Edited version of your private ruling

Authorisation Number: 1012448233612

Ruling

Subject: Division 7A: Trust Entitlements

Question 1

Where the private company beneficiary is presently entitled to the income of the Y main trust for a year of income and an amount of that entitlement remains unpaid before the lodgement of the trust's tax return for that year (or due date for lodgement if this is earlier), will the proposed sub-trust arrangement entered into by the trustees of the sub trust and the private company beneficiary ensure that the private company beneficiary does not provide financial accommodation to the trustees of the Y main trust for the purposes of the extended meaning of loan in subsection 109D(3) of the ITAA 1936?

Answer

Yes

Question 2

Where the Y main trust is presently entitled to the income of the X main trust for a year of income and an amount of that entitlement remains unpaid before the lodgement of the trust's tax return for that year (or due date for lodgement if this is earlier), will the proposed sub-trust arrangement entered into between the trustee for the sub trust and the trustees of the Y main trust ensure that the Y main trust does not provide financial accommodation to the trustee of the X main trust for the purposes of the extended meaning of loan in subsection 109D(3) of the ITAA 1936?

Answer

Yes

This ruling applies for the following periods:

year ended 30 June 2012

year ending 30 June 2013

year ending 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The X main trust

The X main trust was settled by deed.

The trustee of the X main trust is a company.

The directors of corporate trustee are Mr X and Mrs X and their two children. The company's shareholding is beneficially held by Mr X and Mrs X.

The trust deed for the X main trust provides that the trustee shall stand possessed of the income of the trust of a financial year (or such portion of the income as the trustee determines) upon trust for one or more of the eligible beneficiaries in such shares and proportions as the trustee determines prior to 30 June of that year.

The Y main trust is within the class of beneficiaries eligible to benefit from an appointment of income of the X main trust.

The Y main trust was presently entitled to income of the X main trust for the income year ended 30 June 2012 as a result of the valid exercise of the trustee's powers of appointment under the trust deed.

The Y main trust

The Y main trust was settled by deed.

The trustees of the second main trust are Mr X and Mrs X.

Pursuant to the deed for the Y main trust, the trustee has the power to pay, apply or set aside an amount of income of the trust for the year to one or more of the eligible beneficiaries. The deed further provides that any amount set aside for a beneficiary in accordance with that determination does not form part of the main trust but, upon being set aside, is to be held by the trustee on a separate trust for the beneficiary absolutely.

The private company beneficiary is within the class of beneficiaries eligible to be appointed income of the Y main trust.

The directors of the private company beneficiary are Mr X and Mrs X and their two children. The company's shareholding is beneficially held by Mr X, Mrs X and their two children.

The private company beneficiary was presently entitled to income of the Y main trust for the income year ended 30 June 2012 as a result of the valid exercise of the trustee's powers of appointment under the trust deed.

Unpaid present entitlements and proposed sub-trust arrangements

$1,000 of the Y main trust's entitlement to income of the X main trust for the income year ended 30 June 2012 will be unpaid before 15 May 2013 (or the lodgement of the 2012 tax return of the X main trust if this is earlier).

Similarly, $1,000 of the private company beneficiary's entitlement to income of the Y main trust in the income year ended 30 June 2012 will remain unpaid before 15 May 2013 (or the lodgement of the trust's 2012 income tax return if this is earlier).

The entire amount of the unpaid present entitlements of $1,000 will be retained by the X main trust to fund increases in stock, debts and purchases of plant and equipment in order to expand its business.

Before 15 May 2013, or the lodgement of the X main trust's 2012 income tax return if that is earlier, a sub-trust arrangement (the first sub-trust) will be established as follows:

(a) Corporate trustee for the X main trust resolves to hold the amount of the Y main trust's present entitlement to the income of the X main trust in the 2012 income year that is unpaid at this date on sub-trust for the sole benefit of the Y main trust.

(b) The unpaid entitlement will be invested in the X main trust on the following terms:

· The sub-trust will be paid a percentage of the net annual income of the X main trust before any interest expense applicable to the borrowings by the Trust and before any expense representing a return on sub-trust arrangements.

· This percentage will be equal to the proportion of the amount invested by the sub-trust at the end of each preceding financial year ending 30 June, compared to the other sources of funding for the X main trust.

· The percentage return will be paid in cash to the sub-trust and in turn to the Y main trust by the due date for lodgement of the income tax return for the X main trust for the year in which the percentage return relates.

· On withdrawal of the investment the sub-trust will be paid an amount equal to the principal of the sum originally invested

(c) Separate financial statements will be prepared for the sub-trust and an annual income tax return will be prepared for the sub-trust.

