• Certain payments, loans and debt forgiveness by trustees (section 109UB and Subdivision EA)

    84. What are the rules that apply to trust arrangements?

    Section 109UB applied to certain trustee loans made between 4.00pm (ACT time) 27 March 1998 and 11 December 2002 (inclusive).

    Section 109UB has been repealed and replaced by Subdivision EA.

    Subdivision EA applies to certain payments, loans and forgiven debts that occur on or after 12 December 2002. The new provisions extend the operation of the former section 109UB to cover payments and forgiven debts in addition to loans.

    85. When does Subdivision EA take effect?

    Subdivision EA applies to certain trustee payments, loans and debt forgiveness made in favour of a shareholder (or associate) of a private company on or after 12 December 2002. The rules are however subject to the following requirements regarding unpaid present entitlement.

    • For the period 12 December 2002 to 18 February 2004 - the private company must be presently entitled to an amount from the net income of the trust estate at the time the payment, loan or debt forgiveness occurs and the whole of that amount has not been paid to the company before the 'lodgment day'.
    • For transactions on or after 19 February 2004:

    (a) the private company must be presently entitled to an amount from the net income of the trust estate at the time the payment, loan or debt forgiveness occurs and the whole of that amount has not been paid to the company before the 'lodgment day', or

    (b) the private company become presently entitled to an amount from the net income of the trust estate after the payment, loan or debt forgiveness occurs, but before the 'lodgment day', and the whole of that amount has not been paid to the company before the 'lodgment day'.

    However, Subdivision EA does not apply in all cases where there is an unpaid present entitlement. See question 86.

    The 'lodgment day' is the earlier of the due date for lodgment and date of lodgment of the trustee's tax return for the income year in which the payment, loan or debt forgiveness occurs. If the Commissioner has deferred the due date for lodgment of the tax return then the due date for lodgment is the deferred due date.

    From 1 July 2009 Subdivision EA can apply to deemed payments and notional loans. Subdivision EB was introduced to ensure that the operation of Subdivision EA cannot be circumvented by interposing an entity between either the trust making a payment or loan to a shareholder (or their associate) or between a trust and the private company that holds an unpaid present entitlement to an amount from the net income of the trust.

    Where an entity is interposed between a trust and the shareholder (or their associate), the trust will be treated as having directly paid or loaned an amount to the shareholder (or their associate) for the purposes of Subdivision EA where a reasonable person would conclude that the trustee made the payment or loan to the interposed entity as part of an arrangement involving the shareholder (or their associate).

    If a reasonable person would conclude that a private company is entitled to an amount from a trust estate that is interposed between the private company and a trust (target trust) making a payment, loan or forgiveness of debt to a shareholder (or their associate) as part of an arrangement involving that target trust, the private company is taken to be entitled to an amount from the net income of the target trust.

    86. Are all unpaid present entitlements of private companies relevant for Subdivision EA purposes?

    No. Subdivision EA does not apply in respect of all unpaid present entitlements.

    For the purposes of Division 7A 'loan' has an extended meaning and in addition to including ordinary loans a 'loan' is defined to include the provision of credit or any other form of financial accommodation and transactions that in substance effect a loan of money.

    If a private company beneficiary, in respect of its unpaid present entitlement arising after 15 December 2009, provides financial accommodation to the trustee of a trust, or enters into a transaction with the trustee of a trust which in substance effects a Division 7A loan, it will be taken to make a loan to the trustee of the trust for Division 7A purposes.

    The ATO will not treat any unpaid present entitlement arising after 15 December 2009 that is considered to constitute a loan as a present entitlement that remains unpaid for Subdivision EA purposes in situations where the trustee is a shareholder or an associate of a shareholder of the private company. As a result Subdivision EA has no application in respect of such an unpaid present entitlement. For more information refer to Taxation Ruling TR 2010/3.

    87. What is meant by net income?

    Net income means the income less expenses of the trust for the income year as determined by the trustee in accordance with the trust deed and applicable accounting standards.

