Imagine this scenario. The police in a provincial town have noticed that there are three prevalent forms of crime. One is being drunk and disorderly, another is vandalisation of shops, and the third is motor vehicle theft. The police announce to all citizens that they will only “apply compliance resources” to one type of crime, the stealing of motor vehicles. Good approach?

In a sense, this is what is happening with the ATO approach to the operation of section 100A ITAA 1936. Let me explain.

In drafting Practical Compliance Guideline PCG 2022/D1, the ATO proposes the use of three coloured ‘zones’ (the blue zone has now been withdrawn). However, for most practical purposes, there are now two zones: green and red. These zones are said to be for the purpose of understanding “how the ATO differentiates risk for a range of trust arrangements to which section 100A might apply”.

If your arrangements are in the green zone, the ATO “will not dedicate compliance resources to consider the application of section 100A”. If your arrangements are in the red zone the ATO “will conduct further analysis on the facts and circumstances of your arrangement as a matter of priority”.

The important point to understand is that the ATO is not saying section 100A does not apply to arrangements in the green zone. It is simply saying it will probably not pursue you. This idea is confirmed in the above quote from the PCG when it speaks of “trust arrangements to which section 100A might apply” — clearly implying that there is a possibility section 100A might apply to green zone arrangements.

Issues of interpretation

Using zones to identify whether the ATO will pursue you or not is an unsatisfactory method of administering the taxation laws. This is because it permits the ATO to avoid having to address the difficult interpretation issues of section 100A. Rather, it leaves an understanding of the ATO’s position unclear.

Under this approach, there is no need for the ATO to give detailed reasons why any particular scenario does, or does not, fall foul of section 100A. There is no need for the ATO to explain why there is, or is not, a “reimbursement agreement”. There does not need to be any significant attempt to say why certain scenarios are being conducted in the course of ordinary family or commercial dealings or not.

This gives the ATO an easy method of “administering” the law by simply waving a green or red flag over an arrangement. No detailed reasons are required. The hard analysis required by section 100A can be avoided. The result is that the taxpayer community is left confused in relation to knowing what the ATO does think about section 100A.

Ordinary family or commercial dealing

The ATO has approached the important issue of “ordinary family or commercial dealing” using the “predication test” as referred to in Newton’s case. This says that a dealing is ordinary where a person can examine the acts and predicate that they can be explained by familial and/or commercial objects they are apt to achieve without further explanation (see paragraph 79 of TR 2022/D1).

The problem with this is that the ATO is talking about what the ATO considers to be familial and/or commercial objects. This is the issue. Exactly what does the ATO consider these to be? The zone approach means that the ATO escapes the need to explain, in detail, this critical issue.

For example, consider red zone scenario 1. An individual adult beneficiary is made presently entitled to income of the trust and (for example) funds that represent the entitlement are paid to the parent of the beneficiary in connection with expenses incurred by the parent before the beneficiary turned 18 years of age. With those facts alone, would you not predicate that this was being done in the course of achieving familial objectives without further explanation? But the ATO does not see it that way. It considers that this situation must be investigated with priority. This is because the ATO clearly has a different view (to many others) of what doing something in the course of achieving familial or commercial objectives means.

There seems to be an assumption made by the ATO that everyone understands what familial or commercial objectives are. Put another way, everyone understands what the ATO thinks are ordinary family or commercial actions. This is not so, and the zone approach means that the ATO does not need to explain itself in detail. The zone approach absolves the ATO from doing this. It simply waves a red flag and says a red zone arrangement must be investigated to see if section 100A applies.

Focus on the wrong issues

To some extent, the approach of the ATO is, in my opinion, focusing on the wrong issue. The examples in PCG 2022/D1 and the recent draft additions to be added to the green zone are all based on what has occurred after a beneficiary has become presently entitled to income. There seems to be an assumption by the ATO that whether a reimbursement agreement existed before the beneficiary became presently entitled to the income can be determined by what happened with the distribution after the beneficiary has been made presently entitled. This assumption is false.

