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Updated ATO guidance on unpaid trust entitlements and sub-trust arrangements - Draft Taxation Determination TD 20221/D1

The ATO has released Draft Taxation Determination TD 20221/D1 to provide the Commissioner's view on when unpaid present entitlements from trusts to private company beneficiaries will constitute loans for Division 7A purposes, including in the context of sub-trust arrangements. The new view will take effect from 1 July 2022.

Daniel Hui, Maddocks Lawyers

We have previously published articles on the topic of Division 7A, unpaid present entitlements (UPEs) and sub-trust arrangements, in particular on the release of Practical Compliance Guideline PCG 2017/13 and our update article in 2021.

The ATO has now released Draft Taxation Determination TD 20221/D1 (Draft Determination) setting out the Commissioner's updated view on when a UPE with a private company beneficiary (corporate beneficiary) is a loan for the purposes of Division 7A, including where there is a sub-trust arrangement in place.

This replaces the Commissioner's previous view expressed in Taxation Ruling TR 2010/3 (TR 2010/3), Practice Statement Law Administration PSLA 2010/4 (PS LA 2010/4), upon which Practical Compliance Guideline PCG 2017/13 was based.

What was the previous view and what does the Draft Determination change?

In TR 2010/3 and PSLA 2010/4, the Commissioner states that a UPE owing to a corporate beneficiary can constitute 'financial accommodation' and therefore is treated as a loan from the corporate beneficiary back to the trust for Division 7A purposes. The Draft Determination provides the Commissioner's updated view on the circumstances and timing of when this Division 7A loan will arise.

The Draft Determination states that a corporate beneficiary with a UPE consents to the trustee of the trust retaining the amount of the UPE and continuing to use that amount for trust purposes where the corporate beneficiary:

  • has knowledge of an amount that it can demand immediate payment of from the trustee; and
  • does not demand payment.

The Commissioner's view is that this amounts to the provision of 'financial accommodation' and therefore a loan by the corporate beneficiary to the trustee of the trust for Division 7A purposes. This loan is taken to be made at the point in time when the corporate beneficiary both has knowledge of the amount that it can demand immediate payment, and does not demand payment (see below).

Where the corporate beneficiary and the trustee of the trust have the same individual or group of individuals in control (i.e. the same directing minds), the corporate beneficiary is taken to have knowledge of the amount for which it can demand immediate payment, from the point in time when the trustee knows that amount.

The time the amount is known will depend on how the entitlement is expressed, as follows:

  • where a corporate beneficiary is made presently entitled to a fixed amount of trust income, the beneficiary is taken to have knowledge of that amount at that time; and
  • where a corporate beneficiary is made presently entitled to a percentage of trust income, the beneficiary is taken to have knowledge of the amount at the time the trust's accounts are finalised (typically after the end of the relevant income year).

Whether the distribution is expressed as a fixed amount or a percentage has an important (one year) timing impact on how Division 7A operates to the UPE.

For fixed amount UPEs, the Commissioner's updated view in the Draft Determination means the Division 7A loan arises a year earlier than the Commissioner's previous view (expressed in TR 2010/3 and PSLA 2010/4).

For example, imagine a corporate beneficiary is made entitled to a fixed amount of income at 27 June 20XX (Year 0). Under the Commissioner's new view, the UPE must be either discharged or made subject to a loan agreement on Division 7A complying terms by the lodgement date of corporate beneficiary's income tax return for the following year (i.e. in Year 1). However, for percentage UPEs, the amount of the UPE for Year 0 will only be determined in Year 1 (once the accounts for Year 0 are finalised) and therefore the UPE is only required to be either paid or made subject to a loan agreement on Division 7A complying terms by the lodgement date of corporate beneficiary's income tax return for Year 1 (i.e. in Year 2) – this timing is consistent with the Commissioner's previous view.

Sub-trust arrangements

The Draft Determination also provides that where a corporate beneficiary is made presently entitled to trust income and the trustee sets aside an amount from the main trust and holds it on sub-trust for the exclusive benefit of the corporate beneficiary, the present entitlement to income is treated as paid and there is no UPE.

The amount set aside by the trustee ceases to be an asset of the main trust and forms part of the corpus of the sub-trust. The trustee's obligation in respect of that amount comes to an end and a new obligation arises for the sub-trustee under a separate trust. Whilst the corporate beneficiary has a new right to call for payment of the sub-trust fund, the choice to not exercise that right does not constitute financial accommodation, because the amount is still held for solely for the corporate beneficiary's benefit.

A corporate beneficiary may however by arrangement (express or implied) consent to the sub-trustee allowing those funds to be used by the corporate beneficiary's shareholder or their associate (including the main trust itself) if:

  • all or part of the sub-trust fund is used by that entity, and
  • the corporate beneficiary has knowledge of this use.

The Commissioner's updated view in the Draft Determination is that this constitutes financial accommodation by the corporate beneficiary to the entity using the sub-trust fund, and therefore a loan is taken to have been provided for Division 7A purposes at that point in time. This will be the case whether or not the use of the sub-trust fund is on commercial terms.

This differs to the previous treatment of sub-trusts, which allowed the funds in the sub-trust to be invested in the main trust for a 7 or 10 year interest-only term or applied to acquire a specific income producing asset. This should however simplify compliance matters for advisors as the UPEs will either be segregated and held on sub-trust, or placed on complying Division 7A loan terms.

Application date

The Draft Determination will apply from 1 July 2022.

The Commissioner's previous view in TR 2010/3 and PSLA 2010/4 will continue to apply to UPEs arising from present entitlements existing as at 30 June 2022, including distributions made for the year ending 30 June 2022 (so there is a grace period before the Commissioner's updated view, particularly in bringing forward Division 7A loans from fixed amount UPEs, comes into effect).

The ATO will not devote compliance resources to sub-trust arrangements that correspond to the guidance in TR 2010/3 and PS LA 2010/4 where the trust entitlement has been created on or before 30 June 2022.

What happens now?

In light of the ATO's recent guidance for family groups (including new Draft Taxation TR 2022/D1 – see our new article), we recommend that family groups carefully review and consider their distribution strategies and Division 7A arrangements for the year ending 30 June 2022 (where the views in TR 2010/3 and PSLA 2010/4 continue to apply) and future income years (where the Draft Determination – presumably in final form – will apply).

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Revenue Practice Group.

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Lawyer in Profile

Daniel Hui
Daniel Hui
Lawyer
PH: 61 3 9258 3563

Daniel is a lawyer in the Maddocks Tax & Revenue team.

Daniel advises extensively in the following areas:

  • structuring of businesses and transactions;
  • mergers and acquisitions;
  • corporate reorganisations;
  • sale of businesses; and
  • joint ventures and property developments.

His advice covers both direct and indirect tax considerations.

Prior to joining Maddocks, Daniel worked at a Big Four Chartered Accounting Firm focusing on tax consulting for mergers and acquisitions.