(d) The annual return payable to the sub-trust will be treated as an expense for the purposes of calculating the amount of net income that is available for distribution to trust beneficiaries pursuant to the deed.

Before the lodgement of the Y main trust's 2012 income tax return (or 15 May 2013 if this is earlier), a sub-trust arrangement (the second sub-trust) will be established as follows:

(a) the trustees for the Y main trust, resolve to hold the amount of the private company beneficiaries present entitlement to the income of the Y main trust in the 2012 income year that remains unpaid at this date on sub-trust for the sole benefit of the private company beneficiary.

(b) The unpaid entitlement will be invested in the Y main trust on the following terms:

· The second sub-trust arrangement will be paid a return on the amount invested equal to the investment return which flows to the Y main trust from the first sub-trust arrangement.

· The return will be paid in cash to the second sub-trust and in turn to the private company beneficiary by the due date for lodgement of the income tax return for the Y main trust in the income year in which the return relates.

· On withdrawal of the investment the sub-trust will be paid an amount equal to the principal of the sum originally invested.

Separate financial statements will be prepared for the second sub-trust and an annual income tax return will be prepared for the sub-trust.

It is assumed that:

· The amount of the Y main trust's present entitlement to the income of the X main trust for the income year ended 30 June 2012 that remains unpaid at 15 May 2013 is not a loan within the ordinary meaning of that term.

· The amount of the private company beneficiary's present entitlement to the income of the Y main trust for the income year ended 30 June 2012 that remains unpaid at 15 May 2013 is not a loan within the ordinary meaning of that term.

Relevant legislative provisions

Subsection 109D(3) of the Income Tax Assessment Act 1997

Reasons for decision

Division 7A of Part III of the 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 (or their associates) are, unless they come within specific exclusions, treated as assessable dividends to the extent that a company has a distributable surplus.

Taxation Ruling TR 2010/3 Income Tax: Division 7A loans: trust entitlements (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 associate trust makes a loan to that trust within the meaning of subsection 109D(3) of the ITAA 1936 where funds representing that present entitlement remain intermingled with other funds of the trust estate.

A beneficiary can become presently entitled to an amount of income from a trust pursuant to a direct term of the trust deed or as a result of the trustee exercising a power of appointment under the deed in the beneficiary's favour. In situations where the funds to which the beneficiary is made presently entitled are unpaid, the entitlement is commonly referred to as an unpaid present entitlement (UPE).

Meaning of 'loan'

For the purposes of Division 7A, a 'loan' is defined in subsection 109D(3) of the ITAA 1936.

Paragraph 109D(3)(b) includes within the meaning of loan 'a provision of credit or any other form of financial accommodation'.

The term 'financial accommodation' is not defined in the ITAA 1936 and is to be interpreted having regard to the statutory context in which the phrase appears. In the Commissioner's view, the phrase is limited for Division 7A purposes to:

· the supply or grant of some form of pecuniary aid or favour;

· under a consensual arrangement; and

· where a principal sum or equivalent is ultimately payable (see paragraph 96 of TR 2010/3).

Accordingly, if a private company beneficiary has knowledge that funds representing its UPE are being used by the trustee for trust purposes, in allowing for this to continue the private company provides the trustee with financial accommodation and, by extension, makes a Division 7A loan to the trustee. (see paragraph 104 of TR 2010/3).

However, a private company beneficiary does not provide financial accommodation in respect of a UPE where the funds representing the UPE are used only for the private company's sole benefit. For example, if there is a sub-trust but the funds representing the UPE remain intermingled in the main trust as a consequence of an investment back by the sub-trust, the private company does not provide any financial accommodation to the main trust if this investment by the sub-trust is on terms entitling the sub-trust to:

· all the benefits from use of those funds; and

· a repayment of the principal of the investment (see paragraph 113 and 114 of TR 2010/3).

The private company provides no financial accommodation in these circumstances because the main trust receives no pecuniary aid or favour from the private company. These circumstances may be evidenced by the terms of the agreement between the sub-trust and the main trust.

The existence of a sub-trust can 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 or it may be expressly provided for under the trust deed. Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements (PSLA 2010/4), indicates that evidence of a sub-trust could also include:

· 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

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

· 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.

The question of when funds in the sub-trust are held for the sole benefit of a private company beneficiary is considered in PSLA 2010/4 at paragraph 55. Here, 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.

