For many families with a discretionary trust, deciding how the trust’s income will be distributed is an important part of the annual tax planning process.

But there is a question that can sometimes be overlooked.

What actually happens to the money after the distribution is made?

It might sound like a simple question, but the answer can matter.

A distribution is more than a name on a resolution

A family trust may distribute income to one or more beneficiaries each year in accordance with its trust deed.

For example, a trust might distribute income to an adult son or daughter. That beneficiary may then be required to include their share of the trust’s net income in their individual tax return.

But simply recording a distribution to a beneficiary doesn’t necessarily end the conversation.

• We also need to understand what happens to the beneficiary’s entitlement.
• Was the money actually paid to them?
• Was it retained by the trust and properly recorded as an amount owing to them?
• Was it used for their benefit?
• Or did somebody else ultimately receive or use the benefit of that distribution?

Those circumstances can have different tax consequences.

Why does it matter who benefits?

Australia’s tax law contains provisions designed to address certain arrangements where a beneficiary is made presently entitled to trust income, but another person receives a benefit in connection with that entitlement.

These rules are commonly referred to as section 100A.

Section 100A has existed for many years, but the ATO has increased its focus on how it applies to trust distributions and reimbursement agreements.

That doesn’t mean every family arrangement involving a trust distribution is a problem.

The legislation contains an important exclusion for agreements entered into in the course of an ordinary family or commercial dealing. The difficulty is that whether an arrangement falls within that exclusion depends on the circumstances.

There isn’t a simple rule that says a transaction is acceptable merely because it occurs between family members.

Consider a common family situation

Imagine a family trust distributes $50,000 to an adult daughter.

The daughter includes the appropriate amount from the trust distribution in her tax return.

What happens next is important.

• If the daughter receives and keeps the money, that is one set of circumstances.
• If the trust retains the amount and genuinely owes it to her, that requires appropriate accounting and records.
• If the money is applied towards expenses genuinely relating to the daughter, that may be another situation again.

But suppose the arrangement was always that the daughter would be made entitled to the income while the economic benefit of that income would go back to her parents.

That deserves much closer consideration.

The tax result shouldn’t be assessed simply by looking at whose name appears on the trust distribution resolution.

“But we’ve always done it this way”

This is where established family practices can sometimes create a false sense of security.

An arrangement doesn’t necessarily become an ordinary family dealing simply because it has happened for several years.

Similarly, an arrangement isn’t necessarily inappropriate because money moves between members of a family.

The facts matter.

Why was the distribution made? What was understood between the people involved? Who ultimately benefited? What records exist? And does what actually happened correspond with the way the transaction was recorded?

These are much more useful questions than simply asking whether the trust was technically able to make the distribution.

Documentation matters

Good record keeping is particularly important for trusts.

Depending on the circumstances, relevant records might include:

• the trust deed and any amendments
• trustee resolutions
• financial statements and beneficiary accounts
• correspondence or other records explaining an arrangement
• evidence of payments made to beneficiaries
• records showing how a beneficiary’s entitlement was satisfied or applied.

This isn’t about creating paperwork for the sake of it.

The records should help tell the same story as the transaction itself.

If a distribution is made to a beneficiary, we should be able to understand what happened to that entitlement and why.

Trust planning shouldn’t finish on 30 June

Trust distribution planning often receives considerable attention before the end of the financial year, and rightly so. Trustees need to understand their trust deed and make appropriate decisions about distributions within the required timeframe.

But good trust management doesn’t finish once the resolution has been signed.

What happens after the distribution can be just as important.

That is why we encourage clients to tell us about arrangements involving beneficiaries rather than assuming something is too informal or too much a part of normal family life to be relevant.

A parent and adult child might see a transaction simply as helping each other out. Tax law may require us to look more closely at how that transaction relates to a trust distribution.

The aim isn’t to make family trusts difficult

Family trusts remain an important structure for many Australian families and businesses.

The point isn’t that distributions to adult children or other family members should be avoided. Nor does section 100A mean that every movement of money between family members creates a tax problem.

The important thing is that distributions have a genuine basis, the consequences are understood, and what happens in practice is consistent with the arrangement being recorded.

If you’re unsure what has happened to a beneficiary’s trust entitlement, or you’re considering a distribution where the money may ultimately be used by somebody else, it is much better to discuss it before assuming the tax outcome.

Because when it comes to trust distributions, who is taxed is important, but who actually gets the benefit can be just as important.

At Indigo Financial, we work with trustees and family groups to understand their circumstances, plan trust distributions and ensure the transactions that follow are properly considered and documented.

Talk to us if you would like to review your trust distribution arrangements or understand how these rules may apply to your family.

Contact Indigo Financial on (08) 8212 8585 if you need help with understanding any of your accounting, taxation and business development needs.

Sources
Australian Taxation Office, Section 100A reimbursement agreements
Australian Taxation Office, Practical Compliance Guideline PCG 2022/2: Section 100A reimbursement agreements – ATO compliance approach
Australian Taxation Office, Taxation Ruling TR 2022/4: Income tax: section 100A reimbursement agreements