ATO new approach to unpaid present entitlements and sub-trusts
The long awaited Taxation Determination on the treatment of UPEs and sub-trusts under the deemed dividend rules in Division 7A has been finalised with the publication of Taxation Determination TD 2022/11. The Determination outlines two situations where a private company will be considered to provide financial accommodation to a trustee or a shareholder and therefore a loan for Division 7A purposes. The Determination will apply to any trust entitlements arising on or after 1 July 2022.
For trust entitlements arising before 1 July 2022, taxpayers can rely on the previous Ruling (TR 2010/3) and Practice Statement (PS LA 2010/4) which have been withdrawn.
Taxation Determination TD 2022/11
The ATO has recently finalised the long awaited Determination on its approach to the application of the deemed dividend rules in Division 7A where a private company beneficiary is made presently entitled to trust income. Taxation Determination TD 2022/11 applies from 1 July 2022. While this final Determination contains no substantive changes on the previously issued Draft Determination (TD 2022/D1), it does finally provide a definitive view and certainty for taxpayers
UPE and provision of financial accommodation
Broadly, Division 7A operates to ensure that private companies cannot make tax-free distributions of profits to shareholders and their associates in the form of payments, loans or forgiven debts. Where a private company makes a loan to their shareholder or associate that is not repaid before the lodgment date of the company, then the company is taken to have made an unfranked dividend in that income year.
Under Division 7A the term “loan” has a wide meaning which includes both the provision of credit (i.e. a traditional loan) or any other form of financial accommodation. To help provide clarity for taxpayers, the ATO’s current opinion as contained in TD 2022/11 states that a private company will be providing financial accommodation to a trustee or a shareholder (and hence a loan for Division 7A purposes) in the following situations:
- Where there is an unpaid present entitlement (UPE) and the company has knowledge of an amount that it can demand, but does not do so, therefore, the company is taken to have consented to the trustee retaining that amount and continuing to use it for trust purposes.
- Where present entitlements are satisfied by a sub-trust and the company has knowledge that a shareholder or an associate is using all or part of the sub-trust fund. This will be the case whether or not the use of the sub-trust fund is on commercial terms where a return is paid to the sub-trust fund.
Relevance of directing mind and will
In addition to the above, the private company will be deemed to have the requisite knowledge (i.e. knowledge of the amount that it can demand immediate payment of) if the company and trustee (or sub-trustee) have the same directing mind and will. According to the ATO, the phrase “directing mind and will” of a private company beneficiary is not necessarily limited to its board or one or more directors. The ATO notes that case law establishes that different persons may for different purposes satisfy the requirements of being an entity’s directing mind and will. On this basis, the ATO takes the view that:
“If the same person or persons are the directing mind and will of both the relevant private company beneficiary and the trustee in respect of affairs relevant to the private company beneficiary’s UPE…[or sub-trust], then subject to sufficient evidence to the contrary the Commissioner takes the view that both the private company beneficiary and the trustee know what the other knows because they have this same directing mind and will.”
Date of effect
This new ATO approach will apply to any trust entitlements arising on or after 1 July 2022. For trust entitlements arising before 1 July 2022, taxpayers can rely on the previous Ruling (TR 2010/3) and Practice Statement (PS LA 2010/4) which have now been withdrawn. In addition, and in order to instil certainty, the Commissioner notes that he will not dedicate compliance resources to sub-trust arrangements conducted in accordance with the previously issued guidance.
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Disclaimer: The information on this page is for general information purposes only and is not specific to any particular person or situation. There are many factors that may affect your particular circumstances. We advise that you contact Mathews Tax Lawyers before making any decisions.