Edited version of private advice

Authorisation Number: 1012634676661

Ruling

Subject: Trust entitlements and unpaid present entitlements

Question and answers

Is the Trust a part of the same 'family group', as described in Taxation Ruling TR 2010/3, of that with its unit holders and/or the beneficiaries or other entities associated with the unit holders?

No.

Will any unpaid present entitlements between the trust and any of its unit holders (which include corporate entities) constitute a loan or an 'in-substance' loan for the purpose of section 109D of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?

No

This ruling applies for the following periods:

Financial year ended 30 June 2015

Financial year ended 30 June 2016

Financial year ending 30 June 2017

Financial year ending 30 June 2018

Financial year ending 30 June 2019

Relevant facts and circumstances

The Trust is an Australian resident unit trust that has many issued units. No additional units have been issued since the trust was settled.

The Trust was formed by the Deed of Settlement of Unit Trust. This Deed was amended in respect of some clauses.

The trustee of the Trust is a trustee company.

The Trustee owns and derives rental income from land on which a business is conducted.

The purchase of the land was financed by borrowings, upon which interest is paid by the Trustee.

The shareholders of the Trustee are the same as the unit holders of the Trust and their shareholding is in the same proportion as their unit holding in the Trust.

All units on issue in the Trust are of equal value, carry equal rights to the income and capital of the Trust fund and have a right to one vote per unit. In addition the Trustee's constitution states that there is the right to one vote for each share held. The shareholders agreement then further states that meetings will be decided by a majority of shareholding (that is 50.1% or more) and additionally that decision must be supported by at least two shareholders. On this basis, even if one shareholder holds an interest greater than 50.1%, they are still required to have the support of another shareholder before a decision is ultimately agreed upon.

A couple of the unit holders are related to one another and account for less than 50% of the units in the Trust.

All other unit holders, which hold the remaining more than 50% of the units, are not associated to each other or the related unit holders, and have simply come together to participate in a common investment in real property via a unit trust.

A clause of the Deed requires the Trustee to 'distribute amongst the Unit Holders in accordance with the entitlement of the units so held the amount decided to be distributed in respect of the accounting period…'.

The Unpaid Present Entitlements (UPEs) outstanding as at xx xx xx are on a strictly proportionate basis (that is, no one unit holder has been paid any of their entitlements - each unit holder's entitlements are equally outstanding).

The distributions have been made and will be made on a strictly proportional basis to Unit Holders based on units held.

None of the entitlements have been discharged either partially or in full.

At a meeting of the unit holders it was agreed that 'all profits in the Trust would be used to retire debt'. Accordingly, it is understood that none of the unit holders will demand payment of any of their entitlements over the period covered by the Ruling. The trustee has no intention to otherwise discharge any such entitlements over the period covered by the Ruling, however, if any entitlements are so discharged (in full or in part), all unit holders will have their entitlements discharged (in whole or in part) proportionately.

The Trustee has used and will use the funds representing the UPEs to repay debt in the financial years up until and including xx xx xx.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 subsection 109D(3)

Income Tax Assessment Act 1936 paragraph 109D(3)(a)

Income Tax Assessment Act 1936 paragraph 109D(3)(b)

Income Tax Assessment Act 1936 paragraph 109D(3)(c)

Income Tax Assessment Act 1936 paragraph 109D(3)(d)

Reasons for decision

Question 1

Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements provides the Commissioner's view on when a private company beneficiary with an Unpaid present entitlement (UPE) from an associated trust will be taken to have made a loan to that trust within the meaning of subsection 109D(3) of the Income Tax Assessment Act (ITAA 1936), in circumstances where funds representing that UPE remain intermingled with funds of the trust.

As will be explained in response to question 2, a loan for Division 7A purposes includes the provision of financial accommodation and in-substance loans. Both of these require there to be a consensual agreement (paragraph 19 of TR 2010/3).

A company can enter into a consensual agreement to provide financial accommodation to a trustee if it knows the funds to which it is entitled to receive from the trust are being used by the trustee for general trust purposes, and acquiesces to this use by not calling for payment of the UPE or for those funds to be invested for its own benefit instead (paragraph 21 of TR 2010/3).

For these purposes, where a private company and a trust share the same directing mind and will and share a commonality of control, in the absence of sufficient evidence to the contrary, the Commissioner takes the view that the private company knows the use to which the trustee is putting the funds to which the company is entitled (paragraph 26 of TR 2010/3). That is, knowledge of the use to which the funds that the beneficiary is solely entitled to can be imputed by virtue of the relationship.

