ATO Crackdown on Income Splitting Explained

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Income splitting — the practice of directing business income to lower-income family members to reduce the overall tax bill — has been a legitimate tax planning strategy for decades. The problem is that many arrangements have drifted well beyond what the law permits, and the ATO has made it very clear that it's watching.

If you operate a business through a family trust, a company with a spouse shareholder, or any other structure where income flows to people who don't actually work in the business, you need to understand where the line is — and whether you're currently sitting on the right side of it.

The Rundown — and Why the ATO Cares

Australia's progressive tax system means income earned by a high-income individual is taxed at up to 47 cents in the dollar (including the Medicare levy). If that same income can instead be attributed to a spouse on a much lower income, or to an adult child who earned little else that year, the combined tax bill drops substantially.

The ATO is not opposed to tax planning. What it targets is arrangements where the legal form of an income distribution doesn't reflect the economic reality — where someone receives a share of business profits they didn't genuinely earn and wouldn't receive in an arm's-length transaction.

Two main sets of rules are being actively enforced:

• Personal Services Income (PSI) rules — which apply when income is predominantly derived from the personal skills or efforts of one individual
• Section 100A of the Income Tax Assessment Act 1936 — which targets trust distributions made as part of a "reimbursement arrangement" where the economic benefit doesn't truly flow to the beneficiary

When Your Income Is Really Just Yours

The PSI rules are designed to prevent contractors and consultants from using a company or trust to split income that is, in substance, earned by a single individual.

Your income is likely classified as PSI if more than 50% of the income you receive from a contract is for your personal labour, skills, or expertise — rather than for the use of assets, a business risk you're taking on, or a product you've manufactured.

Common examples of PSI earners who may not realise it:

• IT contractors providing services through their own company
• Engineers or architects operating through a family trust
• Medical professionals with service entities
• Consultants who invoice through a spouse's company
• Financial advisers with personal service income directed to a trust

When the PSI rules apply, the income must be attributed back to you personally — regardless of how your structure is set up — and it's taxed at your marginal rate. You can't split it, and most business deductions available to genuine businesses are also denied.

The four tests that can save you

There are four tests that can take you outside the PSI rules, even if more than 50% of your income is personal services income. You need to pass at least one:

• Results test — you're paid for producing a specific result, you provide your own tools, and you're liable to rectify defects at your own cost
• Unrelated clients test — you have at least two unrelated clients who found you through general advertising
• Employment test — you employ or subcontract others who perform at least 20% of your principal work
• Business premises test — you maintain and use your own business premises that are separate from your home and your clients

If none of these tests apply, the PSI rules almost certainly apply to you — and any income splitting that has occurred may need to be unwound or could attract ATO attention.

Stepping Outside the PSI Test: Genuinely Running a Business

The flip side of the PSI rules is that if you genuinely run a personal services business (PSB) — meaning you pass one of the four tests above — you can operate through a company or trust and enjoy more flexibility around income distribution.

But "genuinely running a business" has to be real. The ATO will look beyond the paperwork and ask: does this arrangement make commercial sense? Would an unrelated party on arm's-length terms receive the same distributions?

A consulting practice with genuine clients, commercial premises, and employees will likely qualify. A sole contractor who routes invoices through a spouse's company specifically to split income probably will not — regardless of how the documentation is structured.

Part II: The Section 100A Trust Crackdown

For those who operate genuine businesses through family trusts — and who genuinely pass the PSI tests — Section 100A is the more relevant risk to understand.

Section 100A applies when a trustee makes a distribution to a beneficiary as part of a "reimbursement arrangement" — essentially, where the tax benefit flows to a low-tax beneficiary but the economic benefit (the actual money) flows elsewhere.

The classic example: a trust distributes $50,000 to an adult child who is a low-income earner. The child is assessed for tax on $50,000 at a low rate. But the money never actually reaches them — instead, it stays in the family business, or is used to pay the parents' household expenses, or is "lent" back to the trust with no genuine expectation of repayment.

The ATO updated its guidance on Section 100A in 2022, narrowing what it considers "ordinary family dealings" (which are excluded from the provision) and making clear it will apply the section to arrangements that lack genuine economic substance.

What the ATO considers a reimbursement arrangement

The ATO is likely to scrutinise your trust distributions if any of the following apply:

• The distributed amount is not actually paid to the beneficiary in cash or cash equivalent
• The beneficiary's entitlement is converted to a loan back to the trust with no commercial terms
• The funds are used by another person (e.g., a parent or the trust itself) with the beneficiary's tacit agreement
• The arrangement was entered into with a dominant purpose of reducing someone else's tax liability
• There is no genuine connection between the beneficiary's lifestyle costs and the distributed amount

Reading the Risk Map

Not all income splitting is equally risky. The ATO's compliance approach is broadly risk-based: the more your arrangement departs from commercial reality, the more scrutiny it will attract.

