When does an unpaid present entitlement become providing 'financial accommodation'?

On 13 July 2022, the ATO released Taxation Determination TD 2022/11 on when an unpaid present entitlement (UPE) or amount held on sub-trust will be the provision of ‘financial accommodation’. The Determination, previously issued in draft earlier this year, covers when a private company beneficiary provides financial accommodation in circumstances where it is made presently entitled to income of a trust and either:

• that entitlement remains unpaid (a UPE); or
• the trustee satisfied the present entitlement by setting aside an amount from the main trust fund and holding it on a new separate trust (sub-trust) for the exclusive benefit of the corporate beneficiary.

This article outlines the Commissioner’ current approach to financial accommodation in the above circumstances using examples drawn from the Determination. The content will be relevant to financial advisers and accountants whose clients utilise trust structures, in particular the use of sub-trusts.

After initially releasing the Determination in draft as TD 2022/D1 on 23 February 2022, the Commissioner has now clarified his view on when certain trust entitlements will constitute ‘financial accommodation’, for Division 7A purposes, in the finalised Determination. For more information regarding the draft determination, see this ClearLaw Article.

The Determination applies to trust entitlements arising after 1 July 2022 and replaces the Commissioner’s previous view expressed in Taxation Ruling TR 2010/3 and Practice Statement Law Administration PS LA 2010/4.

Circumstance 1: Private company entitled to UPE

In the Determination, the Commissioner states that a corporate beneficiary with a UPE consents to the trustee retaining that amount to continue using it for trust purposes if the corporate beneficiary:

• has knowledge of an amount that it can demand immediate payment of from the trustee; and

• does not demand payment of the amount.

If both of these requirements are met, it is taken that this amounts to the provision of ‘financial accommodation’ and therefore a loan by the corporate beneficiary for Division 7A purposes.

Where the trustee and corporate beneficiary share the same directing mind and will, then the corporate beneficiary will have knowledge of the amount it can demand at the point in time when the trustee obtains this knowledge. This will typically be after the end of the income year in which the entitlement arises (i.e. in the following income year).

The Determination’s position on the timing of when a UPE will constitute a loan is a welcomed change from the more onerous position stated in the draft determination. Under TD 2022/D1, a UPE constituted a loan was dependent on how the entitlement was expressed, as follows:

• where a corporate beneficiary is 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 presently entitled to an uncertain amount of trust income (i.e. a percentage or ‘the balance’), 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 income year).

This ‘dual approach’ presented significant compliance concerns for practitioners, in particular, that the timing of when the UPE becomes a loan could have been 30 June of the year the UPE was created. The Determination, however, in response to many submissions on TD 2022/D1, which focused on this timing issue, has resulted in the Commissioner altering his position on timing and consequently provides a welcomed and streamlined approach to determining when a UPE will constitute a loan.

Circumstance 2: Present entitlement set aside in sub-trust

The Determination provides that when a trustee sets asides and holds the corporate beneficiary’s entitlement on sub-trust, this may give rise to ‘financial accommodation’, despite the present entitlement being satisfied.

The creation of the sub-trust provides the corporate beneficiary with a new right to call for payment of the sub-trust fund and can call the sub-trust to an end. However, a choice by the corporate beneficiary to not exercise this right will not, in and of itself, give rise to ‘financial accommodation’, because the sub-trust fund is held for the corporate beneficiary’s sole benefit.

The sub-trust arrangement will, however, constitute a provision of financial accommodation if the corporate beneficiary consents (express or implied) to the sub-trustee allowing the sub-trust funds to be used by or for the benefit of the corporate beneficiary’s shareholder or their associate where:

• all or part of the sub-trust fund is used by or for the benefit of that entity; and

• the corporate beneficiary has knowledge of this use,

regardless of whether the use of the sub-trust fund is on commercial terms.

This is a significant departure from the precedent set in the now-withdrawn PS LA 2010/4, which expressly 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.

Examples drawn from the Determination

Assume the following factual scenario applies to all four examples set out in this article:

• Ashley and Bo are spouses;

• Ashley and Bo have organised their family business affairs via a discretionary trust (AB Family Trust);

• Ashley and Bo control the trustee of the AB Family Trust (Trustee Ltd);

• Ashley and Bo, together with other family members and related entities are objects of AB Family Trust; and

• X Co is one such related entity and is a private company controlled by Ashley and Bo.

