Edited version of your private ruling

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Ruling

Subject: Unpaid present entitlements and the application of Division 7A

Question 1

Will Division 7A apply to the unpaid present entitlements (UPEs) between the unit trust and the private company (the taxpayer), in the absence of the taxpayer taking any action regarding the UPE such as repayment or conversion to a complying Division 7A loan for:

• the UPE arising during the year ended 30 June 2010?
• the UPE arising during the year ended 30 June 2011 and later income years?

Advice/Answers

No.

Question 2

Does the Commissioner consider the capitalisation of a UPE, into further units in the unit trust prior to the date of lodgement of the relevant tax return in which the UPE is deemed to be a loan, means that the UPE has/will be satisfied such that Division 7A cannot apply for:

• For the year ended 30 June 2010?
• For the year ended 30 June 2011 and later income years?

Advice/Answers

As the Commissioner does not consider Division 7A applies in this situation (as per the answer to Question 1), the UPE is not deemed to be a loan and therefore there is no need to answer this question.

Question 3

Where the Commissioner seeks to apply Division 7A and does not consider the capitalisation of the UPE into further units results in UPEs being satisfied and thus mitigating a deemed dividend under Division 7A, will the Commissioner exercise his discretion to disregard the operation of Division 7A under section 109RB of the ITAA 1936 for:

• the year ended 30 June 2010?
• the year ended 30 June 2011 and later income years?

Advice/Answers

As the Commissioner does not consider Division 7A applies in this situation (as per the answer to Question 1), there is no need to answer this question.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2009

Relevant facts

A private company (the taxpayer) is a privately owned company with two discretionary trust shareholders.

The taxpayer owns all the units in a unit trust.

The unit trust carries on business within Australia. A number of subsidiary entities perform supplementary roles for the unit trust.

The taxpayer and the unit trust constitute a "family group".

None of the entities are consolidated for tax purposes.

There was a UPE at 30 June 2010. This was calculated as the 2010 profit, less income tax paid on behalf of the taxpayer, less cash distributions made to the taxpayer (which in turn distributed the same amount as dividends to its shareholders).

All funds representing the UPEs have been retained within the unit trust for the furtherance of its business. No loans or payments (other than the above distributions) have been made by the unit trust to any shareholder or associate of the taxpayer.

The UPEs are recorded as such in the financial accounts of the unit trust and the taxpayer.

The 30 June 2010 UPE was capitalised into further units in the trust. The number of units issued to the taxpayer in satisfaction of the UPE was done after conducting a market valuation of the unit trust.

No action has yet been taken with later year UPEs as the relevant tax returns are not yet required to be lodged.

Assumptions

Other than appropriate trust distributions to the taxpayer, no other payments or loans will be made by the unit trust to any shareholder or associate of the taxpayer in the income years covered by this Ruling.

Relevant legislative provisions

Division 7A of the ITAA 1936

Section 109D of the ITAA 1936

Reasons for decision

Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates). In particular, advances, loans and other payments or credits to shareholders are, unless they come within specified exclusions, treated as assessable dividends to the extent that a company has a distributable surplus.

For the purposes of Division 7A, the term "loan" is given a broad meaning by ss109D(3) of the ITAA 1936. It is defined as:

• an advance of money;
• a provision of credit or any other form of financial accommodation;
• a payment of an amount for, or on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount;
• a transaction (whatever its terms or form) which in substance effects a loan of money.

Taxation Ruling TR 2010/3 expresses the Commissioner's opinion on the circumstances in which a private company with a present entitlement to an amount from an associated trust estate makes a loan to that trust within the meaning of ss109D(3) of the ITAA 1936, in circumstances where funds representing the present entitlement remain intermingled with the funds of the trust.

In situations where the funds to which the beneficiary is made presently entitled continue to be held on trust for that beneficiary until such time as the beneficiary calls for payment, the entitlement is commonly referred to as an unpaid present entitlement (UPE).

Section two of TR 2010/3 considers loans within the ordinary meaning. Essentially, if a trustee and a private company beneficiary have consistently maintained in its accounts that there is an outstanding UPE and not a loan, and both parties have acted consistently with this, this would be evidence suggesting that the private company has not agreed to the trustee treating the UPE as being satisfied and being replaced with a loan to the trust.

In this situation, the applicant has advised that neither entity has treated the outstanding UPE as a loan, within the terms of its ordinary meaning.

Section three of TR 2010/3 considers loans within the extended meaning. This section discusses where a private company beneficiary provides financial accommodation to the trustee of a trust which in substance effects a Division 7A loan.

This accommodation includes where the private company does not call for:

• the payment of the UPE; or
• the investment of the funds representing the UPE for the company's sole benefit rather than their use of the benefit of the trust.

Accordingly, if a private company beneficiary has knowledge that the funds representing its UPE are being used by the trustee for trust purposes, in not calling for payment of its UPE the private company prima facie provides the trustee with financial accommodation and, by extension, makes a Division 7A loan to the trustee.

However, TR 2010/3 refers on several occasions to whether or not the funds representing the UPE are "used other than for the sole benefit of the private company beneficiary". Paragraph 113 and 114 state:

113. If funds representing the UPE are instead used only for the private company's sole benefit, the private company does not provide financial accommodation in respect of that UPE. ...

114. The private company provides no financial accommodation in these circumstances because the main trust receives no pecuniary aid or favour from the private company. ...

In this situation, the taxpayer is a private company beneficiary in a unit trust. More importantly, the taxpayer is the ONLY unit holder of the trust, and therefore has the entitlement to all of its income and capital.

Therefore, by extension, it is obvious that any improvement to the net asset position and/or future profits of the unit trust will solely benefit the taxpayer.

For this reason, on the continuing assumption that no loans or payments will be made by the unit trust to any associate or shareholder of the taxpayer, the Commissioner does not consider that Division 7A of the ITAA 1936 will apply to deem a dividend from any UPE existing between the unit trust and the taxpayer whilst the taxpayer remains the sole beneficiary/unit holder of the unit trust.

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