On Wed 15.8.2018, the ATO released an updated version of Practical Compliance Guideline PCG 2017/13, its guidance on unpaid present entitlements (UPE) and sub-trust arrangements.
This was only to deal with UPE’s, dealt with as ‘Option 1’, 7-year interest only loans, arising from UPE’s created in the 2nd year after the 16 December 2009 grandfathering date, for UPEs. The first year, would be UPE’s in respect of the trust’s income for the year ended ended 30 June 2010. The PCG set out the relevant dates for this first tranche of affected UPEs, culminating in the 7-year loan being due for repayment on 30 June 2018 (just a few months ago).
The 2nd set of UPE’s, in that category, were for the year ended 30 June 2011, due for repayment by 30 June 2019. The Commissioner updated the PCG, to include another set of dates, for this 2nd tranche of UPE’s – those dates all being one year later than for the first tranche of UPE’s.
Before going through those dates, it would be useful if I explained the background.
The background is as follows.
- It is not uncommon for family trusts to distribute trust income, to corporate beneficiaries (also known as ‘bucket companies’), which are used to cap tax on trust income at the 30% corporate rate (perhaps now a 27.5% rate).
- Commonly these companies (like many related party beneficiaries) did not to call for payment of the income, to which they were presently entitled. Instead, they left the funds, in the trust, so that it didn’t have to deplete its capital to make the payment. They are called ‘unpaid present entitlements’ (for obvious reasons).
- This practice had dangers, though, as anti-avoidance (deemed dividend) provisions, could apply (viz: Division 7A of Part III of the ITAA36).
- People knew that a company could not afford to lend the distributed income, back to the trust, as it would almost certainly be an ‘associate’ of a shareholder, deeming the loan to be an unfranked dividend (under s109D). But, taxpayers were generally content to leave UPEs outstanding, as they were not (in their purest form, anyway) ‘loans’. There was not an advance, by the company to the trust and a promise, by the trust, to repay that money. In fact, it was the opposite, no money had travelled to the company and it might not even be aware of its present entitlement to demand payment of the trust income (for some time).
- However, the definition of ‘loan’ (in s109D(3)(b)) included giving ‘financial accommodation’ and the Commissioner (rightly) ruled that giving the trustee, interest free use of the distributed income amounts was giving the trustee ‘financial accommodation’ – and he so ruled in TR 2010/3. Indeed, the aggregate UPE amounts, over all beneficiaries, accumulating over years, could be a very significant source of the trust’s financing.
- This ‘financial accommodation’ treatment (of UPEs), however, represented a change of approach by the ATO, so the Commissioner’s ruled that this treatment would only apply prospectively, from the 16 December 2009 date, when the draft of the above ruling came out: TR 2009/D8. This was the first time that the Commissioner publicly signalling this new treatment of UPE’s. UPEs created before that date, are ‘grandfathered’ and do not have to worry about being left outstanding, so long as they aren’t booked as loans (eg. are not booked as ‘beneficiary loans’).
- A present entitlement to 2009/10 trust income, however, is not deemed to be a loan, until there is a period of ‘financial accommodation’. Effectively, the entitlement can remain unpaid until just before the end of 30 June in the following year (in this example, just before midnight on 30.6.2011). If it were still outstanding then (at 30.6.11), the corporate beneficiary/trustee would have to turn the UPE into a loan back, by the company, on terms that complied with s109N (principal and interest loan, etc) so as to exempt it from being deemed to be a ‘dividend’ (under Div 7A). They would have to do this by the time the company has to lodge its return for that 2010/11 year – say May 2012 (viz: its ‘lodgement date’, as defined).
- But the Commissioner also issued a Practice Statement: PS LA 2010/4 on how to administer his new ruling: TR 2010/3 – particularly, a ‘sub-trust’ characterisation of a UPE, that did not give ‘financial accommodation’ to the trustee. The sub-trust had to be suitably invested for the benefit of the corporate beneficiary, and Option 1′ was for the trustee (as trustee of the sub-trust) to lend the money to itself (as trustee of the main trust) on a 7-year, interest only, loan. The interest rate had to be at least equal to the ‘benchmark’ rate specified for a s109N complying loan.
- The 7-year interest only loan could be made at any time, during the year in which ‘financial accommodation was being given. But typically, this would be done before midnight on 30 June, in that first year of being left unpaid (30.6.11, in the above example).
- As a result, the first tranche of ‘non-grandfathered’ UPEs, invested in these 7-year interest only loans, were falling due for payment by 30 June 2018 (a couple of months ago).
