25 February 2022
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On 23 February 2022, the Australian Taxation Office (ATO) released the draft taxation determination TD2022/D1.
Effectively it signals that the ATO will be administering the tax system from 1 July 2022 on the basis that trust distributions will not be effective for tax purposes unless the distributions are paid to or applied for the benefit of the relevant beneficiary or an interest bearing fixed term section 109N complying loan agreement is in place.
In particular, there is a move away from sub-trusts as a means to comply with Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). The shift is to an approach that treats all unpaid present entitlements (UPEs) and amounts held on sub-trust on behalf of private company beneficiaries as ordinary loans and as deemed Division 7A unfranked assessable dividends paid by the private company beneficiary to the entity that received the loan (in most instances the trust) unless section 109N complying loan agreements are put in place.
The views expressed are contentious and in some respect at odds with those set out in TR 2010/3 and PSLA 2010/4. The ATO recognises as much. Regardless, it is the administrative approach to be applied going forward.
Although there is still some time to adapt to the new guidance proposed to apply to trust entitlements that arise from 1 July 2022, there is much to consider and discussions that need to be had, especially around how trusts may satisfy working capital requirements going forward.
Division 7A of the ITAA 1936 is an anti-avoidance measure directed toward ensuring that private companies are not able to make tax-free distributions of profits to shareholders or associates in the form of payments, loans or forgiven debts. Loans for this purpose include a provision of credit or any other form of financial accommodation.
The effect of Division 7A is to deem a private company beneficiary to have paid an unfranked dividend in an income year if it makes a loan to a shareholder or their associate during an income year and that loan is not repaid by the private company’s lodgement day. The deemed unfranked dividend is taken to be equal to the amount of the loan remaining unpaid at the lodgement day and is treated as paid to the recipient of the loan (in most cases, the trust for UPEs and sub-trusts).
UPEs arise when a trustee appoints trust income to a beneficiary but does not actually pay that amount to the beneficiary. This form of appointment has been a common practice, with UPEs commonly being utilised as a means to fund working capital of a trust.
TD 2022/D1 states that a private company beneficiary with a UPE by arrangement, understanding or acquiescence, consents to the trustee retaining the amount and continuing to use it for trust purposes if the private company:
Where this is the case, it constitutes financial accommodation to the trustee under paragraph 109D(3)(b) of the ITAA 1936 and will constitute a loan to the trust for the purpose of Division 7A.
Consequently, the private company will be taken to have paid an unfranked dividend to the trust if the amount is not repaid by the company’s lodgement day or put on section 109N compliant loan terms by that time.
With respect to the knowledge requirement, knowledge will be assumed where the private company beneficiary and trustee have the same directors or controllers.
Where a private company beneficiary is presently entitled to trust income and the trustee sets aside that amount to be held on sub-trust for the exclusive benefit of the beneficiary, the present entitlement to income is paid and there is no UPE.
The private company beneficiary has a new right to call for payment of the sub-trust fund and can call the sub-trust to an end.
TD2022/D1 provides that a choice by the private company not to exercise that right to bring the sub-trust to an end does not constitute financial accommodation in favour of the trustee in its capacity as trustee of the sub-trust, because the sub-trust fund is held for the private company beneficiary's sole benefit. However, it will constitute financial accommodation to the trust under paragraph 109D(3)(b) of the ITAA 1936 and will constitute a loan to the trust for the purpose of Division 7A if:
This will be the case even if the use is on commercial terms where a return is paid to the sub-trust for the use.
Consequently, the private company will be taken to have paid an unfranked dividend to the trust if the amount is not repaid by the company’s lodgement day or put on section 109N compliant loan terms by that time.
As with UPEs, with respect to the knowledge requirement, knowledge will be assumed where the private company beneficiary and trustee have the same directors or controllers.
For a loan agreement to be a 109N compliant loan agreement, the agreement:
TD 2022/D1 signals a shift from the position adopted in TR 2010/3 and PSLA 2010/4 with respect to sub-trusts. That is, TD 2022/D1 adopts a view that sub-trust arrangements will constitute an arrangement for financial accommodation and therefore trigger Division 7A deemed dividend liabilities in a wider variety of circumstances than TR 2010/3 or PSLA 2001/4 did.
Consequently, TR 2010/3 and PSLA 2010/4 will be withdrawn from 1 July 2022 and have no application for trust entitlements arising on or after that time.
The ATO has made a commitment not to apply compliance resources to sub-trust arrangements that correspond to guidance in TR 2010/3 and PSLA 2010/4 where the trust entitlement is created on or before 30 June 2022 – this includes sub-trust arrangements commenced on or after 1 July 2022 in respect of trust entitlements arising on or before 30 June 2022.
If you have any questions about TD2022/D1 or how it may impact you, please contact us or send us your enquiry here.
Author: Megan Bishop
Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.
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