    88. What happens if Subdivision EA applies?

    If Subdivision EA applies, an amount is included, as if it were an unfranked dividend, in the assessable income of the shareholder or associate.

    The amount of the dividend is limited to the private company's distributable surplus.

    A franking debit does not arise to the franking account of the private company.

    The Commissioner has a discretion to disregard a deemed if that dividend arises because of an honest mistake or inadvertent omission. This discretion, although a June 2007 amendment, applies in relation to the 2001-02 and later income years. The Commissioner may make the decision subject to specified conditions. See questions 17 to 22.

    (See section 109XB.)

    89. How is the amount of the payment, loan or debt forgiveness worked out?

    The amount of the loan, payment or debt forgiveness is the lesser of:

    • the amount paid, loaned or forgiven, and
    • the unpaid present entitlement less amounts that have previously been taken to be dividends under Subdivision EA or taken to be loans under section 109UB, but only to the extent that those amounts relate to the unpaid present entitlement.

    (See subsection 109XA(4).)

    90. What happens if a loan made by the trustee has been treated as a dividend and the debt is subsequently forgiven?

    From the 2009-10 income year, a debt will not be treated as a dividend where the debt that has been forgiven results from a loan from a trustee that has been treated as a dividend under Division 7A.

    (See section 109XD.)

    91. How is the deemed dividend determined under Subdivision EA?

    The deemed dividend is determined by treating the trust as a private company for Division 7A purposes.

    This is achieved through the hypothesis contained in section 109XB. Section 109XB provides that an amount is included in the assessable income (as if it were a dividend) of the shareholder or associate if that amount, referred to as the 'Division 7A amount', would have been included in assessable income had:

    • the actual transaction (that is, the payment, loan or forgiven debt provided by the trustee) been made by a private company, and
    • the shareholder (or their associate) been a shareholder of that company at the time of the actual transaction.

    To enable Division 7A to apply, the general operation of Division 7A is modified by section 109XC.

    The amount of the dividend is limited to the private company's distributable surplus.

    From 1 July 2009 amounts that have been included in the assessable income of a shareholder (or their associate) under section 109XB are taken into account in the distributable surplus formula. The amounts are taken into account when determining the amount of non-commercial loans in the formula.

    Where an amount is included in the non-commercial loan calculation it will be reduced by the total of the unfranked parts of any later dividends received by the shareholder which have been offset and the later dividend rules apply.

    (See sections 109XB,109XC and 109Y.)

    92. Does Subdivision EA apply to all payments?

    Not all payments are affected.

    A payment is only affected if it is attributable to an unrealised gain (for example, capital profits reflected in an asset revaluation reserve) and the payment discharges a present entitlement due to the shareholder or associate by the trust. There is an exception, however, for payments that are loan repayments made as part of certain loan back arrangements related to the distribution of an unrealised gain. See question 93.

    If a payment is only partly attributable to an unrealised gain, then only the part attributable to the unrealised gain is subject to Subdivision EA.

    A trustee may nominate whether a payment is attributable to an unrealised gain. However, if a payment is nominated as being attributable to a realised gain and there are insufficient realised gains to fund the payment, the excess will be treated as from an unrealised source.

    (See subsection 109XA(1), subsection 109XA(1A) and subsection 109XF(3).)

    93. Does Subdivision EA apply to loan repayments made by a trustee to a shareholder (or their associate) on or after 1 July 2009?

    Certain loan repayments can result in a deemed dividend as these repayments are now payments to which Subdivision EA can apply. The condition that the payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain is disregarded if:

    • during a previous year of income the trustee made a payment to the shareholder (or their) associate and Subdivision EA had applied because of the payment (the original transaction), and
    • the shareholder (or their associate) made a loan or loans to the trustee on or after 1 July 2009, and
    • either:
      (i) a reasonable person would conclude (having regard to all the circumstances) that at the time the original transaction took place the shareholder (or their associate) intended to make the loan or loans to the trustee, or
      (ii) the shareholder (or their associate) made the loan or loans to the trustee before the time the original transaction took place and a reasonable person would conclude (having regard to all the circumstances) that the trustee obtained the loan or loans in order to make the payments, and
    • the payment made is applied to repay all or part of the loan or loans.

