On 23 February 2022, the Australian Taxation Office (ATO) released a number of draft guidance documents which are relevant for private groups and high-net-wealth individuals, these include:
- Division 7A: UPEs and Sub-Trusts (TD 2022/D1), the subject of this alert;
- Trust reimbursement agreements (TR 2022/D1 and PCG 2022/D1); and
- Parents benefiting from the trust entitlements of their adult children (TA 2022/1).
Following on from the findings of the “top 500 tax performance program” report for 2021 (that only 10% of private groups taxpayers were treating tax issues “correctly”) it is unsurprising that the ATO is targeting these taxpayers with its latest draft guidance.
This alert discusses draft Taxation Determination TD 2022/D1, which provides the Commissioner of Taxation’s revised views as the circumstances when a private company will be taken to make a “loan” to a shareholder or their associate (and consequentially trigger the application of Division 7A of the Income Tax Assessment Act 1936 (Cth) (Division 7A) with respect to certain common arrangements involving trusts.
A “loan” for the purposes of Division 7A includes a “provision of credit or any other form of financial accommodation”.
The draft Taxation Determination outlines the Commissioner’s position on the breadth of the phrase “financial accommodation” and accordingly, what constitutes a loan for the purposes of applying Division 7A.
More specifically, it:
- confirms the Commissioner’s position espoused in 2010 that an unpaid present entitlement (UPE) is a form of “financial accommodation” where the private company can (but does not) demand the entitlement; and
- extends the Commissioner’s previous position as to the application of Division 7A as it relates to sub-trust arrangements.
This draft Taxation Determination (to the extent it is finalised in similar form) could have three practical implications for taxpayers, being:
- taxpayers moving away from utilising sub-trust arrangements (as they may no longer provide a material benefit);
- given the reiteration of the requirement for a private company to demand payment of a UPE before it is characterised as a loan, a review of trust deeds to ascertain the mechanisms for making a distribution in order to ensure private companies and trusts are aware of the date when financial accommodation is provided to the private company; and
- a review of existing arrangements to consider whether they may trigger the operation of Division 7A based on the views provided in the draft Taxation Determination (and what actions, if any, should be undertaken).
Importantly, there should be no change to the Commissioner’s position with respect to UPEs in existence prior to 16 December 2009 and the Commissioner will not devote compliance resources to the use of sub-trusts arrangements where the trust entitlement was created on or before 30 June 2022.
Overview of Commissioner’s views
The draft Taxation Determination provides the following:
- the phrase “financial accommodation” in Division 7A has a wide meaning and extends to cases where an entity with a trust entitlement has knowledge of an amount that it can demand and does not call for payment;
- where a private company is made presently entitled to income of a trust and either:
- the entitlement remains unpaid (and the private company has knowledge of this amount and can demand immediate payment of this amount); or
- an amount is set aside in a sub-trust and the private company (by arrangement, understanding or acquiescence) consents to utilisation of those funds by a shareholder or associate of the shareholder (whether or not on commercial terms and whether or not solely for the benefit of that private company),
this would constitute financial accommodation and therefore a “loan”.
In order for Division 7A to be triggered with respect to a loan, it is further necessary that the relevant “loan” is made to a shareholder or the private company or an associate of such a shareholder. Given that trust arrangements in the private group and high-net-wealth individual space can involve common or related parties (and given the breadth of the definition of associate in the tax legislation) it will be important for these taxpayers to carefully consider whether the provision of any such financial accommodation with respect to dealings with related trusts may in fact trigger the operation of Division 7A.
From what date will the Commissioner apply his revised views?
The draft Taxation Determination, once finalised, is proposed to apply to trust entitlements arising on or after 1 July 2022, being trust distributions made for the income year ending 30 June 2023 or later (and will replace Tax Ruling TR 2010/3 and the accompanying practical guidance of PS LA 2010/4).
This should mean that the Commissioner’s position with respect to UPEs that were in existence before 16 December 2009 should not change (which is that they fall outside the scope of TR 2010/3).
The draft Taxation Determination further provides that compliance resources will not be devoted to sub-trust arrangements that correspond to previous guidance in TR 2010/3 and PS LA 2010/4 where the trust entitlement has been created on or before 30 June 2022. For the avoidance of doubt this would include a sub-trust arrangement that commenced on or after 1 July 2022 in respect of a trust entitlement arising before that date. Accordingly, it may still be possible to put in place a sub-trust arrangement for the year ended 30 June 2022 which should not, in and of itself, attract ATO compliance activity in line with the Commissioner’s revised interpretation.
How has the Commissioner’s views changed?
The Commissioner’s view as to the whether a UPE constitutes the provision of “financial accommodation” is consistent with the Commissioner’s previously public position as contained in TR 2010/3 and PS LA 2010/4, as they apply to UPEs in existence on or after 16 December 2009.
However, the draft Taxation Determination is an extension of the Commissioner’s previous position on the application of Division 7A as it relates to sub-trusts. The previous ATO guidance construed more narrowly the circumstances where sub-trust funding would be “financial accommodation” and broadly limited it to where the funds were not being used solely for the benefit of the private company on terms where the sub-trust would not benefit from the use.
This draft Taxation Determination is the draft formalisation of the policy announcement in the 2018-19 Budget, that unpaid present entitlements (UPEs) will be subject to Division 7A rules (as currently drafted). As outlined above, it is the continuation of the ATO’s increasingly expansive view on the application of Division 7A, which serves to increase the compliance burden and reduce any ability to utilise sub-trust funds for investment purposes, for private group and high-net-wealth individual taxpayers.
With the ATO’s focus squarely on private groups and high-net-wealth individuals, we would encourage taxpayers with arrangements that may fit within the draft Taxation Determination TD 2022/D1 to review these arrangements. Please contact us for further details.