ATO shifts its view on Corporate Beneficiary UPEs and Division 7A

25 August 2022

The ATO has issued their finalised view on when an unpaid present entitlement (UPE) owing to a corporate beneficiary constitutes the provision of financial accommodation for the purposes of Division 7A.

This new approach applies to trust entitlements that arise on or after 1 July 2022.  

For trust entitlements that arose on or before 30 June 2022 the current approach will continue to apply.

What is the new approach? 

Division 7A ( Div 7A) of Pt III of ITAA 1936 operates to prevent private companies from making tax-free distributions of profits to shareholders or their associates by way of payments, loans or forgiven debts.

A private company will be taken to pay an unfranked dividend if it makes a loan to a shareholder or their associate and the loan is not either fully repaid before the company’s lodgment date or falls within the exclusions.

For the purposes of Div 7A, a “loan” includes a provision of credit or any other form of financial accommodation.

It is relatively common practice for trustees to distribute trust income to a corporate beneficiary.

Company beneficiary with UPE

A private company beneficiary with a UPE will provide financial accommodation to a trustee if it has knowledge of an amount that it can demand immediate payment of from the trustee and does not demand payment.

Where the company and the trustee have the same directing mind and will, the company is taken to have knowledge of the amount when the trustee does.

In this circumstance, the company is taken to have consented to the trustee continuing to use the retained amount for trust purposes.

As a result, the company provides financial accommodation to the trustee under the extended definition of a loan.

The ATO clarifies in their view that the time when a beneficiary’s entitlement is known will typically arise after the end of the financial year, that is, in the income year after the entitlement arises.

Typically, the distributable income of a trust for an income year can only be determined with sufficient certainty to quantify the amount of an entitlement when the financial statements are finalised.

Key timeline

The main difference with this new approach from the ATO, is that as of 1 July 2022, no longer are Trustees able to place the UPE arrangements initially on 7 year interest only arrangements to then extend into a further 7 year principal and interest complying loan.

Refer to the below example which highlights a potential timeline in relation to a UPE that was subsequently put on a complying loan agreement under the new revised ATO approach.

The time when the amount of a beneficiary’s entitlement is known will typically arise after the end of the income year, that is, in the following income year, in which the entitlement arises.

Therefore, UPEs arising during the 2022-23 income year may generally give rise to the provision of financial accommodation in the following year (i.e. 2023-24).

Sub-trusts to phase out

Sub-trust arrangements were often used where the amount in the sub-trust was invested in the main trust in working capital, plant and equipment, or real property acquisitions.

The interest-only feature was commercially attractive to private groups enabling trading or property trusts to finance their business or property investments on interest only terms.

While the ATO will accept sub-trust arrangements, the requirement is that the funds on sub-trust need to be held for the exclusive benefit of the corporate beneficiary, and not used by a shareholder or associate of that corporate beneficiary, including by the main trust. This means that few, if any, are likely to enter into these type of sub-trust arrangements. 

Clarification for pre-16 December 2009 UPEs   

The ATO have clarified that: 

  • taxpayers can continue to rely on the ATO’s past approach in relation to trust entitlements that arose on or before 30 June 2022 whereby such UPEs can be placed on interest only arrangements for no longer than 7 years. Presumably, these arrangements can then be converted to a complying principal and interest only loan after the initial interest only 7 year period;  and
     
  • their recent finalised view does not apply to unpaid present entitlements arising before 16 December 2009. Accordingly, these arrangements can continue where qualify, to be placed on interest free terms.

What does the final ATO release mean for you? 

  1. Where a trust declares present entitlements and either pays those in full or the UPE is discharged and placed on complying Division 7A loan terms, the effect of the finalised ATO view should be minimal.  
     
  2. Where there has been a practice of interest only sub-trust arrangements, the change in ATO views will be a material change for present entitlements arising on or after 1 July 2022.
     
  3. Care and review is required to ensure up to date year end resolutions, accounting, and loan documentation for the 30 June 2023 year to ensure compliance with the final ATO’s view on the operation of Division 7A.

Next Steps

Cooper Partners regularly advises on Division 7A and UPEs. If you have any questions about what the ATO views may mean for you and your arrangements, please contact your Cooper Partner’s engagement team to review your situation and determine what action is required.

Authors:

Michelle Saunders, Managing Director

Nicholas James, Senior Manager

This newsletter is current as of 25 August 2022, however, please note that announcements and changes are being made by the Government and the ATO regularly, and we expect that the tax and business-related responses will continue to evolve.  Before acting upon the content of this newsletter, please contact us to discuss how the above applies to your specific circumstances.

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