Practical Compliance Guideline

PCG 2017/13

Division 7A - PS LA 2010/4 sub-trust arrangements maturing in or after the 2016-17 income year

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What this Guideline is about

1. This Guideline applies to a private company (or trustee^[1]) beneficiary of a trust and sub-trust where the trustee:

•

has, in accordance with Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements (now withdrawn), validly adopted either investment Option 1^[2] or investment Option 2^[3] to place funds representing a UPE under a sub-trust arrangement on a 7-year or 10-year interest-only loan respectively with the main trust, and

•

does not repay the principal of the respective 7-year or 10-year interest-only loan when it matures in the 2016-17 income year^[4] or a later income year.^[4A]

When this Guideline applies

2. This Guideline only applies where a UPE:

•

arose on or before 30 June 2022^[4B], and

•

has been dealt with in accordance with either investment Option 1 or investment Option 2, as described in paragraph 1 of this Guideline.

Background - Division 7A and UPEs

3. Division 7A of Part III of the Income Tax Assessment Act 1936 contains integrity provisions that aim to prevent tax-free distributions of private company profits to shareholders and their associates.

3A. All legislative references in this Guideline are to the Income Tax Assessment Act 1936.

4. Broadly speaking, it does this by deeming a private company to have paid a dividend^[6] to a shareholder, or shareholder's associate, if it makes a loan to the shareholder or associate and that loan is not repaid in full or put on complying terms^[7] before the private company's lodgment day.^[8]

5. For the purposes of Division 7A, a 'loan' includes the provision of credit or any other form of financial accommodation.^[9]

6. Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements (now withdrawn) contains the Commissioner's former view of how Division 7A applies where a private company beneficiary has, or had, a present entitlement to an amount of income from an associated trust that is part of the same family group as the private company.

7. Relevantly, TR 2010/3 stated that a UPE that has not been satisfied from a trust to a private company beneficiary in the same family group is the provision of financial accommodation and therefore a 'loan' where:

•

the trustee continues to use the funds representing the UPE for trust purposes, and

•

the company does not call for either

-

payment of the UPE, or

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the investment of the funds for the company's sole benefit (rather than their use for the benefit of the trust).^[10]

7A. On 13 July 2022, the Commissioner issued Taxation Determination TD 2022/11 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'?. This Determination describes when a private company beneficiary made presently entitled to income of a trust provides financial accommodation. It replaces both TR 2010/3 and PS LA 2010/4 in respect of trust entitlements arising on or after 1 July 2022.

7B. Taxpayers will be able to continue to rely on both TR 2010/3 and PS LA 2010/4 for trust entitlements arising on or before 30 June 2022.

Administrative guidance in PS LA 2010/4

8. PS LA 2010/4 provides guidance on the administrative aspects of TR 2010/3, including where the UPE funds remain intermingled with funds of the trust but are claimed to be held on sub-trust for the sole benefit of the private company beneficiary.

9. For arrangements in respect of which it continues to apply, PS LA 2010/4 states that the Commissioner will consider that the UPE funds in the sub-trust are held for the sole benefit of the private company beneficiary if they are lent to the main trust under either a 7-year interest-only loan or under a 10-year interest-only loan with the principal of the respective loan repayable at the end of the 7-year interest-only loan (investment Option 1) or at the end of the 10-year interest-only loan (investment Option 2).^[11]

10. A trustee adopting either investment Option 1 or investment Option 2 must document the terms of the investment agreement and the investment agreement must be legally binding. The terms of the investment must include the obligation to repay the principal of the loan at the end of the term.^[12]

Obligation to repay the principal of the loan, entered into under either investment Option 1 or investment Option 2, is not met at the end of the loan term in the relevant income year

11. Those trustees who adopted investment Option 1 or investment Option 2 will, under the terms of the investment agreement, be obligated to repay the principal of the loan in the 2016-17 or a subsequent income year, whichever is applicable. PS LA 2010/4 makes it clear that to comply with either investment Option 1 or investment Option 2, the trustee must actually repay the principal of the loan at the end of the loan term and meet this term of the investment agreement.^[15]

12. The Commissioner maintains the clear expectation that this term of the respective investment agreements be met and that the principal of the loan, entered into under either investment Option 1 or investment Option 2, must be repaid at the end of the loan term.

13. If the trustee fails to meet this term of the investment agreement, when an investment Option 1 or Option 2 matures, any unpaid principal of the loan will be treated by the Commissioner as the provision of financial accommodation and therefore a Division 7A loan.

14. If all, or part, of the principal of the loan is not repaid on or before the date of maturity, the Commissioner will accept that a 7-year loan on complying terms in accordance with section 109N may be put in place between the sub-trust and the private company beneficiary prior to the private company's lodgment day. This will provide a further period for the amount to be repaid with periodic payments of both principal and interest.

15. However, if such a 7-year loan on complying terms in accordance with section 109N is not put in place between the sub-trust and the private company beneficiary prior to the private company's lodgment day, a deemed dividend will arise at the end of the income year in which the loan matures (to the extent that it remains unpaid).

16. The following tables outline the key dates of which the relevant parties to sub-trust arrangements under this Guideline (where the investment Option 1 or Option 2 is not repaid by the relevant due date) must take note.

The following table outlines the key dates that the relevant parties must note where the investment Option 1 is not repaid by the due date in the relevant income year.

Table 1: investment Option 1 not repaid on maturity

The following table outlines the key dates that the relevant parties must note where the investment Option 2 is not repaid by the due date in the relevant income year.

Table 2: investment Option 2 not repaid on maturity

17. [Omitted.]

18. The Commissioner will not accept that the rolling over of all or part of either the investment Option 1 or the investment Option 2 that is not repaid into a further investment option described in PS LA 2010/4 will prevent the provision of financial accommodation to which Division 7A may apply. Consequently, the approach in PS LA 2010/4 will cease in respect of existing (original) sub-trust arrangements at the time either the investment Option 1 or the investment Option 2 matures.

19. Where the facts and circumstances indicate that there has never been an intention to repay the principal of the loan at the end of either the 7-year interest-only loan or the 10-year interest-only loan, the sub-trust arrangement was not entered into in accordance with PS LA 2010/4 and this may lead the Commissioner to consider that the purported arrangement was a sham, and/or that there was fraud or evasion. In these circumstances, the Commissioner may go back beyond the standard period of review^[16] and deem a dividend in the income year in which the provision of financial accommodation originally arose.

Application of section 109R to complying loans entered into after maturity of sub-trust arrangements

20. Section 109R can apply in some circumstances to not treat a payment as a repayment of a loan for Division 7A purposes.

21. The Commissioner will not seek to apply section 109R to the principal of a loan under a sub-trust arrangement that is not repaid and is the subject of a 7-year loan on complying terms under section 109N in accordance with this Guideline. Commissioner of Taxation 19 July 2017

Amendment history

© AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA

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ATO references: File 1-BQE1QD6

Business Line:  PW

Related Rulings/Determinations:
TR 2010/3
TD 2022/D1

Legislative References:
ITAA 1936 109D
ITAA 1936 109D(3)
ITAA 1936 109D(6)
ITAA 1936 109N
ITAA 1936 109R

Other References:
PS LA 2010/4