With TR 2022/D1 comes clarity as the application of the reimbursement agreement provisions, and a warning as to the strict consequences of their application

Recently published, Draft Taxation Ruling TR 2022/D1 provides insight and guidance as to how the ATO will assess reimbursement agreements and apply s 100A of the Income Tax Assessment Act 1936 (Cth) (“ITAA 1936” or “1936 Act”).

Basic structure of s 100A

Section 100A of the ITAA 1936 is not new – it has been around for some decades. Nonetheless, as it attempts to clamp down on tax-avoidance schemes, the ATO has sought to increasingly apply s 100A. Section 100A concerns present entitlement arising from reimbursement agreements.

Where the Commissioner is satisfied that a reimbursement agreement exists, the essential structure of s 100A is to allow the ATO to disregard trust distributions and deem a beneficiary to never have been presently entitled to the trust income in question. Consequently, the income is then assessed in the hands of the trustee at the top marginal rate.

This raises the question – what is a reimbursement agreement?

Reimbursement agreement – the four requirements

The term “reimbursement agreement” is defined in s 100A(7) as an agreement that provides for the payment of money (or other property, services or benefits) for a person other than the beneficiary that has been made presently entitled to that income. Section 100A(7) is subjection to s 100A(8), whose purpose is to exclude the application of s 100A(7) from agreements that do not have as a purpose the removal or reduction of a liability to tax by a relevant person in an income year (Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT[1] (‘Guardian AIT”).

Whilst it is defined in s 100A(7), the term “reimbursement agreement” has been the subject of ambiguity – the purpose of TR 2022/D1 is to provide some clarity on the issue.

The Commissioners view, as expressed in TR 2022/D1, is that for a reimbursement agreement to be present, the following four basic elements – expressed as “requirements” – must be present:

1. The connection requirement;

2. The benefit to another requirement; and

3. The tax reduction purpose requirement;

The connection requirement

The first element requires, that for s 100A to apply, there must be a present entitlement (deemed or otherwise) of a beneficiary to a share of trust income in connection with or as a result of a reimbursement agreement. For this element to be satisfied, there must be a relevant connection between:

(a)  a legally-effective entitlement; and

(b)  an agreement

An “agreement”, as noted by the ATO in TR 2022/D1 is defined widely to include arrangements and understandings. An arrangement does not need to be express or formal, and will exist where two or more parties have an exact understanding of the nature and extent of the agreement, and the agreement sets out a series of steps undertaken by the parties individually or collectively over a period of time. An agreement need not be enforceable.

Further still in the eyes of the Commissioner, the relevant connection need not be direct causal connection. Rather, it is sufficient for the present entitlement in question to have arisen form another act, transaction or circumstance that occurred in connection with, or as a result of, the reimbursement agreement.

Benefits to another requirement

An agreement will be a reimbursement agreement whereby the payment of money (or other property or services), in some form for a person or persons other than the presently entitled beneficiary.

Tax reduction purpose requirement

For this requirement to be met, an agreement must have been entered into for a purpose of securing for a person a reduction in a tax liability that would have otherwise arisen had it not been for the existence of the agreement. The purpose need not be the sole, dominant or even continuing purpose. Importantly, it is not necessary that the person whose tax liability is intended to be reduced as a result of the agreement be a party to the agreement. In TR 2022/D1 the ATO stakes out the position that features of an agreement that appear to be tax driven will be the subject of objective enquiry to determine whether an agreement is entered into in the course of ordinary dealing.

The ordinary dealing exception

Importantly, agreements entered into in the course of ordinary family or commercial dealings are not captured by s 100A. This raises question as to what constitutes “the course of ordinary family or commercial dealing”. The ATO states in TR 2022/D1 that ordinary family and commercial dealings must be capable of explanation as achieving normal or regular familial or commercial ends. It should be noted that the absence of arm’s length dealing does not itself prevent a dealing from being explained as achieving ordinary commercial dealings.

Capital gains and franked distributions

Section 100A casts a wide net – allocations of capital and franked distributions fall within the ambit of its application.

Getting it right

If you, or a client of yours, is planning on entering into some form of trust arrangement that may even remotely resemble a reimbursement agreement under s 100A, it is vital that you carefully consider the nature and structure of the agreement. It is equally important that you be prepared to put forward to the ATO a compelling explanation as to why your particular arrangement does not constitute a reimbursement agreement.

Why is this? The tax consequences of the application of s 100A are potentially significant. As previously mentioned the result of the will be tax being paid by the trustee at the top marginal rate. TR 2022/D1 also makes clear that contingency planning for s 100A will not work. The ATO states in the tax ruling that the deeming of s 100A “creates a fictitious set of facts which are substituted for reality and are state to apply for the purposes of the [1936] Act.” The ATO goes on to state that the “substation of the fictitious set of facts under the section 100A deeming is limited and does not extend to treat an entitlement as having arisen for another person (such as a default beneficiary)”.

If you require specific advice regarding reimbursement agreements relevant to you or your clients particular circumstances, please do not hesitate to contact us.