On 13.7.22, the ATO issued Taxation Determination TD 2022/11 (TD), settling its final position on UPEs Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of ‘financial accommodation’? This is Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) and UPEs are to ‘unpaid present entitlements’. The Determination describes when a private company (company) makes a ‘loan’ under s109D(3), by giving ‘financial accommodation’ within the meaning of section 109D(3) of the ITAA 1936.
This is where that company is made presently entitled to trust income and either:
- that entitlement remains unpaid; or
- the trustee sets aside an amount from the main trust and holds it on a new separate trust (sub-trust) for the company.
Transition from 2010 to 2022 guidance
The Determination finalises TD 2022/D1 (issued on 23 February 2022) and applies to trust entitlements arising on or after 1 July 2022.
Alongside finalising the Determination, TR 2010/3 Income tax: Division 7A loans: trust entitlements and PS LA 2010/4 Division 7A: trust entitlements (2010 products) were withdrawn on 30 June 2022 and 1 July 2022 respectively, both with effect from 1 July 2022.
The ATO has advised that taxpayers may continue to rely on:
- TR 2010/3 and the Commissioner will not devote compliance resources to arrangements conducted in accordance with TR 2010/3 in respect of trust entitlements arising on or before 30 June 2022
- PS LA 2010/4 and the Commissioner will not devote compliance resources to sub-trust arrangements conducted in accordance with PS LA 2010/4 in respect of trust entitlements arising on or before 30 June 2022, even though those arrangements may commence after 30 June 2022.
Company has a UPE
The Determination explains that a company with a UPE provides financial accommodation to the trustee where it:
- has knowledge of an amount that it can demand immediate payment of from the trustee;
- consents to the trustee retaining the amount and continuing to use the funds for trust purposes; and
- does not demand payment of the amount.
This will need to be managed as a complying Division 7A loan otherwise a deemed dividend will arise for the trustee.
The Determination states that an unpaid entitlement that results in the provision of financial accommodation should be treated as a loan, rather than a UPE. This is limited to its characterisation for Division 7A purposes and does not change the character of the amount for trust law purposes.
Where the present entitlement is satisfied by sub-trust
The ATO’s view is that a company that is presently entitled to an amount set aside by the trustee and held on sub-trust, for the company’s sole benefit — where the funds are not used by the company’s shareholder or their associate (shareholder/associate) — does not provide financial accommodation.
However, the Determination states a company that is presently entitled provides financial accommodation to the shareholder/associate where:
- that amount is set aside by the trustee and held on sub-trust; and
- the company consents to those funds being used by the shareholder/associate.
This will need to be managed as a complying Division 7A loan otherwise a deemed dividend will arise for the shareholder/associate.
The Determination states that the setting aside of the amount on sub-trust for the company discharges the trustee’s obligation to pay the entitlement. Holding the amount on sub-trust satisfies the UPE.
The ATO has confirmed that the word ‘use’ takes its ordinary meaning and includes allowing the funds to be used as security in respect of financial arrangements of the shareholder/associate.
Timing rule
Sensibly, the ATO has shifted from its preliminary position in the draft Determination on when the company is taken to have knowledge of its entitlement, and consequently, when the financial accommodation is taken to be provided. The preliminary position was that the time when the company’s entitlement is known will depend on how that entitlement is expressed in the resolution.
Responding to feedback provided during consultation, including by The Tax Institute, the ATO now generally accepts that the provision of financial accommodation will typically occur after the end of the income year in which the entitlement arises.
According to the ATO, this will be the case whether the entitlement is expressed as:
- a fixed amount from the trust income;
- a percentage of trust income (or some other calculable part); or
- a combination of fixed and calculable amounts.
Evidencing a sub-trust
It may seem there is a vacuum of guidance on how to evidence a sub-trust, following the withdrawal of the 2010 products which were quite prescriptive in the type of documentation that was required and the manner of managing the arrangement.
However, it is expected that the existence of a sub-trust could be readily evidenced by holding funds on behalf of the company in a separate bank account. That said, practically, holding funds in a separate bank account is uncommon.
The ATO has advised at Issue No. 12 of the Public advice and guidance compendium (Compendium) accompanying the Determination that:
The Commissioner has rarely seen examples of sub-trusts holding non-cash assets. The outcomes of non-cash assets being held in a sub-trust can be worked through on a case-by-case basis. Private company groups that intend to put non-cash assets into sub-trusts to satisfy UPEs are encouraged to seek advice before doing so.