    The law was amended to bring these loan repayments within the scope of Subdivision EA because taxpayers had been entering into arrangements to circumvent the operation of Division 7A.

    The schemes typically involved:

    • an asset revaluation and the payment made to the shareholder that was attributable to the unrealised gain significantly exceeded the unpaid present entitlement held by the private company
    • the shareholder (or their associate) loans back to the trust the amount of the payment that exceeds the unpaid present entitlement held by the private company
    • in subsequent years the trustee declares an unpaid present entitlement to the private company that remains unpaid
    • the trustee making loan repayments to the shareholder (or their associate), a payment that was no longer a discharge or, or a reduction in, a present entitlement that is attributable to an unrealised gain.

    (See subsections 109XA(1), 109XA(1A) and 109XA(1B).)

    94. Is the creation of a present entitlement to the capital or income of the trust a payment?

    No. The creation of a present entitlement to the capital or the income of the trust in favour of the beneficiary or private company is not taken to be a payment.

    (See subsection 109XA(6).)

    95. What if the unrealised gain will or has been included in the trust's assessable income?

    Even if a payment does discharge or reduce a present entitlement that is attributable to an unrealised gain, it will not give rise to a dividend to the extent the unrealised gain has been or will be included in the trust's assessable income for:

    • a year of income before the year in which the payment is made
    • the year of income in which the payment is made, or
    • the year of income following the year in which the payment is made.

    (See subsection 109XA(7).)

    96. What happens under Subdivision EA if a loan is repaid?

    If a loan is repaid before the earlier of the due date for lodgment and date of lodgment of the trust's tax return for the income year in which the loan is made, the loan will not be treated as a dividend.

    However, a repayment will not be counted if at the time it is made there is an intention to obtain a loan from the trust of an amount similar to or larger than the repayment. From 1 July 2009, a repayment will not be counted if in order to make the payment the entity obtained a loan from the trust of an amount similar to or larger than the repayment.

    97. Can a loan be made under a written agreement so that Subdivision EA will not apply?

    Yes, if the written loan agreement meets the requirements covered in questions 44 to 59 (Loans made under written agreements), then Division 7A will not apply in respect of the loan in the income year.

    The written agreement must be between the trustee and the shareholder (or shareholder's associate).

    98. When must the written loan agreement be in place?

    The agreement must be in place before the earlier of the due date for lodgment or the date of lodgment of the trust's tax return for the year of income in which the loan is made.

    99. What types of loan repayments will be taken into account when calculating how much of a loan has been repaid or whether the minimum yearly repayment has been made?

    There is a modified application of the rules that apply to private companies. See question 80 (Loan repayments not taken into account) for the rules that apply to private companies.

    Prior to the law being amended with effect from 1 July 2009 the following types of payments (set offs) were not taken into account if subsection 109R(2) applied:

    • work and income support related withholding payments and benefits payable to the recipient of the loan
    • payments covered by section 12-55 in Schedule 1 to the Taxation Administration Act 1953.

    From 1 July 2009 they can be taken into account even if there was an intention to obtain a loan similar to or larger than the payment.

    (See section 109R and subsection 109XC(6) and (8).)

    100. What is the tax treatment of a dividend (the later dividend) distributed by a private company, if some or all of the later dividend is set off against amounts that have already been included in assessable income under Subdivision EA?

    For the 2009-10 and later income years, later dividends that are set off against some or all of a trustee loan amount that has been taken to be a dividend under section 109XB will be excluded from shareholders (or their associates) assessable income to the extent that the dividend is unfranked.

