Edited version of your written advice

Authorisation Number: 1051219014768

Date of advice: 4 May 2017

Ruling

Subject: Income Tax - Division 7A - Unpaid present entitlements

Question 1

Will unpaid present entitlements (UPE) for the years ended 30 June 20XX and 30 June 20YY conferred by the B Trust on A Co be a loan for the purposes of subsection 109D(3) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

If the answer to question 1 is 'yes', would the deemed dividend under Division 7A of the ITAA 1936 at the end of the 20XX and 20YY income years be reduced to nil to the extent that A Co has no distributable surplus in respect of the 20XX and 20YY years pursuant to section 109Y of the ITAA 1936?

Answer

Yes

Question 3

Does Division 7A of the ITAA 1936 apply to deem dividends to B Trust, in relation to the “Initital loans” and A Co's UPE, by operation of section 109T?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20YY

Year ended 30 June 20ZZ

The scheme commences on:

20WW

Relevant facts and circumstances

In 20WW, A Co was established as a holding company to make investments in B Co. A Co owned approximately XX% of the shares in B Co. A Co did not otherwise carry on any active business.

A Co is a beneficiary of the B Trust. At the end of the 20XX and 20YY income years, B Trust made A Co presently entitled to trust income as follows:

● $X million, on or about 30 June 20XX (the 20XX UPE), and

● $X million, on or around 30 June 20YY (the 20YY UPE).

A Co has been owned by various related entities since establishment, with the following shareholdings:

RE 1, RE 2 and B Trust are all entities controlled by the same individual.

The 20XX UPE was not paid or placed on sub-trust for the sole benefit of A Co by the lodgement day of B Trust's 20XX tax return, being 20YY.

As at the 20ZZ, the 20YY UPE has not been paid or placed on sub-trust for the sole benefit of A Co. The due date for lodging B Trust's 20YY income tax return is 20ZZ.

While A Co has not prepared financial statements since being placed into administration, the balance sheet of A Co as at 30 June 20XX and 30 June 20YY have been provided.

With the exception of the UPEs, A Co made no payments or loans to shareholders, forgave no shareholder debts, and neither made nor repaid any non-commercial loans in the 20XX or 20YY income years.

The “Initial loans”

B Co ran into financial difficulties during its operations and required significant funding from key shareholders of A Co, including the related group entities and unrelated third party shareholders, to maintain its operations.

The related entities lent the following total amounts to A Co over a number of years (the Initial Loans).

In 20VV, A Co also obtained funding from a bank in relation to the B Co's operations.

Non-related third party shareholders also lent to A Co.

In 20UU, both A Co and B Co were placed into administration. B Co subsequently went into liquidation and, in the 20XX year, the assets of B Co were sold. The proceeds were insufficient to repay the secured lender. As a consequence, in the 20YY year, A Co wrote off loans to B Co. Also in this year, RE 3, a related entity to RE 2, acquired all outstanding debts owed by A Co to unrelated third parties, including the ANZ loan.

Assumptions

The following assumption applies to this ruling:

● The present entitlement conferred on A Co in the 20YY income year will not be paid or placed on sub-trust for the sole benefit of A Co before the due date for lodging B Trust's 20YY income tax return, being 20ZZ.

Relevant legislative provisions

Income Tax Assessment Act 1936

Division 7A

subsection 109D(3)

section 109T

paragraph 109T(1)(b)

section 109Y

subsection 109Y(1)

subsection 109Y(2)

subsection 109Y(3)

Reasons for decision

Question 1

Summary

Yes. The unpaid present entitlements (UPEs) conferred by B Trust on A Co in the years ended 30 June 20XX and 30 June 20YY, are loans for the purposes of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Subsection 109D(3) of the ITAA 1936 defines a loan for the purposes of Division 7A. Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements (TR 2010/3) discusses when a UPE is a Division 7A loan. If a private company beneficiary authorises (including allowing with knowledge of) the trustee's continued use of a UPE for trust purposes, 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;

this is considered to be an 'other form of financial accommodation', and a loan for Division 7A purposes, under paragraph 109D(3)(b) of the ITAA 1936 (paragraphs 19-26 of TR 2010/3).

