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Ruling

Subject: Division 7A: trust entitlements

Question 1

Will the proposed sub-trust arrangement, to be entered into by the trustees for the main trust in relation to all post 16 December 2009 unpaid present entitlements owing to the private company beneficiary, ensure that the private company beneficiary does not provide financial accommodation to the trustees for the main trust for the purposes of the extended meaning of loan in subsection 109D(3) of the Income Tax Assessment Act 1936?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 2011

Income year ended 30 June 2012

Income year ended 30 June 2013

Income year ended 30 June 2014

Income year ended 30 June 2015

Income year ended 30 June 2016

Income year ended 30 June 2017

Income year ended 30 June 2018

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

On 17 August 2007, the trustees for the main trust acquired commercial land.

The purchase of the land and subsequent construction of the building in the 12 months to 30 June 2011 has been financed by way of:

· unpaid present entitlement ('UPE') amounts owing to an associated private company beneficiary, where those UPEs arose before and after 16 December 2009, and

· a commercial bill facility.

As at 30 June 2011, the main trust had UPEs owing to the private company beneficiary consisting of:

· a pre 16 December 2009 UPE, and

· a post 16 December 2009 UPE which arose during the income year ended 30 June 2011.

On 1 July 2011, a lease agreement has been entered into between the trustees for the main trust and an associated entity (which carries on a business under a business name) for an annual rental.

The trustees for the main trust propose to put in place a sub-trust arrangement prior to 15 May 2012 (being the lodgment due date for the main trust's income tax return) in respect of the post 16 December 2009 UPE owing to the private company beneficiary as at 30 June 2011.

The terms of the proposed sub-trust arrangement are as follows:

· Prior to 15 May 2012, the trustees for the main trust will confirm that the post 16 December 2009 UPE is held on sub-trust for the private company beneficiary pursuant to a clause of the main trust's trust deed.

· The sub-trust will be paid a percentage of the net rent and other investment income of the main trust before the interest expense applicable to the commercial bill facility is taken into account. This percentage will be equal to the proportion of the amount invested by the sub-trust compared to the other sources of funding for the main trust. This percentage return will be paid in cash to the sub-trust, and in turn to private company beneficiary by the lodgment due date for the income tax return for the main trust for each applicable income year.

· On withdrawal of the investment, the sub-trust and in turn the private company beneficiary will be paid an amount equal to the principal of the sum originally invested.

· Separate financial statements and income tax returns will be prepared for the sub-trust for each applicable income year.

It is proposed that the terms of this sub-trust arrangement will also apply to future UPEs owing to the private company beneficiary that will arise in the next three to four income years until the commercial bill facility has been repaid in full.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 109D(3), and

Income Tax Assessment Act 1936 Section 109R.

Reasons for decision

Summary

The proposed sub-trust arrangement, to be entered into by the trustees for the main trust in relation to all post 16 December 2009 unpaid present entitlements owing to the private company beneficiary, will ensure that the private company beneficiary does not provide financial accommodation to the trustees for the main trust for the purposes of the extended meaning of loan in subsection 109D(3) of the Income Tax Assessment Act 1936.

Detailed reasoning

Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements provides the Commissioner's view on when a private company beneficiary with a UPE from an associated trust will be taken to have made a loan to that trust within the meaning of subsection 109D(3), in circumstances where funds representing that UPE remain intermingled with funds of the trust.

However, it is the Commissioner's view in TR 2010/3 that a subsisting UPE (in other words a UPE in which the beneficiary has not called for payment) owing to a private company beneficiary will not be considered to be financial accommodation for the purposes of subsection 109D(3), and therefore a Division 7A loan, if funds representing the UPE are held on sub-trust by the trustee of the associated trust for the sole benefit of the private company beneficiary.

Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements provides practical guidance to tax officers on the administrative aspects of Taxation Ruling TR 2010/3.

Paragraphs 50 to 53 of PS LA 2010/4 provide guidance on when the Commissioner will consider that there is a sub-trust in place for the purposes of TR 2010/3.