There must be a focus on whether there was a reimbursement agreement in the first place. Events that have happened after making the beneficiary presently entitled should be considered in this analysis, but they are not determinative of the issue.

‘In the course of …’

An important point emphasised by Justice Thawley as part of his recent decision in BBlood Enterprises Pty Ltd v Commissioner of Taxation was that section 100A uses the words, “agreement … entered into in the course of ordinary family or commercial dealing”; not an agreement that was an ordinary family or commercial dealing.

This is a point well made. When families make decisions about money, it is very often the case that this is being done “in the course of” an ordinary family dealing. There may be parts of the overall dealing that someone might consider not to be “ordinary”, however, there still is an “agreement … entered into in the course of ordinary family or commercial dealing”.

One can’t help coming to the view that whenever the ATO sees an agreement or approach being used that results in lower tax than another method, the ATO views the chosen arrangement with the suspicion that the chosen arrangement is not an ordinary family dealing. If this is the case, this is unfortunate because many families enter into arrangements that are “in the course of ordinary family dealing” that have tax savings/planning involved.

For example, a family wants to send their daughter to art school in Paris and provide the daughter with $50,000 in order to do so. The family considers different ways of doing this. Method A will cost $20,000 in tax. Method B will cost $5,000 in tax. The family, understandably, chooses method B. Does the family need to be concerned that the ATO will say using method B is not an ordinary family dealing because tax was saved? Cannot the family simply say that all of the events that involved providing the daughter with $50,000 (the family objective) are being done in the course of an ordinary family dealing?

This is the problem. This is why the taxpayer community, and their advisers are confused.

Deficiencies of the zone approach

PCG 2022/D1 is not the only document in which the ATO has used its zone approach to administering the tax laws. It also used this approach in PCG 2021/4 relating to the distribution of profits in professional services firms. The ATO uses the zone approach to state where it will, or will not, apply compliance resources.

The ability of the ATO to amend assessments related to the issue of the distribution of profits in professional services firms is largely dependent on its ability to apply Part IVA (the general anti-avoidance provision of the Australian tax law) to the scenario. The ATO acknowledges this in the PCG.

However, the ATO makes no attempt to explain how Part IVA might apply by considering all of the various factors required by that provision. It doesn’t have to if it applies a zone approach to administering the tax laws. All it need do is wave a red flag without the hard analysis required by such technical provisions as Part IVA and section 100A.

The basis of the ATO approach in PCG 2021/4 boils down to: not enough tax (in the opinion of the ATO) was paid, therefore we (the ATO) are coming after you with Part IVA.

Clear explanations required

The professional bodies representing accountants need to call out the flawed zone approach that has been adopted by the ATO. Because this has not been done, the ATO has been able to reduce the discussion to the nuances of whether certain actions should be in a particular zone or not. This is missing the big issue.

The ATO should be administering Australian tax law in a manner that enables the millions of taxpayers affected to understand the ATO’s views. The zone approach does not do this and the ATO should stop using this method of administering the tax laws.

It is incumbent on the ATO to give clear explanations of its views about the tax law — not to wave green, red or some other colour flag over an arrangement. It would make advising clients on these issues a lot easier and far less costly.

The zone method of administration turns us away from the rule of law to the rule of what the ATO likes and doesn’t like – indicated by colours.

Accountant’s Daily Strategy Day

I will be speaking on how to solve the section 100A issue at the Accountant’s Daily Strategy Day.

At the Accountants Daily Strategy Day 2022, John Jeffreys will unpack s100A exclusions and high to low-risk zones, while providing practical tips to reduce risk and handle this year’s trust decisions, and ensure clients are audit-ready with the required documentation.

The event will take place on 29 November at Grand Hyatt Melbourne and 1 December at Parkroyal Parramatta.

Click here to buy your tickets and make sure you don’t miss out!

For more information, including agenda and speakers, click here.

John Jeffreys is director of John Jeffreys Tax Pty Ltd.