ATO’s compliance approach to arrangements involving trusts. It categorises arrangements into zones – green, blue, red, and white – to reflect different levels of risk and the ATO’s corresponding compliance activities.

Taxation Determination TD 2022/11 addresses a particular situation: the treatment of unpaid present entitlements as section 100A reimbursement agreements. This determination clarifies the tax implications in these specific circumstances.

What advisers should focus on

Advisers should prioritise a thorough understanding of the commercial rationale behind every distribution made from a trust. This is especially critical when distributions are directed to beneficiaries who pay tax at a lower rate, such as corporate beneficiaries with unpaid present entitlements. Detailed documentation of this purpose is essential to demonstrate the legitimacy of the distribution strategy and to support the trust’s tax position.

A key focus should also be on ensuring that distributions are either actually paid or that any unpaid present entitlements are managed in accordance with the Australian Taxation Office’s guidance. Failure to do so can raise concerns about whether the distributions are genuinely for the benefit of the beneficiaries and not primarily for tax avoidance purposes.

Finally, advisers should undertake a comprehensive review of the trust deed before each 30 June. This review should confirm the trust’s capacity to stream income and resolve any potential issues. Trust distribution resolutions should be treated as a significant year-end compliance step, requiring careful consideration and not simply viewed as an administrative task.