Example 1 - Circumstance 1: UPE

Additional Facts: On 30 June 2023, Trustee Ltd resolves that 100% of AB Family Trust’s income for the 2022-23 income year be distributed to X Co. X Co does not know the amount of trust income, if any, that it can demand immediate payment of from Trustee Ltd. On 1 August 2023, Trustee Ltd determines the net income of AB Family Trust for the 2022-23 income year as $10,000. No cash payment is made.

Application of Division 7A: X Co is taken to have made a loan to Trustee Ltd, on 1 August 2023, for the following reasons:

• Trustee Ltd, in its capacity as trustee of AB Family Trust, is in a better or more favourable position that it would have been had it been required to arrange funds for the payment of the X Co entitlement, therefore X Co has provided financial accommodation to Trustee Ltd as trustee for the AB Family Trust; and

• given both X Co and Trustee Ltd are controlled by Ashley and Bo, X Co is taken to have knowledge of the amount that it can demand immediate payment of on 1 August 2023.

Example 2 - Circumstance 2: Sub-trust

Additional Facts:In regards to the amounts resolved to be distributed to a beneficiary, the trust deed of AB Family Trust gives Trustee Ltd the power to either pay such amounts to the beneficiary or set aside and hold such amounts on sub-trust for the exclusive benefit of the beneficiary. On 1 August 2023, after determining the net income of AB Family Trust, Trustee Ltd sets aside $10,000 on sub-trust for the absolute benefit of X Co.

Application of Division 7A: No part of X Co’s entitlement is used by Trustee Ltd for the purposes of AB Family Trust, or by or for the benefit of any other shareholder or their associate. Therefore, X Co has not provided financial accommodation to a shareholder or their associate, or made a loan to Trustee Ltd, in its capacity as trustee for AB Family Trust or the sub-trust.

Example 3 – Circumstance 2: Sub-trust used by the trustee of AB Family Trust – No commercial rate of return

Additional Fact: If we assume an identical circumstance to that of Example 2, however, Trustee Ltd in this instance uses the $10,000 set aside on sub-trust for the purposes of AB Family Trust.

Application of Division 7A: X Co is taken to have made a loan to Trustee Ltd, for the following reasons:

• Trustee Ltd, in its capacity as trustee of AB Family Trust, receives a benefit from X Co, being the use of the sub-trust funds; and

• given both X Co and Trustee Ltd are controlled by Ashley and Bo, X Co is taken to have knowledge that the sub-trust is being used by Trustee for the purposes of AB Family Trust.

Example 4 – Circumstance 2: Sub-trust used by the trustee of AB Family Trust – commercial rate of return

Additional Fact: If we assume identical facts to that of Example 3, however, in this instance Trustee Ltd used the sub-trust fund for the purposes of AB Family Trust on the condition that a commercial rate of interest is paid to the sub-trust fund.

Application of Division 7A: The commercial rate of interest paid does not alter this outcome, for the same reasons as set out at Example 3, this is a provision of financial accommodation by X Co to Trustee Ltd as trustee for AB Family Trust.

Impact of the Determination

The Determination makes it clear that to ensure the provisions of Division 7A are not triggered, the trustee must act before the corporate beneficiary’s tax return is lodged, or the date it’s due to be lodged (whichever occurs first), to either:

• pay the private company its present entitlement (i.e. pay in cash or distribute assets with a market value equal to that entitlement); or

• enter into a Division 7A complying loan agreement with the corporate beneficiary.

The Determination, however, will apply exclusively to entitlements arising on or after 1 July 2022, therefore, 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.

What happens now?

In light of the ATO’s recent guidance for family groups (including new Draft Taxation TR 2022/D1 – see our ClearLaw Article), we recommend that family groups carefully review and consider their distribution strategies and Division 7A arrangements.

More information from Maddocks

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

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of topics, such as:

• Updated ATO Guidance on Unpaid Trust Entitlements And Sub-Trust Arrangements – Draft Taxation Determination TD 2022/D1

• The New Draft Section 100A Ruling is Here! What Do Trustees and Advisors Need to Know?

• Extension of PCG 2017/13 for Unpaid Present Entitlements Subject to Sub-trust Arrangements

• Action required for Unpaid Present Entitlements subject to 7 Year Sub-Trust Arrangements

Order related document packages

• Company Minutes & Resolutions Package

• Discretionary (Family) Trust set up