The ATO’s view on evidencing the existence of a sub-trust is set out at Issue No. 7.1 of the Compendium, which explains that the existence of a sub-trust depends on the trust deed and the trustee’s exercise of power in each particular case.
Generally, however, the ATO considers that most sub-trusts will be:
- a ‘Transparent Trust’ as described in Practice Statement PS LA 2000/2 An exemption for the trustees of some trust estates from the requirement to furnish a tax return on behalf of the trust estate
- able to access the concessional treatment set out in this practice statement that relieves certain trustees from the requirement to furnish a tax return.
No dual layer of financial accommodation
An issue was raised during consultation that Division 7A could potentially apply twice to a single arrangement in instances where an amount is held on sub-trust and the funds are used by a shareholder/associate.
However, there were concerns that the arrangement would constitute the provision of financial accommodation by the company in favour of the sub-trustee. This would be in addition to the financial accommodation already provided by the company to the shareholder/associate.
The Determination pleasingly makes the ATO’s position clear that the company does not financially accommodate the sub-trustee (in that capacity) in this circumstance. This ensures that there can be no dual layer of financial accommodation for Division 7A purposes in respect of a single arrangement.
Treatment of pre-16 December 2009 UPEs
Based on feedback provided during consultation, and consistent with the 2010 products, the Determination makes it clear that it does not apply to UPEs arising before 16 December 2009.
Accordingly, UPEs arising before 16 December 2009 continue to be grandfathered and the company does not provide financial accommodation to the trustee where it does not demand payment of these UPEs. This position is welcome and provides certainty to taxpayers.
Legacy sub-trust arrangements
The position in revised PCG 2017/13 applies to legacy sub-trust arrangements created in respect of UPEs arising from the 2009–10 to 2021–22 income years (inclusive). Interest-only sub-trust arrangements set out in Option 1 and Option 2 in withdrawn PS LA 2010/4 may continue until maturity and remain eligible for managing any unpaid principal on maturity as a complying Division 7A loan. This allows a further period for the amount to be repaid with periodic payments of principal and interest.
The updated PCG has a legacy impact for UPEs arising during 2021–22 until the maturity of the sub-trust arrangement, generally:
- 14 May 2030 (Option 1)
- 14 May 2033 (Option 2).
Further, if on maturity the principal amount is not fully repaid, the outstanding amount can be placed on complying loan terms, with the liability for the first minimum yearly repayment under the new 7-year complying loan arising on:
- 30 June 2031 (Option 1)
- 30 June 2034 (Option 2),
and the entire arrangement concluding by 30 June 2037 and 30 June 2040 respectively.
Little benefit is to be gained from implementing a sub-trust arrangement for UPEs arising on or after 1 July 2022 as — except where the funds are held on sub-trust for the company’s sole benefit — they will generally be treated as loans for Division 7A purposes.
What is the legacy of Subdivisions EA and EB?
These provisions have no application where there is no UPE.
The Determination states that a UPE that is treated as a loan is regarded as a loan for all purposes of Division 7A, including Subdivision EA. The Commissioner will not treat a UPE in those circumstances as a present entitlement that remains unpaid for Subdivision EA (and EB) purposes.
The Determination goes on to say that where a company is presently entitled and the trustee satisfies that UPE by holding it on sub-trust for the sole benefit of the company, the present entitlement is paid and there is no UPE. In these circumstances, the conditions for Subdivision EA (and EB) to operate are not satisfied.
However, it follows that Subdivision EA (and EB) may continue to apply where the UPE:
- arose before 16 December 2009
- arose on or after 16 December 2009 but on or before 30 June 2022 and is held on sub-trust in accordance with PS LA 2010/4
- arises on or after 1 July 2022 but does not constitute the provision of financial accommodation — for example, where the company does not have knowledge of the amount that it can demand immediate payment of from the trustee at the relevant time, in which case the amount continues to be a UPE and is not taken to be a Division 7A loan.
[This article appeared in the Tax Institute’s 15.7.22 TaxVine email, and was written by their Senior Advocate: Robyn Jacobson, CTA]
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