In TR 2010/3, this relationship is referred to as one of a family group. Paragraph 3 of TR 2010/3 defines a family group as:

a group of related entities including or comprising a private company and a trust , that ultimately share the same directing mind and will, or in other words where the same entities or persons have the practical ability to, or capability to, control the family group.

In your case you have stated that the unit holders that are related (in the same family group) account for less than 50% of the units in the trust. The other unit holders are not connected to them.

As they control less than 50% of the trust and the other unit holders are not related, the trust is not part of the same family group as the beneficiaries or other entities associated with the unit holders.

The other corporate unit holders have different shareholders and directors that are unrelated. The trust unit holders have different trustees that are also unrelated.

They do not share the same directing mind that will control the trustee company and trust. Therefore the trust is not part of the same family group as the unit holders and/or beneficiaries or other entities associated with the unit holders.

However, although TR 2010/3 is mainly concerned with private company beneficiaries that are part of the same family group, it does not follow that the principles discussed in the Ruling do not extend to private companies that are not part of the same family group. Whether or not the private company has made a loan for Division 7A purposes is a question of fact. If the unit holders have actual knowledge that the funds to which they are entitled are not being used for their own benefit, then knowledge will not need to be imputed by virtue of a family group, and the unit holders may nonetheless be taken to be providing financial accommodation to the trustee.

Question 2

A loan for Division 7A purposes is defined in subsection 109D(3) of the ITAA 1936 to include:

(a) an advance of money; and

(b) provision of credit or any form of financial accommodation; and

(c) 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 ; and

(d) a transaction (whether its terms or form) which in substance effects a loan of money.

The definition extends the definition of the term 'loan' beyond its commonly understood meaning to include advances of money, provision of credit, provision of other forms of financial accommodation and any transaction which effects a loan of money.

As stated in the reasons for decision in relation to Question 1, the Commissioner expressed his view on Division 7A and its application to trust entitlements in TR 2010/3.

A beneficiary can become presently entitled to an amount from a trust pursuant to a direct term of the relevant trust deed, or as a result of the trustee of the trust exercising a power under a trust deed to make the beneficiary so entitled (usually by resolution). 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 UPE. In TR 2010/3, references to a 'subsisting UPE' means an UPE that has not been satisfied, including by being converted into (or replaced by) an ordinary loan.

A subsisting UPE, in some circumstances, can amount to a Division 7A loan under the extended definition of loan in paragraphs 109D(3)(b) and (d) of the ITAA 1936 (paragraph 18 of TR 2010/3). Paragraphs 19 to 25 of TR 2010/3 provide the following explanation:

Provision of financial accommodation or an in-substance loan

19. A private company beneficiary provides financial accommodation to the trustee of a trust in respect of which it has a UPE if, under a consensual agreement:

• the private company supplies or grants some form of pecuniary aid or favour to the trust; and

• a principal sum or equivalent is ultimately payable to the private company.

21 As the amount of the UPE is a principal sum ultimately payable to the private company beneficiary, the private company provides financial accommodation to the trustee of a trust for the purposes of the extended meaning of a loan in subsection 109D(3) if it provides any pecuniary aid or favour to the trustee of that trust under a consensual agreement.

22 A consensual agreement for the provision of pecuniary aid or favour to the trustee of a trust arises if a private company beneficiary authorises (including by acquiescing with knowledge of) the trustee's continued use for trust purposes of the funds representing the private company's UPE by not calling for:

• the payment of that UPE; or

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

23 In these circumstances the private company provides pecuniary support to the trustee equal to the whole amount of the UPE that the private company beneficiary has allowed the trustee to use (including by knowledgeably acquiescing to this use) for trust purposes.

24 Accordingly, if a private company beneficiary has knowledge that funds representing its UPE are being used by the trustee for trust purposes (rather than being held and / or used for that private company's sole benefit), in not calling for payment of its UPE the private company provides the trustee with financial accommodation and, by extension, makes a Division 7A loan to the trustee.

25 The overall transaction between the private company beneficiary and the trustee includes:

• the use of the funds representing the private company's UPE by the trustee for trust purposes (until such time as the UPE is called for), and

• the private company's authorisation (or acquiescence with knowledge) of this use.

26 As such the overall transaction also effects, in substance, a loan of money from the private company to the trustee of the trust.

It follows from paragraph 19 of TR 2010/3 that the unit holders are only taken to provide financial accommodation where the following exists:

• the unit holders supply or grant some form of pecuniary aid or favour to the trust;

• under a consensual agreement; and

• where a principal sum or equivalent is ultimately payable to the unit holders.