Here is a rough guide to where arrangements tend to sit on the risk spectrum:

Lower risk

• Distributions to a spouse who genuinely works in the business at a commercially justifiable salary or distribution level
• Distributions to adult children who have their own income and actually receive and spend the funds
• Arrangements where trust loan accounts are on formal commercial terms with regular repayments
• Structures reviewed and documented by a qualified tax adviser with reference to current ATO guidance

Higher risk

• Distributing large amounts to low-income family members who contribute nothing to the business
• Distributing to a spouse who doesn't work in the business and whose entitlements accumulate as an unpaid loan
• Using a corporate beneficiary to "park" income at the 25–30% company tax rate with no genuine plan to pay it out
• Consistent patterns of distributing to the lowest-tax beneficiary each year with no documented commercial rationale
• Structures set up purely to split income with no genuine business or investment activity justifying the trust

Features That Will Attract ATO Attention

The ATO uses sophisticated data matching to identify arrangements that warrant review. Beyond the structural issues above, certain fact patterns tend to trigger closer examination:

• High-income professionals — doctors, lawyers, engineers, and consultants are specifically named in ATO guidance as common PSI risk groups
• Significant year-on-year variation in distributions — particularly if the pattern follows changes in family members' income tax positions rather than commercial drivers
• Large unpaid present entitlements (UPEs) — trust entitlements that accumulate on paper but are never actually paid out to beneficiaries
• Corporate beneficiaries with accumulated franking credits — the ATO has specific Taxpayer Alerts targeting structures that indefinitely defer income by parking it in a corporate beneficiary
• Recent restructures — particularly if a business moved from a sole trader or company structure to a trust in the last few years, specifically to enable income splitting

Are You Actually Running a Business — or Just Splitting Income?

This is the question the ATO wants you to ask yourself honestly. There is no rule against operating through a trust or company. There is no rule against paying family members who genuinely contribute to your business. And there is no rule against minimising tax through legitimate planning.

What the ATO objects to — and what the courts have consistently supported the ATO in objecting to — is using a legal structure as a fig leaf for arrangements that have no commercial substance beyond reducing someone's personal income tax.

The practical test is straightforward: if a stranger, dealing at arm's length, would not receive the same distributions in the same circumstances, the arrangement is likely to be challenged.

A Note for Existing Arrangements: Review, Don't Just Maintain

One of the most common mistakes we see is business owners who set up a trust structure years ago — when the rules were less strictly enforced or when their circumstances were different — and have simply continued without reviewing whether the arrangement still holds up.

The ATO's 2022 guidance on Section 100A applies to existing arrangements as well as new ones. You cannot rely on the fact that your accountant set this up ten years ago and the ATO never said anything. The standard for what constitutes an "ordinary family dealing" has narrowed, and distributions that were uncontroversial five years ago may now fall within the scope of Section 100A.

A Partnership Arrangement: What Genuine Looks Like

To illustrate the difference between a legitimate arrangement and a problematic one, consider two scenarios.

Scenario A: A plumbing business is run through a family trust. The husband is the licensed plumber. His wife handles all administration, invoicing, client communications, and supplier relationships — roughly three days per week. The trust distributes income to both of them in proportion to their genuine contribution. Both distributions are paid into their personal accounts and used for living expenses. The wife's distribution is commercially reasonable for the work she performs.

Scenario B: A software consultant operates through a family trust. His wife has no involvement in the business. The trust distributes $80,000 to her each year because she's in a lower tax bracket. The funds never actually reach her bank account — they accumulate as an unpaid loan on the trust's balance sheet. There is no formal loan agreement. The consultant draws his own income separately.

Scenario A is legitimate tax planning. Scenario B is exactly what Section 100A and the ATO's general compliance approach targets.

My Closing View

Income splitting through family structures is not going away — and done correctly, it remains a legal and effective tax planning strategy. But the days of setting up a trust, splitting income across family members, and treating it as a set-and-forget arrangement are well and truly over.

The ATO has made its position clear through its published guidelines, its Taxpayer Alert program, and its litigation record. Arrangements that lack genuine economic substance will be challenged — and the penalties and interest on a successful ATO assessment can be severe.

The good news is that with proper advice and documentation, there's still substantial scope for legitimate tax planning through trust and company structures. The key is to make sure your arrangement reflects commercial reality, is properly documented, and is reviewed whenever your circumstances or the relevant law changes.

If you're not sure whether your current structure would hold up to ATO scrutiny, a one-hour review with a Chartered Accountant is far cheaper than a compliance audit. Our Perth small business accounting service includes tax planning and structure reviews for sole traders, companies, and family trusts — with fixed fees agreed before any work begins.