A new ATO tax ruling confirms that unpaid present entitlements from trusts to corporate beneficiaries can now be treated by the ATO as Division 7A loans. The new approach significantly broadens the range of transactions that can be taxed under Division 7A. It largely reflects the ATO’s draft ruling 2009 D8.
The change has significant implications for many people — especially those with a small business operating under a trust structure.Kate Hocking
On 2 June 2010, the ATO released a Ruling, setting out the Commissioner's views on when a private company with an unpaid present entitlement from an associated trust is considered to have made a loan to the trust within the meaning of subsection 109D(3) of Division 7A of Part III of the Income Tax Assessment Act 1936 (Div 7A).
You can access a copy of the Ruling here.
An ‘unpaid present entitlement’ is a distribution from a trust which a trustee has decided to make, but has not yet paid out. It also applies to an amount not yet paid out of a sub-trust.
Simply put, an ‘unpaid present entitlement’ arises when a trustee:
Broadly, the Ruling provides that if a private company that is the beneficiary of a trust has an ‘unpaid present entitlement’ from that trust, then the company will be considered to have made a ‘Div 7A loan’ to the trust if either:
This ruling has not materially changed from what was detailed in the draft ruling, TR 2009 D8.
Before the issue of this Ruling, the ATO's position was that ‘unpaid present entitlements’ were not treated as loans for Div 7A purposes.
You can read a brief outline of Div 7A here.
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A loan by a private company can be taxed under Div 7A in each of the following circumstances:
The Commissioner considers this is a 'loan' within its 'extended meaning' for the purposes of Div 7A.
A company is treated as knowing anything that is known to its directors. Consequently, if the same person or people are the 'directing mind and will' of both the relevant private company and the trustee in the same family group, then the company and trust will be treated as sharing the same directing mind and will.
In light of this, it is important to be mindful that (unless there is evidence to the contrary), if a trust and a private company beneficiary form part of the same family group, then the Commissioner takes the view that the private company has knowledge of the trustee crediting a loan account in its name. An example of this is described in paragraph 2 above under the heading above ‘When will an ‘unpaid present entitlement’ result in a Div 7A loan to the trust?’
The changes affect small businesses that use private companies as beneficiaries in an attempt to limit tax on trust distributions at the 30% company tax rate.
Essentially, the company:
As taxable income of the trust in tax year 2, the trustee again distributes the net income to the company as a beneficiary of the trust and the company is taxed again in tax year 2. Thus, over tax years 1 and 2 — although there has not been any actual distribution paid to the company — it has tax liabilities in both tax years.
The Ruling applies to UPEs retrospectively.
If the UPE was created before 16 December 2009, then the Ruling will not apply to circumstances outlined in paragraph 3 under the heading above ‘When will an ‘unpaid present entitlement’ result in a Div 7A loan to the trust?’
The ATO has published a Draft Practice Statement Law Administration PS LA 3362 (Draft Practice Statement) offering practical guidance on the administrative aspects of the Ruling. You can access a copy of the Draft Practice Statement here.
The Institute of Chartered Accountants has summarized the key implications set out in the Draft Practice Statement as follows:
The Draft Practice Statement does not represent the final view, or process, of the Commissioner. Even so, the ATO has advised that if taxpayers reasonably rely, in good faith, on the Draft Practice Statement to determine the tax treatment of trust distributions made in respect of the 2010 financial year, then they will be given the same protection from interest and penalties as would be the case if this was a final practice statement.
Public comment on the Draft Practice Statement was due on 25 June 2010.
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For more information, please contact Maddocks (03 9288 0555) and ask for a member of the Tax & Revenue Team in Melbourne or Sydney.
Read about the Cleardocs Division 7A Loan Agreement
Download a checklist of the information you need to order Cleardocs Division 7A Loan Agreement
 Taxation Ruling TR 2010/3
 See Ruling paragraph 9.
 Ruling paragraph 10.
 See Ruling paragraph 13.
 Ruling paragraph 11.
 Ernst & Young Tax Insight: A new landscape for the distribution of income, 16 June 2010, pg 5.
Andrew is a lawyer in the Maddocks Tax & Revenue team.
Andrew provides advice on:
His advice covers both direct and indirect tax considerations.
Prior to joining Maddocks, Andrew was a tax consultant at a Big 4 Chartered Accounting Firm.
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