For most discretionary trusts, by 30 June each financial year the trustee must decide to which beneficiaries the income of the trust will be distributed.
In many situations, the decision as to which beneficiaries receive income, and what types of income, is driven by the overall tax outcome for the family or family group. Clients know this. Accountants know this. The ATO knows this. It is just an accepted fact of Australian small business and family investment life.
But can the decision of a trustee to make distributions to beneficiaries in the most tax effective manner be a “scheme” to which the general anti-avoidance provision of the tax law (Part IVA ITAA 1936) apply? If so, the Tax Office is permitted to reconstruct what happened into a set of events (that did not occur) that will result in more tax payable.
Minerva Financial Group case
This issue has been raised by the Federal Court decision in Minerva Financial Group Pty Ltd v Commissioner of Taxation  FCA 1092handed down on 16 September 2022.
The taxpayer lost the case because Part IVA was applied by the Commissioner, successfully, to the decision of a trustee to distribute only a small percentage of its income to a particular beneficiary. This resulted in less tax being paid when compared to the tax that could have been paid under the Commissioner’s view of what would have happened if the “scheme” had not been entered into. Essentially, so it was held, income of a group was taxed at a withholding tax rate of 10 per cent when it could have been taxed at a corporate rate of 30 per cent if the trustee had exercised its discretion to make the taxpayer company entitled to the income.
Should accountants be worried about the decision in the Minerva Financial Group case? Will the Commissioner begin to aggressively attack the hundreds of thousands of trustee decisions made each year that clearly have the purpose of saving tax for a family group? I think not, but with some caveats.
Elements of Part IVA
For Part IVA to apply, four elements are required:
- There must be a “scheme”
- There must be a “tax benefit”
- It must be concluded, objectively, that the scheme was entered into with the sole or dominant purpose of obtaining the tax benefit
- The Commissioner must decide to apply Part IVA
If a trustee decides to distribute $10,000 to a beneficiary who has no other income and there are other beneficiaries of the trust that are on the top marginal tax rate, there is no escaping the conclusion that Part IVA can have potential application if this was done to save tax for the family.
Due to the extremely broad definition of “scheme” in the law it is almost impossible not to have a scheme. The decision by the trustee would clearly be a “scheme”.
Is there a tax benefit? Yes, the non-inclusion of the $10,000 in the assessable income of the beneficiaries on the top marginal rate, would be a “tax benefit”.
Could it be objectively concluded that the distribution of the $10,000 to the taxpayer with no other income, as opposed to other beneficiaries on the top marginal rate, has been done to obtain the tax benefit? Very likely, yes.
So, what stops Part IVA applying? It is the last element in the requirements — the Commissioner must decide to apply Part IVA — and this is why I don’t think accountants need fear any significant adverse ramifications from the Minerva Financial Group decision.
The Commissioner “may”
The key operative provision of Part IVA (section 177F) begins by saying:
“Where this Part applies to a scheme in connection with which a tax benefit has been obtained, or would but for this section be obtained, the Commissioner may …” (emphasis added).
The point here is that the reconstructing of the taxable income of affected taxpayers under the provisions of Part IVA is at the option of the Commissioner. This is different from most other anti-avoidance provisions that are self-acting (for example, section 100A ITAA 1936). The Commissioner is not permitted to enforce the operative provision in Part IVA. Some years ago, I was told by a person involved with the drafting of Part IVA that this was included in the wording of the law as a safeguard against unintended consequences of the provision applying.
It is my proposition that the Commissioner has not in the past, and will not in the future, choose to apply Part IVA to standard family trust distribution decisions even though they may be solely motivated from a tax point of view. Of course, I am not the Commissioner and cannot say for certain what he will or won’t do. However, if the Commissioner now decided on the strength of the Minerva Financial Group decision to start applying Part IVA to the hundreds of thousands of trustee decisions made each year, there would be an uproar from the small business community that would be clearly heard in the halls of federal parliament.
It should also be appreciated that the Minerva Financial Group case was a “big end of town” issue involving a large amount of money and did not involve a normal family group running a small business or investments through a family trust.
Section 100A — Part IVA for trusts?
Rather than rely on the difficulties of applying Part IVA, it could be argued (and I have suggested this in various forums) that the current stance of the Tax Office with regard to section 100A indicates the Commissioner may now consider section 100A as the “new ” Part IVA for trusts. Of course, tax aficionados will immediately tell me that they are different provisions with different aims — and that, of course, is true. However, I wonder if the ATO has, in its own thinking, decided to use section 100A as the key method of “attack” on discretionary trusts situations that the ATO doesn’t like rather than run the gauntlet with the more difficult to apply Part IVA.
At the time of writing, it is not known if the taxpayer in the Minerva Financial Group case will appeal against the decision of the Federal Court. If the taxpayer does not appeal against the decision, we should read, with much interest, the ATO’s Decision Impact Statement on the Minerva Financial Group case to see whether there is any hint of the ATO widening the use of Part IVA to normal discretionary trust distribution decisions.
John Jeffreys is the director of John Jeffreys Tax Pty Ltd.