New ATO Division 7A Guidelines – current unpaid fees and financial adjustment

On February 23, 2022, the Australian Taxation Office (ATO) released Draft Tax Determination TD2022/D1.

In effect, this signals that the ATO will administer the tax system from July 1, 2022 on the basis that trust distributions will not be effective for tax purposes unless the distributions are paid or applied for the benefit of the relevant beneficiary. or interest-bearing fixed term interest. a Section 109N loan agreement is in place.

In particular, there is a move away from sub-trusts as a means of complying with Division 7A of the Income Tax Assessment Act of 1936 (ITAA 1936). Moving to an approach that addresses all current unpaid fees (UPR) and amounts held in subtrust on behalf of private corporation beneficiaries as ordinary loans and as Division 7A duty-free taxable dividends deemed paid by the private corporation beneficiary to the entity that received the loan (in most cases, the trust), unless loan compliant Section 109N agreements are in place.

The views expressed are controversial and in some respects contradict those set out in TR 2010/3 and PSLA 2010/4. The ATO recognizes this. In any case, this is the administrative approach to be applied in the future.

While there is still some time to adjust to the proposed new directions to apply to trust rights as of July 1, 2022, there is much to consider and discussions need to take place, particularly on the how trusts can meet working capital needs in the future.

Division 7A

Division 7A of the ITAA 1936 is an anti-avoidance measure designed to ensure that private companies are not able to make tax-free distributions of profits to shareholders or partners in the form of payments, loans or canceled debts. Loans for this purpose include an extension of credit or any other form of financial housing.

The effect of Section 7A is to treat a beneficiary private corporation as having paid an unfranked dividend in an income year if it makes a loan to a shareholder or his partner in an income year. and that this loan is not reimbursed on the day of the filing of the private company. The dividend deemed unfranked is taken equal to the amount of the loan remaining unpaid on the day of deposit and is considered paid to the beneficiary of the loan (most often, the trust for PSUs and sub-trusts).

Division 7A processing of PSUs

EPUs arise when a trustee allocates trust income to a beneficiary but does not actually pay that amount to the beneficiary. This form of appointment is common practice, with PSUs commonly used as a means of funding a trust’s working capital.

TD 2022/D1 provides that a private corporation receiving an UPR by arrangement, understanding or acquiescence, consents to the trustee retaining the amount and continuing to use it for fiduciary purposes if the private corporation:

  • is aware of an amount which he can demand immediate payment from the trustee
  • does not require payment.

If so, this constitutes a financial accommodation for the trustee under Section 109D(3)(b) of the ITAA 1936 and will constitute a loan to the trust for Division 7A purposes.

Accordingly, the private company will be deemed to have paid an unfranked dividend to the trust if the amount is not repaid on the day of the company’s filing or subject to loan terms consistent with Section 109N at that time. the.

With respect to the knowledge requirement, knowledge will be presumed where the beneficiary private company and the trustee have the same directors or controllers.

Section 7A treatment of monies held in sub-trust

Where a beneficiary of a private corporation is currently entitled to trust income and the trustee sets aside that amount to be held in a subtrust for the exclusive benefit of the beneficiary, the current income entitlement is paid and there is no there is no UPE.

The beneficiary private company has a new right to call the payment of the sub-trustee and can terminate the sub-trustee.

TD2022/D1 provides that the choice of the private company not to exercise this right to terminate the sub-trust does not constitute a financial accommodation in favor of the trustee in its capacity as trustee of the sub-trust, because the sub-trust trust fund trust is held for the sole benefit of the beneficiary private corporation. However, it will constitute financial accommodation for the trust under Section 109D(3)(b) of the ITAA 1936 and will constitute a loan to the trust for Division 7A purposes if:

  • all or part of the sub-trust fund is used by a shareholder of the private company or an associate of the shareholder
  • the beneficiary private company is aware of this use, and
  • the beneficiary private company, by arrangement, agreement or acquiescence, consents to the sub-trustee authorizing the use of these funds by the shareholder of the beneficiary private company or his partner.

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.

Accordingly, the private company will be deemed to have paid an unfranked dividend to the trust if the amount is not repaid on the day of the company’s filing or subject to loan terms consistent with Section 109N at that time. the.

As with PSUs, with respect to the knowledge requirement, knowledge will be presumed where the beneficiary private company and the trustee have the same directors or controllers.

109N Compliant Loan Agreement

For a loan agreement to be a 109N-compliant loan agreement, the agreement:

  • must be made in writing and be concluded before the day of filing of private companies
  • the interest rate must be equal to or higher than the benchmark interest rate for each year it is in effect, the benchmark interest rate being the Bank’s Variable Housing Lending Rate Indicator loans interest rate last published by the Reserve Bank of Australia before the start of the income year
  • the term of the loan must not exceed the maximum term – currently seven years for most loans and 25 years if 100% of the loan value is secured by a mortgage on registered real estate in accordance with state and local laws jurisdiction where when the loan was first made, the market value of that real property (less other debts secured on it) was at least 110% of the loan amount.

What does this mean for arrangements in accordance with TR 2010/3 and PSLA 2010/4?

TD 2022/D1 signals a change from the position taken in TR 2010/3 and PSLA 2010/4 with respect to subtrusts. That is, TD 2022/D1 takes the view that sub-trust agreements will constitute a financial accommodation agreement and therefore trigger Section 7A deemed dividend liabilities in a wider variety of circumstances than TR 2010/ 3 or PSLA 2001/4 did.

Accordingly, TR 2010/3 and PSLA 2010/4 will be withdrawn effective July 1, 2022 and will have no application to trust rights arising on or after that date.

The ATO has committed not to apply compliance resources to sub-trust agreements that fall within the guidance of TR 2010/3 and PSLA 2010/4 when the right of trust is created on or before June 30, 2022 – this includes sub-trust agreements commenced on or after July 1, 2022 with respect to rights of trust arising on or before June 30, 2022.

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