Family Trusts: Understanding Recent ATO Changes

The Latest ATO Changes

Do you use a family (discretionary) trust as part of your tax strategy – or thinking about this option? If so, you need to be aware of important changes by the ATO in relation to trust distributions – particularly for those with adult children as beneficiaries.

Important note: Businesses that operate in the construction sector in Queensland and require a QBCC licence must be extremely careful using Family Trusts – read more.

The Impact

Traditionally, it was common practice to distribute trust income to lower-tax-rate beneficiaries, like adult children, to reduce the family’s overall tax liability. However, the ATO is tightening its focus on these arrangements, and whether they genuinely benefit the recipients or serve merely to minimise tax.

Situations where income distributions are made to adult children and then returned to the parent (or never paid out) is an area that is now under the microscope.

Where the ATO believes that the beneficiary has not genuinely received the economic benefit of the distribution, they plan to invalidate the distribution and tax the trustee of the trust at 47% on the amount of the distribution.

What can you do?

The ATO has released guidance to help trustees understand the level of risk associated with their distribution strategies. Here’s a simple breakdown:

1. Green Zone: Your Safe Harbor

• What it is: Trust distributions that fall into everyday family or commercial dealings.
• Examples:
  • An adult child beneficiary uses trust distributions to pay for their university tuition.
  • A distribution is made to an adult child, who then uses it as a deposit on their first home.

Tip: Keep detailed records, such as bank statements or receipts, to prove the funds are used for the beneficiary’s direct benefit.

2. Red Zone: Proceed with Caution

• What it is: Arrangements that raise red flags as potential tax avoidance schemes.
• Examples:
  • A trust distribution is made to an adult child in a lower tax bracket, who then transfers it back to the parents, reducing the overall family tax.
  • Regular ‘gifts’ from an adult child to the parents shortly after receiving a trust distribution.

Tip: Avoid circular patterns of money that can imply a reimbursement agreement, as this could trigger an ATO audit.

3. White Zone: Historical Compliance

• What it is: Deals with transactions before July 1, 2014, which are typically not under current ATO review.
• Examples:
  • Distributions made in the past where there was less scrutiny on the flow of trust funds.
  • Historical trust arrangements that have not been questioned before the implementation of new guidelines.

Tip: While the ATO is not focusing on this zone, it’s good practice to review past transactions to ensure current and future compliance.

Looking Forward

Understanding these zones is vital to aligning your trust operations with the ATO’s expectations. Here’s how you can apply this system:

1. Review Past Distributions: Look at how your trust has operated in the past and identify any practices that may now fall into the red zone.
2. Plan for the Future: Strategize future distributions to stay in the green zone. This might involve changing who receives distributions or how they are used.
3. Seek Expert Advice: Tax laws can be intricate, and the implications of getting it wrong are serious. Consult with a tax professional to review your trust strategy.

While trusts continue to offer strategic tax benefits, the ATO’s focus on direct benefits and transparency is more pronounced than ever. Ensure your trust distributions are clear, use bank records to demonstrate compliance, and avoid strategies that might attract undue attention.

Need help with the Latest ATO Guidelines?

Understanding these complex tax changes can be challenging, and staying compliant is crucial for your peace of mind and financial health. If you want to ensure your trust strategy is sound and ATO-proof, we’re here to help.

Book a free consultation with one of our Trust accounting experts today. Together, we’ll navigate the nuances of trust distributions, ensure your approach is in the green zone, and maintain the integrity of your tax strategy. Contact us now to secure your future and keep your trust working for you and your beneficiaries.