    Later dividends which are offset can be either fully or partly franked. The later dividend, to the extent that it is franked, remains assessable income (and a dividend). This means that the franking credit attached to the dividend is still available to the shareholder.

    (See section 109ZCA.)

    101. If Subdivision EA applies, will a dividend be taken to arise if the trustee pays over the present entitlement to the private company and it is then loaned back to the trust?

    The rules applying to trust arrangements will not apply. However Division 7A may still apply to treat the loan as a dividend under the general rules. For example, if a private company loans the amount back to the trust and the trustee is an associate of a shareholder of the private company.

    (See the definition of 'associate' in sections 109ZD and 318.)

    102. Can the circumstances described in the previous question be effected by journal entries?

    Yes. This is provided the journal entries represent underlying transactions that convert the parties' relationship regarding the amount from a fiduciary relationship to a debtor-creditor relationship.

    Employee remuneration

    103. Does Division 7A apply to salary and wages or superannuation contributions paid by a private company to a shareholder or shareholder's associate in their capacity as an employee or associate of an employee?

    No. Division 7A does not apply to a payment made by a private company to a shareholder or shareholder's associate in their capacity as an employee or associate of an employee. This includes payments made by way of salary and wages or superannuation contributions.

    (See subsections 109C(3) and 109ZB(3).)

    104. Does Division 7A apply to fringe benefits provided by way of a 'payment' by a private company to a shareholder or shareholder's associate in their capacity as an employee or associate of an employee?

    No. Division 7A does not apply to a payment made by a private company to a shareholder or shareholder's associate in their capacity as an employee or associate of an employee. This includes fringe benefits provided by way of a 'payment' in the form of a transfer of property.

    (See subsections 109C(3) and 109ZB(3).)

    105. Does Division 7A apply to a loan if the amount is lent by a private company to a shareholder or shareholder's associate in their capacity as an employee or an associate of an employee?

    A loan made by a private company to a shareholder or their associate may be treated as a dividend under Division 7A, even if:

    • the loan is made to the shareholder or their associate in their capacity as an employee or an associate of an employee, or
    • the loan is made in respect of the employment of an employee.

    FBT does not arise in relation to loans that are treated as deemed dividends under Division 7A.

    From 1 April 2007, if a loan is put on a qualifying commercial footing meeting the minimum interest rate and maximum term criteria to be an excluded loan under Division 7A, FBT will also not apply to that loan even if the FBT benchmark rate of interest is not met.

    106. Does Division 7A apply to a debt forgiveness if the amount is forgiven by a private company in favour of a shareholder or shareholder's associate in their capacity as an employee or an associate of an employee?

    A forgiveness of debt by a private company in respect of a debt owed by a shareholder or an associate of a shareholder may be treated as a dividend under Division 7A, even if:

    • the shareholder or their associate owed the debt in their capacity as an employee or an associate of an employee, or
    • the forgiveness occurs in respect of the employment of an employee.

    FBT does not apply because forgiven debts treated as dividends paid to a shareholder or their associates are excluded from the definition of fringe benefit.

    107. Can FBT apply if the amount of the loan or debt forgiveness exceeds the amount taken to be a dividend under Division 7A?

    No. A loan or debt forgiveness that is taken to be a dividend under Division 7A is excluded from the definition of a 'fringe benefit', even if the amount of the loan or debt forgiveness exceeds the amount taken to be a dividend. Therefore, any excess amount of the loan or debt forgiveness will not be treated as a fringe benefit.

    For example, if a loan is taken under subsection 109D(1) of the ITAA 1936 to be a dividend but the private company's distributable surplus is nil, the amount of the dividend is reduced to nil under subsection 109D(3). However, the private company is still taken under Division 7A to pay the shareholder or shareholder's associate a dividend and so no FBT is payable in respect of the loan.

    (See section 109Y, subsections 109ZB(1) and 109ZB(2), and paragraph (r) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA.)

      Last modified: 14 Sep 2010QC 16852