Present entitlement can be direct, where the private company is a beneficiary of the associated target trust.
In the simplest case, a beneficiary company is made presently entitled to the income of a trust. However, the income is not actually paid to the company (creating a UPE), but used for the benefit of a shareholder or associate. In this situation, the trust will be treated as a nominal company and the benefit may be assessed as a dividend paid to the shareholder or associate.
Example 1 – Direct unpaid present entitlement
Jay is a shareholder of Trading Company Pty Ltd and both are beneficiaries of Target Discretionary Trust.
Trading Company Pty Ltd is made presently entitled to the income of Target Trust. The amount remains unpaid at the lodgment day of Target Trust's tax return for the income year. Target Trust and Trading Company Pty Ltd place the UPE on sub-trust with a legally binding investment agreement.
During the year the trustee of Target Trust made a loan to Jay. Because Trading Company Pty Ltd has a UPE with Target Trust and Jay is a shareholder of Trading Company Pty Ltd, the loan is subject to Division 7A. The loan amount may be deemed a dividend from Trading Company Pty Ltd to be included in Jay’s assessable income.
Deemed present entitlement
In some circumstances, present entitlement may be deemed. This happens where the arrangement involves a chain of UPEs through interposed trusts.
A private company is deemed to be presently entitled to trust income where:
- at least one trust is interposed between the private company and the target trust
- the company is entitled to an amount of the net income of the first interposed trust
- one of the trusts is entitled to an amount from the income of the target trust
- the entitlement to the income of the trust is mainly part of an arrangement involving entitlement to an amount from the target trust.
The company may become entitled to income before, at the same time, or after an interposed trust becomes entitled to the income of the target trust. It is taken to become entitled at the time the company becomes entitled to the net income from the first interposed trust. It doesn't matter if the company becomes entitled to the same amount.
Example 2 – Deemed present entitlement
Again, Jay is a shareholder of Trading Company Pty Ltd and a beneficiary of Target Trust.
As part of an arrangement, the Target Trust declares a present entitlement of income to Interposed Trust. In turn, the trustee of Interposed Trust exercises its discretion to make Trading Company Pty Ltd entitled to the income of the trust. These entitlements to income remain unpaid as at the lodgment day of the Target Trust's tax return for the income year.
Because of this arrangement, Trading Company Pty Ltd is deemed to be presently entitled to the income of Target Trust, for the purposes of Division 7A. So, the loan to Jay will also be subject to Division 7A.
Value of the deemed present entitlement
The Commissioner of Taxation determines the amount the private company is taken to be presently entitled to. It's limited by the amount of unpaid present entitlement that an interposed trust has in the net income of the target trust immediately before the lodgment day.
The Commissioner will consider:
- the unpaid present entitlement of the private company to the net income of the first interposed trust and any unpaid present entitlement to net income of a trust interposed between the target trust and the company as part of the arrangement
- how much (if any) of that amount represents arm’s length consideration payable to the private company by the target trust or any of the interposed trusts
- how much (if any) of the private company's unpaid entitlement to the net income of the first interposed trust is attributable to the unpaid entitlement that an interposed entity has from the net income of the target trust at that date
- amounts included in the assessable income of a shareholder or an associate of a shareholder of the private company, before the lodgment date, as a result of the company's actual present entitlement to an amount from an interposed trust.
Example 3 – Working out the value of the deemed present entitlement
Following on from Example 2, the amount of UPE of Interposed Trust to the net income of Target Trust is $50,000 and the amount of UPE of Trading Company Pty Ltd to the income of Interposed Trust is $75,000.
For the purposes of Division 7A, Trading Company Pty Ltd is deemed to be presently entitled to the income of Target Trust. The amount of the deemed present entitlement is limited to the UPE of Interposed Trust, so it will be $50,000.
Any benefits to shareholders or associates of Trading Company Pty Ltd subject to Division 7A will be limited to the amount of deemed UPE.
Example 4 – How deemed dividends affect the value
In this example, Interposed Trust has a UPE from Target Trust of $50,000 and Trading Company Pty Ltd has a UPE from Interposed Trust also of $50,000. Because it is part of an arrangement, Trading Company Pty Ltd is deemed to be presently entitled to the income of Target Trust.
In the same year, Jay receives a $5,000 loan from Interposed Trust. The loan is a non-complying loan and $5,000 deemed dividend is included in Jay’s assessable income under Division 7A.
The amount of the deemed present entitlement to Trading Company Pty Ltd is reduced by the $5,000 loan amount that is otherwise included in Jay’s assessable income. Therefore, the deemed present entitlement amount is $45,000.
See also:
- TD 2011/15 Income tax: Division 7A – unpaid present entitlements - factors the Commissioner will take into account in determining the amount of any deemed entitlement arising under section 109XI of the Income Tax Assessment Act 1936