Practice Statement Law Administration PS LA 2010/4 Division 7A: trust entitlements provides further practical guidance on TR 2010/3, and in paragraph 46 clarifies that:

'A UPE owing from a trust to a private company in the same family group will become a loan to which Division 7A applies to the extent that:

(a) it has not been paid out to the private company beneficiary, and

(b) the trustee fails to hold the funds representing the UPE on sub-trust for the sole benefit of the private company beneficiary by the main trust's lodgment day for the income year in which the present entitlement arises and all times thereafter.'

The entitlement conferred on A Co by B Trust in the year ending 30 June 20XX (the 20XX UPE) was not paid or placed on sub-trust for the sole benefit of A Co by 20YY, the lodgement day of B Trust's 20XX tax return.

As such, under subsection 109D(3) of the ITAA 1936, the 20XX UPE is considered to be a loan since 20YY for the purposes of Division 7A.

The entitlement conferred on A Co by B Trust in the year ending 30 June 20YY (the 20YY UPE) has not been paid or placed on sub-trust for the sole benefit of A Co. It is assumed, for the purposes of this private ruling, that the 20YY UPE will remain unpaid and that no sub-trust will be created by 20ZZ, the lodgement date of B Trust's 20YY return.

Under the assumed circumstances, the 20YY UPE will be a loan from 20ZZ under subsection 109D(3) of the ITAA 1936 for the purposes of Division 7A.

Question 2

Summary

Yes. As A Co's distributable surplus for both years was less than zero, the amount of any deemed dividend arising from the 20XX UPE and 20YY UPE would be reduced to nil.

Detailed reasoning

Subsection 109Y(1) of the ITAA 1936 sets out that if, at the end of the income year, the sum of all the Division 7A deemed dividends that a private company is taken to pay would be more than the company's distributable surplus for that year, the amount of each dividend is worked out using the formula in subsection 109Y(3). Subsection 109Y(2) of the ITAA 1936 provides the formula for calculating a private company's distributable surplus.

Subsections 109Y(1) and (3) together, effectively limit the quantum of the deemed dividend to the extent of the private company's distributable surplus for that year of income.

The Commissioner accepts A Co's distributable surplus calculations result in amounts significantly less than zero for each of the 20XX and 20YY income years. As A Co's distributable surplus for both years was less than zero, the amount of any deemed dividend arising from the 20XX UPE and 20YY UPE would be reduced to nil.

Question 3

Summary

No. Section 109T of the ITAA 1936 does not apply and no deemed dividend will arise to B Trust under Division 7A from the initial loans and A Co's UPE.

Detailed reasoning

Section 109T of the ITAA 1936 provides for payments and loans made by a private company to an entity, through one or more interposed entities. In such cases, paragraph 109T(1)(b) requires that:

'a reasonable person would conclude (having regard to all the circumstances) that the payment or loan was made soley or mainly as a part of an arrangement for the payment or loan to the target entity'

Under the circumstances, section 109T may apply as:

● RE 1 and RE 2 (the lenders) provided loans to A Co throughout the 20TT to 20SS income years (the “Initial loans),

● A Co provided Division 7A loans to B Trust (the target entity) in the 20XX and 20YY years in relation to the unpaid present entitlements, and

● The lenders are associates of both A Co and B Trust.

However, it is accepted that the Initial loans were used by A Co to inject funds into B Co to support and maintain the operations of that company, and the Division 7A loans in relation to the UPEs was made under the beneficial relationship between A Co and B Trust and the distribution of trust income.

It is considered that a reasonable person considering the circumstances of the loans would not conclude that the Initial loans were made, either solely or mainly, as part of an arrangement to loan money to B Trust.

Section 109T of the ITAA 1936 does not apply and no deemed dividend will arise to B Trust under Division 7A from the initial loans and A Co's UPE.

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