Unpaid present entitlements (UPEs) owed by a family trust to a related company may give rise to a deemed unfrankable dividend under Division 7A of Part III of the Income Tax Assessment Act 1936 (Act). One option for a trustee to avoid this outcome was to place the funds representing the UPE on a sub-trust arrangement in line with Practice Statement Law Administration PS LA PS LA 2010/4 (PS LA 2010/4).
The Commissioner of Taxation has now extended the application of Practical Compliance Guideline PCG 2017/13 (PCG 2017/13) to sub-trust arrangements maturing in the 2021 income year.Ari Armstrong, Maddocks Lawyers
Ordinarily, the UPE owed by a family trust to a related company - that would otherwise result in adverse Division 7A consequences as a deemed dividend by the company to the family trust - would be dealt with by the trustee entering into a Division 7A complying loan agreement with the company. In PS LA 2010/4, the ATO then gave trustees the option to deal with such UPEs by establishing a sub-trust for the sole benefit of the related company. The UPE is then held on sub-trust for the company and could then be lent back from the sub-trust to the main trust as an interest-only loan, rather than being deemed as a loan by the company to the trust. By doing this, the funds representing the UPE can continue to be used by the main trust and intermingled with the main trust's other funds.
On 19 July 2017, the Australian Taxation Office (ATO) released PCG 2017/13 to provide guidance to taxpayers on how to deal with these sub-trust arrangements coming to an end. The details of PCG 2017/13 are discussed in more detail in an earlier published article.
Division 7A complying loan agreements are the most common way of dealing with UPEs, as they are far more simple than a sub-trust arrangement. Under a Division 7A loan, where a UPE arises at 30 June in Year 1, the UPE will become a Division 7A loan on 30 June in Year 2 and a complying loan agreement must be entered by the next lodgement date of the company (i.e. the lodgement day for Year 2). The minimum repayment must be paid by 30 June in Year 3. The principal of the loan must be repaid by 30 June of Year 8 (if the loan is unsecured) or by 30 June of Year 26 (if the loan is secured by a mortgage over real property).
By contrast, under a sub-trust arrangement where a UPE arises at 30 June of Year 1, an investment agreement could be entered into by the lodgement of the trust return (not the company return) for Year 1. Interest on this sub-trust arrangement accrues at 30 June in Year 2 and must be paid by the trust's lodgement day for its Year 2 income tax return. When the loan from the sub-trust to the main trust matures, the main trust is required to repay the principal of the loan (i.e. the amount of the UPE) to the sub-trust.
It should be noted that the trust deed in question must expressly empower the trustee to set aside income of the trust for the exclusive benefit of one or all of the beneficiaries in order for the trustee to be able to enter into the sub-trust arrangement.
The main benefit to a sub-trust arrangement over a Division 7A loan is that, because only interest is payable until maturity (rather than principal and interest), the minimum yearly repayments will be less than under a Division 7A loan.
PS LA 2010/4 set out two 'investment options' for sub-trust arrangements, namely:
7 year sub-trust arrangements entered in the income year ended 30 June 2014, or 10 year sub-trust arrangements entered in the income year ended 30 June 2011, will have now matured and the trustees were required to repay the principal of the investment amount held in the sub-trust (i.e. the UPE) by 30 June 2021, being the end of the sub-trust term.
Consistent with updates in previous years to PCG 2017/13, the ATO has confirmed that where the principal of the sub-trust has not been repaid to the company by 30 June 2021 as required, trustees may convert the UPE to a loan that complies with section 109N of the Act (i.e. a loan with a Division 7A complying loan agreement) prior to the company's lodgement date for its 2021 income tax return, which is usually 15 May 2022.
This will provide a further period for the UPE to be paid with annual payments of both principal and interest required. However, if a Division 7A complying loan is not put in place prior to the private company's lodgement day, a deemed unfrankable dividend under Division 7A will arise.
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Revenue Practice Group.
You can read earlier ClearLaw articles on a range of matters.
You can read Practical Compliance Guideline 2017/13 here.
Qualifications: LLB (Hons), BCom, University of Melbourne
Andrew is a Partner in Maddocks Tax and Structuring team. He has significant experience in advising Australian and multinational companies, high net worth individuals, accountants and financial advisers on all areas of taxation law.
Andrew regularly provides advice on:
His advice covers both direct and indirect tax considerations.
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