As recognised in TR 2010/3, an investment in a trust on terms requiring all the benefits from the use of the funds invested to flow back to the investor can be structured in a number of ways. One way, as illustrated in Example 8 of TR 2010/3, is where the sub-trust is to be paid a reasonable percentage of the overall income each year generated by the main trust (calculated in that example by reference to the proportion of the amount invested by the sub-trust relative to other sources of funding or borrowings) and, on withdrawal of the investment, an amount equal to the principal sum originally invested.

Application to circumstances - Question 1

The trustees of the Y main trust have appointed income of the Y main trust to the private company beneficiary in the 2012 year. So much of the private company beneficiary's income entitlement that remains unpaid at the earlier of 15 May 2013, or the lodgement of the Y main trusts 2012 income tax return, will be held on a separate trust absolutely for the private company beneficiary pursuant to the trust deed for the Y main trust and the proposed resolution.

A sub-trust will therefore be in place in respect of the UPEs owing by the Y main trust to the private company beneficiary. It is noted that separate financial statements and income tax returns will also be prepared for the sub-trust for each applicable financial year.

The second sub-trust will invest the UPE back to the Y main trust in accordance with the agreement which provides that:

· the sub-trust will be paid a return on the amount invested equal to the investment return which flows to the Y main trust from the first sub-trust arrangement;

· the principal of the amount originally invested (the funds representing the UPEs) will be repaid to the sub-trust and in turn to the private company beneficiary upon the withdrawal of those investments

All of the benefits from the second sub-trust's investment of the UPE back to the Y main trust will be applied only for the purposes of the private company beneficiary as the return on investment and the principal will flow back through the sub-trust. The annual investment return will be paid in cash to the private company beneficiary by the lodgement day of the Y main trust tax return for the year in which the return arises.

Accordingly the conditions outlined in paragraph 55 of PSLA 2010/4 would be met and the Commissioner would consider that the funds held in the second sub-trust would be held for the sole benefit of the private company beneficiary. [It is noted that the trustees of the Y main trust are also directors and shareholders of the private company beneficiary and so it is considered that the company would have knowledge of who can benefit from the investment of its UPE.

Therefore, the private company beneficiary has not provided financial accommodation to the Y main trust within the meaning of paragraph 109D(3)(b) of the ITAA 1936.

Application to circumstances - question 2

The corporate trustee has appointed income of the X main trust to the trustees of the Y main trust in the 2012 year.

So much of the trustee beneficiary's income entitlement that remains unpaid at the earlier of 15 May 2013 or the lodgement of the X main trust's 2012 income tax return will be held on a separate trust absolutely for the trustees of the Y main trust pursuant to the trust deed for the X main trust and the proposed resolution.

A sub-trust will therefore be in place in respect of the UPEs owing by X main trust to the trustees of the Y main trust. It is noted that separate financial statements and income tax returns will also be prepared for the sub-trust for each applicable financial year.

The first sub-trust will invest the UPE in the X main trust in accordance with the proposed agreement which provides:

· the sub-trust will be paid a percentage of the net annual income of the X main trust before any interest expense applicable to the borrowings by the Trust and before any expense representing a return on the sub-trust arrangement.

· this percentage will be equal to the proportion of the amount invested by the sub-trust at the end of each preceding income year ending 30 June, compared to the other sources of funding for the X main trust.

· the percentage return will be paid in cash to the trustees of the sub-trust and in turn to the Y main trust by the lodgement day of the income tax return for the X main trust for the year in which the percentage return arises.

· the principal of the amount originally invested (the funds representing the UPEs) will be repaid to the sub-trust and in turn to the Y main trust upon the withdrawal of those investments.

All of the benefits from the first sub-trust's investment of the UPE back to the X main trust will be applied only for the purposes of the Y main trust. This is because a reasonable percentage of the overall income generated by the X main trust, together with the principal sum invested, will flow back through the sub-trust to the Y main trust. The return on the investment will be charged as an expense against the income of the X main trust in calculating the amount of net income available for distribution to the trust beneficiaries in the 2013 year. The percentage return will be paid in cash to the trustee's of the Y main trust by the lodgement day of the Y main trust tax return for the year in which the return arises.

Accordingly the conditions outlined in paragraph 55 of the PSLA would be met and the Commissioner would consider that the funds held in the first sub-trust would be held for the sole benefit of the trustees of the Y main trust. [It is noted that the trustees of the Y main trust are also directors and shareholders of the corporate trustee of the X Main trust and so it is considered that the trustees would have knowledge of who can benefit from the investment of its UPE].

Therefore, the trustees of the Y main trust, have not provided financial accommodation to the X main trust within the meaning of paragraph 109D(3)(b) of the ITAA 1936.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).