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  • Trust reimbursement agreements and unpaid present entitlements – draft guidance

    A package of draft advice and guidance products released for further consultation in February 2022 sets out our evolving view on the tax treatment of:

    • trust entitlements arising out of reimbursement agreements
    • unpaid present entitlements (UPEs) of trust beneficiaries.

    On this page

    The draft products

    The following draft products have been released for public consultation:

    We have also published Taxpayer Alert TA 2022/1 Trusts: parents benefitting from the trust entitlements of their children over 18 years of age 

    The products are being released together as a package because of the overlap of the subject matter – the tax treatment of entitlements to certain amounts from private trusts.

    The draft guidance sets out the ATO's preliminary but considered views on the interpretation of the relevant law, as well as guidance on how the ATO will administer the ATO view as expressed in the draft products. We have included explanations of proposed transitional arrangements to support clients to adjust their tax affairs to comply with the draft guidance once it is finalised.

    Why the products are needed

    These products have been developed in response to submissions by tax advisers and their clients that they need greater certainty, through ATO public advice and guidance, to meet their tax obligations on the matters covered by the products.

    The products address the situation when certain trust distributions may attract the operation of section 100A or Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

    The guidance will be relevant to any trustee (or controller) of a closely trust that may:

    • have concerns about whether the trust anti-avoidance provision in section 100A may apply when trust income is distributed to relatively favourably taxed beneficiaries, but the benefits of that income are enjoyed by others
    • intend to, or have in the past, made a private company beneficiary presently entitled to trust income but not paid the amount on the basis that the amount is held in a sub-trust for the benefit of the private company and the arrangement avoids the application of Division 7A .

    The vast majority of small businesses operating through a trust will not be affected by this public advice and guidance. If you have a reimbursement agreement in place or Division 7A applies, we encourage you to engage with your registered tax professional if you need further clarification or guidance on how these may affect you.

    The existing view on sub-trust arrangements has become difficult to maintain over time. It is unsupported by what we now understand to be the operation of the law and subsequent judicial decisions, and the practical administration of the position has the effect that the ATO’s ability to collect tax which has become due is impeded. To continue to adhere to existing guidance could result in unintended administrative impacts.

    TR 2022/D1

    Section 100A is an anti-avoidance rule that applies where lower or concessionally taxed beneficiaries of a trust are made entitled to trust income by the trustee, while the income is enjoyed by another person who would otherwise have had to pay more income tax if they were made entitled to the trust income.

    When the rule applies, the trustee (and not the beneficiary) is liable to tax on the income at the top marginal rate.

    Section 100A does not apply to arrangements entered into in the course of 'ordinary family or commercial dealings' or where no party to the arrangement has a tax avoidance purpose.

    TR 2022/D1 provides the Commissioner’s sought-after views on these concepts, for which there is limited judicial guidance. It will meet strong community demand for advice and guidance on this topic and, in particular, the ordinary family or commercial dealing exception.

    PCG 2022/D1

    We recognise that it is critical to give practical certainty about how the Commissioner will dedicate compliance resources to cases where section 100A may potentially apply. Section 100A is expressed in broad terms, and there is an unlimited period in which the Commissioner can amend assessments under section 100A. PCG 2022/D1 outlines what arrangements will attract our attention, and which arrangements are of low risk where we will not seek to apply compliance resources.

    When PCG 2022/D1 is finalised, it will set out our compliance approach in relation to beneficiary entitlements conferred on or after 1 July 2022.

    For beneficiary entitlements conferred before 1 July 2022, the administrative position outlined in Trust taxation – reimbursement agreement (July 2014) will continue to apply.

    TD 2022/D1

    Division 7A is an integrity provision that aims to prevent tax-free distributions of profits of private companies to their shareholders. A loan (including any form of ‘financial accommodation’) provided by a private company to its shareholder or shareholder's associates will, subject to specific exceptions, be included as a dividend in the shareholder’s or associate's assessable income.

    Our view in TD 2022/D1 is that a private company with unpaid trust entitlements (UPEs) will broadly provide financial accommodation to anyone the company allows to have access to the amounts to which they are entitled (whether or not they pay interest or other compensation). As a result, Division 7A can apply. The position taken in this draft determination is the ATO's considered view on when outstanding trust entitlements will be 'financial accommodation' for the purposes of Division 7A.

    The key consequence of our view in TD 2022/D1 is that, for UPEs made for the income year ending 30 June 2023 or later, taxpayers will need to consider the operation of Division 7A when putting in place any sub-trust arrangements set out in Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements. Specifically, in order to avoid Division 7A applying to deem the loans to be deemed dividends, taxpayers will need to consider making them Division 7A complying loans. For most taxpayers, the practical impact will be a switch from arrangements requiring interest payments only, to principal and interest repayments, without the complexity associated with setting up a sub-trust arrangement.

    TD 2022/D1 – Transitional arrangements

    When TD 2022/D1 is finalised, it will only apply from 1 July 2022. That is, it will generally impact trust distributions made for the income year ending 30 June 2023 or later. Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements and PS LA 2010/4 will then be withdrawn. The compliance approach in the finalised determination will make it clear that we will stand by our positions in TR 2010/3 and PS LA 2010/4 for dealings with pre 1 July 2022 entitlements.

    The position taken in TD 2022/D1 is consistent with the policy announced by the government in the 2018–19 Budget – that UPEs will come within the scope of Division 7A.

    TA 2022/1

    TA 2022/1 alerts the community to our concerns with arrangements where family members who have relatively low tax rates are made presently entitled to trust income in circumstances where those members are not intended to retain any benefit.

    We emphasise that the scope of our concerns on these arrangements is not limited to section 100A, and extends to whether the arrangements are legally effective, and whether the general anti-avoidance rules in Part IVA of the ITAA 1936 may apply.

    Related information

    How Division 7A of the ITAA 1936 may apply to an UPE of a private company beneficiary to trust income where the trust and private company are related entities sharing the same directing mind and will:

    We have concerns about several arrangements involving UPEs and unit trusts that may have implications under Division 7A of the ITAA 1936:

    How a beneficiary's entitlement arising out of a reimbursement agreement may be assessed to the trustee instead of to the beneficiary:

    Last modified: 23 Feb 2022QC 67987