What trust distributions to adult children can be questioned under Section 100A?

.

The Australian Taxation Office (ATO) is scrutinising trust distributions where parents may be taking advantage of their adult children’s lower marginal tax rates to reduce the overall tax on the trust’s net income. In some cases, the economic benefit of these trust distributions is, in reality, enjoyed by the parents rather than the children.

Examples include situations where adult children’s trust entitlements are used to cover expenses that the parents would typically pay, or where funds representing these entitlements are redirected for the parents’ benefit. Additionally, concerns arise when there are arrangements that appear to lack genuine consideration or are crafted solely for tax purposes without a commercial basis.

In these cases, the ATO may question the legitimacy of these distributions under Section 100A of the Income Tax Assessment Act. To ensure your trust arrangements are compliant and low risk, book a consultation today with us by using the link here.

How the ATO targets trust distributions used to repay parents for past expenses

The Australian Taxation Office (ATO) has issued a warning to trustees about the risks of distributing trust income to adult children on lower marginal tax rates as a means of repaying debts for their upbringing costs. These expenses might include private school fees, uniforms, extracurricular activities, or even a share of family holiday costs.

When an adult child is made presently entitled to trust income, and that income is then used to reimburse a parent or caregiver for expenses incurred before the child turned 18, the ATO considers this a high-risk arrangement under Section 100A of the Income Tax Assessment Act. The ATO views these costs as parental expenses, not legitimate debts of the child, and considers such arrangements as benefiting the parents rather than the child.

These practices are categorised in the “red zone” for reimbursement agreements, making them likely targets for ATO scrutiny. To avoid falling under the ATO’s compliance activities, trustees and beneficiaries should ensure that trust distributions are backed by genuine consideration and are consistent with ordinary family or commercial dealings. Seeking professional advice is recommended to minimise the risk of ATO challenges.

Example – Trust distributions repaying private school fees

John, who controls a discretionary family trust, agreed with his daughter Emily, a beneficiary, to distribute trust income to her before the end of the 2024 income year. Emily, who recently turned 18 and is studying full-time, agreed to transfer the after-tax amount back to John as partial repayment for $85,000 he had spent on her private school fees in Years 10, 11, and 12.

The trust earned $160,000 for the year, with $110,000 distributed to Emily and $50,000 to John. After paying her tax liability of $28,417, Emily transferred the remaining $81,583 to John. Meanwhile, John’s $50,000 share was added to his salary of $130,000, resulting in an additional tax liability of $19,500. If John had received the entire $160,000, his tax liability would have increased by $51,700.

This type of arrangement, where trust distributions are used to reimburse parents for past expenses, can attract scrutiny under Section 100A of the Income Tax Assessment Act. Trustees should seek professional advice to ensure compliance and avoid potential ATO challenges.

ATO may invalidate trust distribution: High-risk red zone scenario

The ATO is likely to invoke Section 100A to invalidate the trust distribution made to Emily, categorising the arrangement as a high-risk red zone under its guidelines. This case is a priority for the ATO, which intends to allocate compliance resources to challenge the distribution.

The ATO’s position is that Emily is not genuinely benefiting from the distribution, as she is using the funds to repay her father, John, for parental expenses. This undermines the exclusion for ordinary family dealings, making the distribution vulnerable to being invalidated under tax law.

Tax tip: Using trust distributions for adult children’s university fees

The ATO treats trust distributions used to pay an adult child’s university fees differently from those used for school fees under Section 100A. While school fees are seen as parental expenses, university fees are considered “legitimate expenses that might ordinarily be borne by an adult child.”

If an adult child is made presently entitled to trust income and the distribution is used to pay for university fees, this arrangement generally falls within the low-risk green zone. Even if the adult child is on a lower marginal tax rate than their parents, the ATO considers this a legitimate economic benefit for the child, and Section 100A would not be applied to invalidate the distribution.

ATO’s stance on trust distributions used by adult children to pay board”

It’s common for adult children living at home to pay board to their parents to help cover household expenses. Board payments are informal arrangements within families, not considered assessable income for the recipient, and related expenses are not deductible. However, with the ATO’s increased focus on family trust distributions, questions arise about whether Section 100A could apply when an adult child uses their trust entitlement to pay board to a parent who controls the trust.

Although the ATO has not issued specific guidance on this scenario, it has addressed similar cases involving adult children who use trust distributions to pay board to grandparents. In those instances, the ATO did not see Section 100A as an issue, as the payments covered a legitimate expense for the child. This suggests that if an adult child uses their trust distribution to pay board to their parents, Section 100A should not apply, provided the arrangement reflects an ordinary family or commercial dealing and the child genuinely benefits.

However, if a trust distribution is used by a high school-aged child to pay board, the ATO might view this differently, seeing it as a way to cover parental expenses. Additionally, if the board is not set at a reasonable, arm’s length rate or lacks clear agreement, the ATO could argue the arrangement lacks genuine consideration, increasing the risk that Section 100A might be applied to invalidate the distribution.

Tax warning: Trust distributions paid into mortgage offset accounts

The ATO has flagged arrangements where an adult child’s trust distribution is deposited into their parent’s mortgage offset account to reduce interest on the family home loan as high-risk. Such arrangements are categorised in the red zone of the Section 100A compliance guidelines, especially when they result in a reduced overall tax burden.

Due to the high-risk classification, the ATO is likely to prioritise these cases for investigation. This could lead to the application of Section 100A, potentially invalidating the trust distribution. Trustees should exercise caution and seek professional advice to avoid ATO challenges in such scenarios.

What trust distributions are excluded from Section 100A scrutiny?

When assessing if a trust distribution could be invalidated under Section 100A of the Income Tax Assessment Act, certain exclusions can prevent this from happening. If these exclusions apply, the ATO will not use Section 100A to challenge the trust distribution.

Beneficiary under a legal disability

Section 100A does not apply if the distribution is made to a beneficiary under a legal disability, such as a minor or a bankrupt person. In these cases, the trustee is assessed on the trust income under Section 98. The key point is that the beneficiary’s entitlement arises without any intent to reduce tax.

No tax reduction purpose

If the trust distribution was not made as part of an arrangement intended to reduce tax, Section 100A does not apply. A tax reduction purpose involves trying to pay less tax than would have been paid if the income had gone directly to the person who benefited. Even if tax reduction isn’t the main goal, Section 100A could still apply, so it’s important to ensure that the distribution reflects a genuine economic benefit.

Tax tip for distributions to controllers

Section 100A usually doesn’t apply to distributions made to the controllers of the trust, such as the primary beneficiaries or their spouses. Since these individuals typically benefit directly from the trust income and often pay tax at higher marginal rates, there is less risk of a Section 100A challenge. If trust entitlements are retained within the trust for working capital or reinvestment, the ATO’s guidelines suggest this is a low-risk arrangement, provided the funds are used appropriately and align with genuine commercial dealings.

Related article: Understanding section 100A’s impact on distributions to grandparents

If you’re interested in exploring how Section 100A could affect trust distributions made to grandparents, check out our article “Are your trust distributions to grandparents at risk under Section 100A?“.

TMS Financials provides you with a team of experienced professionals that help you achieve your financial goals through smart tax structures and strategic financial structuring. We’re a one-stop shop for all financial needs and pride ourselves on building strong partnerships with our clients.

Book a free financial health review to see the difference we can make in your financial future.

This outline is for general information only and not as legal, tax or accounting advice. It may not be accurate, complete or current. It is not official and not from a government institution. Always consult a qualified professional for specific advice tailored to your unique circumstances.