Where the funds which represent the private company's UPE are used for trust purposes, and there is nothing to indicate otherwise, it is assumed that the company has allowed this to happen (paragraph 125 of TR 2010/3). The Commissioner would then be of the view that a Division 7A loan had been made to the trustee under paragraph 1093D(3)(d) of the ITAA 1936.

Whether or not the unit holders have provided financial accommodation or an in-substance loan is a question of fact. Here the unit holders have agreed that the funds representing the amount to which they are entitled should be applied to reduce the debts of the trust. But ultimately, the unit holders nonetheless are entitled to receive payment of their UPEs pursuant to the trust deed. That is, notwithstanding that the unit holders are not part of the same family group, there is a consensual agreement and a principal sum or equivalent will ultimately be payable to the unit holders.

However, at issue is whether or not on the facts of this arrangement, there has been (or will be) the provision of financial accommodation.

Pecuniary aid or favour

It is understood that:

• the Trust was established whereupon units were issued to the same unit holders who currently hold the units.

• no further units have been issued since the initial issue.

• the Trustee distributes the net income of the Trust in accordance with the Deed, that is, on a strictly proportional basis. This is supported by the financial statements of the Trust.

• the unit holders have agreed that the profits of the Trust (in respect of which they each have a proportionate UPE) will be applied to reducing the debts of the Trust.

• all the net income in the relevant years have been retained by the Trust for trust purposes, that is, no part of the present entitlement of the unit holders has been satisfied.

The unit holders have collectively agreed that all profits are to be retained in the Trust for the trust purposes, in this case, to retire debt owing to the Trust. In doing so, the unit holders have collectively agreed to defer receiving their share of the profit for the relevant years in favour of an entitlement to receive a return equal to their respective share of the total funds, on the premise that the net asset position of the trust will be improved and all future profits (both capital and income) will also be distributed in accordance with the Deed.

In other words, each of the unit holders will be entitled to receive a return completely commensurate with the funds it is allowing the trustee to use. As the arrangement involves each unit holder agreeing that the funds to which it is proportionately entitled can be used to reduce the debts of the trust, this use is proportionately for the benefit of each of the unit holders. On that basis, the unit holders have not provided or are not providing any pecuniary aid or favour to the Trustee or any other taxpayer. They are instead collectively agreeing that the funds be used for their sole benefit.

Therefore, the unit holders have not provided financial accommodation based on the facts and no part of the current post xx xx xx UPEs will constitute a loan as defined in subsection 109D(3) of the ITAA 1936.

On the facts as described above, where the unit holders of the units are entitled to receive income and capital of the trust in proportion with their unit holdings and each has agreed to leave any entitlement they have to be paid income or capital from the trust outstanding, no UPE over the period covered by this Ruling will constitute a loan for Division 7A purposes.

Ruling does not cover change in circumstances

Whether or not a unit holder is taken to be providing any pecuniary aid or favour to the Trustee needs to be assessed on an ongoing basis. A unit holder may be taken to be providing pecuniary aid or favour with a change in circumstances, including issuing of new units in the unit trust, or partial satisfaction or payment in relation to the UPEs other than on a proportional basis. Such a change in circumstances would amount to an arrangement not covered by this Ruling and may result in the entire amount of the post xx xx xx UPEs being treated as a loan for Division 7A purposes.

For example, the unit holders may be providing financial accommodation (and therefore a loan for Division 7A purposes) if they were not all entitled to receive their respective proportionate share of the income and capital of the trust commensurate with their unit holdings (in which case there would be no guarantee of being entitled to a return commensurate with the funds they were allowing the trustee to use).

A Division 7A loan may also arise if not all unit holders agree to let the funds to which they are entitled to be used by the Trustee for trust purposes. For example, if only one of the unit holders has a subsisting UPE (with the other unit holders having their entitlements discharged), the funds represented by that one subsisting UPE would be used to benefit all unit holders proportionately to their unit holdings, rather than commensurate with the funds to which they were allowing the trustee to use. If the unit holder with that subsisting UPE has authorised such use within the meaning of TR 2010/3, they would be providing the Trustee with financial accommodation.

If the only change in circumstance is the full or partial satisfaction of each of the unit holders UPEs equally (that is, in proportion to their unit holdings), this would not of itself produce a situation that would amount to the unit holders being taken to provide a loan to the Trustee for Division 7A purposes.

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