50. A sub-trust may be evidenced by a resolution by the trustee to set aside the

funds representing the UPE for the sole benefit of the private company

beneficiary.

51. However, it is common for trust deeds to expressly provide that UPEs are to

be held on a sub-trust and that the trustee has wide powers to invest the

amount held in the sub-trust. The setting up of the sub-trust may therefore

happen without any requirement for the trustee to resolve to do so.

52. Subject to paragraph 54 of this practice statement, the ATO will consider the

following to evidence the existence of a sub-trust:

· where the amount representing the UPE is set aside separately in the

accounts of the main trust as being held on trust for the private

company beneficiary

· where separate accounts are prepared for the sub-trust, or

· where a separate bank account is opened in the name of the trustee as

trustee for the private company beneficiary in respect of the funds within the sub-trust.

53. Where a sub-trust has invested in a specific income producing asset or investment, as described in paragraphs 86 to 94 of this practice statement, the ATO requires the sub-trust to prepare its own separate accounts.

Furthermore paragraph 54 of PS LA 2010/4 provides guidance that it is sufficient for only one sub-trust to be created for multiple UPEs if they are owed to the same private company beneficiary.

Based on the facts provided, it is accepted that a sub-trust will be in place for the purposes of TR 2010/3 because:

· the trustees for the main trust will confirm that the existing post 16 December 2009 UPE and future total estimated UPEs are to held on one sub-trust for the private company beneficiary pursuant to a clause of the main trust's trust deed, and

· separate financial statements and income tax returns will be prepared for the sub-trust for each applicable financial year.

Whilst PS LA 2010/4 provides three specific investment options to ensure that the funds in the sub-trust are held for the sole benefit of the private company beneficiary for the purposes of TR 2010/3, guidance is provided at paragraph 57 that the Commissioner will also accept that appropriate terms of investment for the sub-trust can be determined by following the criteria set out in paragraphs 55 and 56.

55. The ATO will consider that the funds in the sub-trust are held for the sole

benefit of the private company beneficiary where:

· the trustee of the sub-trust invests the funds representing the UPE in

the main trust on commercial terms pursuant to a power as trustee to

do so, and

· all the benefits from the investment flow back to the sub-trust and the

private company beneficiary, and

· all the benefits (for example, annual return on investment) are actually

paid to the private company beneficiary by the lodgment day of the tax

return of the main-trust for the year in which the return arises.

56. For the avoidance of doubt, the annual return on investment can either be paid in cash or set off against an account owing from the private company to the main trust, but it cannot be paid by crediting it to a liability account owing to the private company from the main trust or sub-trust. The payment of the principal funds invested in the main trust (that is, the funds representing the UPE) and annual return to the private company must be such that if those payments had instead been repayments of a Division 7A loan made by a private company, they would not be disregarded by section 109R.

Based on the facts provided, the proposed sub-trust arrangement will be an acceptable arrangement for the purposes of TR 2010/3, because of the following:

· The trustees of the proposed sub-trust will invest the funds representing both the existing post 16 December 2009 UPE and the future total estimated UPEs in the main trust on commercial terms, in that the sub-trust will be paid net rent and other investment income in proportion of the amounts invested by the sub-trust compared to the other sources of funding for the main trust.

· All the benefits from the sub-trust's investment of these UPEs will flow back to the sub-trust, in that the proportional net rent and other investment income will be paid in cash to the sub-trust, and in turn to the private company beneficiary by the lodgment due date for the income tax return for the main trust for each applicable income year.

· The principal of the investments made (that is, the funds representing these UPEs) will be repaid to the sub-trust and in turn to the private company beneficiary, upon the withdrawal of those investments.

· The payments of both the benefits and the principal of the investments made would not be disregarded by section 109R, as the trustees for the main trust have not obtained and do not intent to obtain a loan or loans from the private company beneficiary of a total amount similar to, or larger than, the amount of these payments.

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