The government has announced in the 2018/19 Federal Budget that unpaid present entitlements (UPE) will come within the scope of Div 7A from 1 July 2019. This changes the current guidance that the ATO does not see a provision of financial accommodation where a UPE is held in a sub-trust for a private company.
An "unpaid present entitlement" for the purposes of Div 7A occurs where a closely-held trust (usually a family discretionary trust) distributes income to a "bucket company". The bucket company pays tax usually at 30%, instead of the higher marginal tax rates of the individual beneficiaries.
Division 7A will apply under Subdiv EA if the trust also has a debit loan to the individual beneficiaries. As the private company will also have a debit loan to the trust, it is assumed that a provision of financial accommodation has been granted.
Also of note is when private companies do not "call" the present entitlement from the trust who allocated it to them. It was determined by the ATO on 16 December 2009 that this situation is also a provision of financial accommodation which attracts Div 7A.
Current UPE loan agreements
Under the rules allowed by the ATO from TR2010/3, a UPE can be held on sub-trust for the sole benefit to the private company. In order for Div 7A to not apply, certain provisions must be adhered to, including putting the UPE on commercial terms.
The first option granted by the ATO is for UPE's at 30 June 2010 to be put into a 7-year interest-only loan at the benchmark interest rate by 30 June 2011. Interest would be charged and payable each year, meaning that the first year of UPE's principal amounts were due to be repaid at 30 June 2018. A further option exists for the principal amount to be moved into a complying loan
The announcement is clear in that the government's intention is to put unpaid present entitlements on the same footing as a loan for Div 7A purposes. Hence, any trust distribution from a closely-held trust to a private company would commence accruing interest immediately following the distribution announcement, which is usually made on 30 June each year.
What we are unsure of at this stage is how far the measures intend to go. Also of note is the announcement to include 2016 Federal Budget measures along with this announcement as it goes through parliament. One of these measures was to simplify Div 7A loan arrangements, which may include one amalgamated loan to be paid off in 10 years.
Clients have an opportunity to get their affairs in order prior to commencement of 1 July 2019, the intended start date of any legislation.
This may include getting current UPE's into an interest-only loan, and making sure any UPE loans about to expire are included in a new loan agreement compliant with s 109N.
However, be warned and informed that major change to Div 7A laws may apply from 1 July 2019. This may include widening the scope of Div 7A to include pre-December 1997 loans. Also, the amalgamation of all loans to be repaid by a certain date may introduce a need to make larger repayments to companies from directors.
Further information will be provided when available.
Information sourced using CCH iknow