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Tax Planning End of Financial Year 2022

Why Family Trusts need tax planning in 2022?

All those with family trusts need to do some tax planning and, at a bare minimum, review the cash distributions and prepare a Resolution before 30 June 2022.

For those clients with trusts, tax planning is always imperative, as profit distributions need to be determined before the end of the financial year. However, this year with the release of new guidance from the ATO in February 2022 regarding acceptable profit allocations to beneficiaries/ family members, we now need to consider the actual cash paid to family members when determining the profit allocation.

In the past, a family could offset profit distributions to children with reimbursement for prior years of costs, e.g. school fees. However, now under the new guidance, retrospective reimbursements are not acceptable, and profit distributions should reflect the actual drawings/cash distributions made to beneficiaries during the year, or cash should be preserved in the trust for future payment. But, Sub-trust arrangements arising prior to 1 July 2022, will not be subject to ATO compliance resources per TD 2022/D1.

Example of  Acceptable Distribution under new guidance (Green Zone)

The Blossom Family Trust is controlled by spouses, Jane and John Blossom, who are the primary beneficiaries of the trust.

Each year, the trust makes Jane and John presently entitled to the trust's income in equal proportions and a proportion to their daughter Jenny who is a full-time University student. Funds are set aside for Jenny's sole benefit, and she can call on this trust entitlement at any time. The amount attributed to Jenny will ensure her taxable income does not exceed a certain marginal tax rate threshold, e.g.19%.

Jane and John have shared financial responsibilities and fund their lifestyle from a common pool of assets.

Trust distributions to spouses who have shared financial responsibilities and who ultimately enjoy the shared benefits of the distribution would usually be capable of explanation as achieving ordinary familial objects without the need for further explanation. Similarly, as Jenny has access to her entitlement, absent any additional factors taking the arrangement beyond those ordinarily encountered in the organisation of financial affairs between spouses and family members, the arrangement would be a Green Zone Distribution. (Green Zone means not likely to draw ATO attention.)

Example of a Red Zone Distribution (likely to be unacceptable to the ATO)

Wobbly Trust's beneficiaries include the members of the Wobbly Family. Wobbly Co is the trustee of Wobbly Trust, and Wendy Wobbly is the sole shareholder and director of the trustee. Wendy is the parent of three adult children; Sandra (aged 26), Simon (aged 21) and Sam (aged 19). During the 2022-23 income year, Sandra is self-employed and has a taxable income of $90,000. Simon and Sam study full-time and derive no income during the income year. Wendy's children live at home with her at all times throughout the income year.

During the 2022-23 income year, Wobbly Trust derives $240,000 in income (the trust's net income is also $240,000). Throughout that year, Wobbly Trust makes regular payments totalling $240,000 into Wendy's bank account. Wendy uses these amounts throughout the year to meet her personal living expenses and those of the household.

On 30 June 2023, Wobbly Co resolves to make Simon and Sam each presently entitled to $120,000 of the Wobbly Trust income.

Wobbly Co applies its entitlements against the beneficiary loan owed by Wendy. The entitlements of Simon and Sam are each recorded as having been fully paid in the accounts of Wobbly Trust. Wendy assists in preparing Simon and Sam's tax returns and pays the tax liability arising in relation to their entitlements from her personal funds.

The entitlements of Simon and Sam are applied in this manner because they each purportedly have an outstanding debt owed to Wendy in respect of education expenses and their share of the Wobbly household expenses that Wendy paid before they each turned 18.

The ATO would consider this a Red Zone scenario and would be more likely to apply compliance resources in these circumstances.

Blue Zone distributions are those arrangements that do not fall within Red and Green Zone transactions and may include unpaid distributions to corporate beneficiaries. 

Low Green
The ATO won't dedicate compliance resources to consider the application of section 100A to these arrangements.
Medium Blue This is the default zone that applies if an arrangement doesn't fall within any of the other zones. Arrangements in this zone might be subject to ATO review, but are less likely to attract the ATO's attention than arrangements in the red zone. The ATO might contact taxpayers in this zone to understand the arrangement.
High Red The ATO will conduct further analysis on the facts and circumstances of the arrangement as a matter of priority. If the analysis confirms the facts and circumstances are high risk, the ATO might proceed to audit where appropriate.

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