- Nearly a year prior (on 19.7.2017) the Commissioner issued Practical Compliance Guideline PCG 2017/13, advising the trustee/corporate beneficiary parties to these loans, what they had to do by 30 June 2018. The first (and the most obvious) option, was for the Main Trust to pay back the loan, and remaining interest, no later than 30 June 2018.
- If that did not happen, the Commissioner wants to stop this ‘interest only’ arrangement going on for ever and ‘jaw bones’ taxpayers into accepting that, on failing to repay the 7-year loan (with the balance of interest), they then (30.6.18) have a deemed loan (through giving financial accommodation to the Main Trust) [para 13 of the PCG]. Quite why this must be so, in theory at least, is not clear. If the ‘interest only’, trustee to trustee – sub-trust loan, was sufficient to prevent there being any ‘financial accommodation’ over that 7 year period, it is hard to see why, rolling that loan over, for another similar loan, would not continue to be effective to prevent there being ‘financial accommodation’.
- In any event, playing by the Commissioner’s rules (as most will do), the Commissioner says that the 30 June 2018 deemed loan, can be turned into an exempt loan (principal and interest), can be recorded as on s109N complying terms, by the time when the company lodges it 2017/18 income tax return – say May 2019.
2nd ‘time-line’ for 2nd tranche of non-grandfathered UPE’s (7-year loans maturing on 30 June 2019)
The additional ‘time-line’ for the 2011 year UPEs, can be found in para 16 of the PCG. I have reproduced those dates below, with some interpolations and corrects (according to my understanding of what is correct).
- 30 June 2011 – the date at which the UPE is created.
- 15 May 2012 (or 30 June 2012) – this the date on which the trustee may (must) decide to put the UPE (sub-trust) on the 7-year interest only loan basis. 15 May 2012 is probably the last day on which the trust can lodge its 2011 income tax return (relying on a tax agent’s lodgement program). It is misleading, though, to think that the trustee must adopt an interest only loan arrangement by its lodgement day. The PS LA [para 70] is clear that this need only be done by the end of the next year (after the UPE year).
- 30 June 2013 [not 2012, as the PCG says] – this is the date on which the Main Trust’s liability to pay interest, for the first year of the 7-year loan, arises and can be booked by journal entry (for the 2012/13 year), subject to being paid, as set out below. This amount of interest must be declared as income, by the corporate beneficiary, in its 2012/13 year, and can be claimed, by the Main Trust, as a deduction, in the 2012/13 year (where the necessary income earning purposes exist).
- 15 May 2014 – The date by which the 30 June 2013 entitlement to interest must be paid by the Main Trust, to the sub-trust, and on-paid to it’s corporate beneficiary.
- 30 June 2019 – The date by which the 7-year loan must be repaid, with the final year’s interest (unlike earlier years’ interest, when up to 11 months was allowed to make payment). The ATO says that failure to repay this loan, by the 7 year date, results in a deemed loan at that time (viz: on 30 June 2019 – which is in the 2018/19 year).
- 15 May 2020 – the date by which the 30 June 2019 deemed loan, must be put on a s109N complying basis, so that it is not deemed to be a ‘dividend’. This, strictly, is the private company’s ‘lodgement day’ (as defined).
- 30 June 2020 – the date on which the liability to make the first minimum principal and interest payment arises (under the s109N terms). This assumes that the loan is made on 30 June 2019, and is only reduced to writing, adopting the complying terms, by the ‘lodgement day’ (and not, that the complying loan starts at the lodgement day). This is probably correct, looking at s109N.
[LTN 156, 15/8/18; Tax Month – August 2018]
Comprehension questions (answers available)
- Is the update, in this PCG, about UPEs created on 30 June 2011?
- Is this the second 30 June, after the grandfathering of UPEs that were created, after the 16 December 2009 start date, in TR 2010/3?
- Does a UPE created, at 30 June 2009, have to be repaid (to avoid being deemed a dividend)?
- Is a UPE a deemed loan, because it gives the trustee ‘financial accommodation’?
- Does a UPE, created on 30 June 2010, give rise to a deemed loan on 30 June 2010?
- Does the PS LA 2010/4 ‘Option 1’ basis, for making the UPE ‘sub-trust’ earn enough income, to neutralise any ‘financial accommodation’, a 7-year interest only loan?
- Does the interest on such a loan, have to be at a minimum of the s109N ‘benchmark’ rate?
- Does the obligation, to pay that interest, arise on the anniversary, of that 7-year loan?
- Can it be recorded, by journal entry, and paid later?
- When does each year’s interest have to be paid by (excluding the interest on the last year of the loan)?
- When does the interest on the last year of the loan have to be paid?
- When does the 7-year loan, on a 30 June 2010 UPE, have to be repaid?
- When does the 7-year loan, on a 30 June 2011 UPE, have to be repaid?