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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your written advice

Authorisation Number: 1051435479901

Date of advice: 4 October 2018

Ruling

Subject: Division 7A loans and unpaid present entitlements

Question

Will the sub-trust arrangement continue to be acceptable to the Commissioner so that the beneficiary will not be taken to have made a loan to the trust within the meaning of subsection 109D(3) of the Income Tax Assessment Act 1936?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Trust X applied for a private binding ruling to the Australian Taxation Office on December 20XX, in respect of a proposed transaction that has since then been implemented.

The Australian Taxation Office issued a private binding ruling on February 20XX that the proposed sub-trust arrangement will be acceptable to the Commissioner so that the beneficiary will not be taken to have made a loan to the Trust within the meaning of subsection 109D(3) of the Income Tax Assessment Act 1936. This private binding ruling applied for three income years.

In the income tax year ended 30 June 20XX, the trustee for Trust X acquired a commercial building (the property).

Additional funds were subsequently paid for improvements to the property prior to 30 June 20XX.

Total expenditure on the property was obtained from loan finance and an unpaid present entitlement (UPE) owing to Company Y, a Trust X beneficiary.

Additional funds were spent on further improvements to the property subsequent to 30 June 20XX.

The reason for purchasing the property in Trust X was to facilitate asset protection.

Trust X received an interim trust distribution from another Trust on 31 March 20XY. This trust distribution income was dealt with by the trustee of Trust X as a second UPE owing to Company Y.

The funds from the distribution were used to repay loan finance and finance improvements to the property.

A copy of the Trust Deed for Trust X was provided which lists the powers of the Trustee.

The Trust Deed includes a section relating to ‘Funds set aside form separate fund’ and is as follows:

On or before 31 March 20XY, the trustee of Trust X confirmed the first UPE was held by it as trustee on sub-trust for Company Y pursuant to the Trust Deed.

The sub-trust was set up in accordance with example 8 of paragraph 167 on pages 38 and 39 of TR 2010/3.

The terms of the sub-trust were as follows:

The terms of the sub-trust also applied to the second UPE that arose during the year ended 30 June 20XY.

The sub-trust continues to hold the annual returns on sub-trust and separate financial statements and income tax returns have been lodged for the sub-trust for three income years.

For the second income year, Trust X made a net loss in relation to the property, largely as a result of depreciation on the recently acquired property. For the third income year, Trust X made a net return on the property, which was recorded in the sub-trust financial statements and income tax return and has been paid by the trust in cash to Company Y before 15 May 20XA, the lodgement date of Trust X’s income tax return for the third income year. It is expected that similar returns will continue to be made on the investment in subsequent years.

Given that the funds the subject of the sub-trust were invested in land and buildings, it was envisaged that the sub-trust arrangement would continue until the investment of Company Y was withdrawn, i.e. until the land and buildings are eventually sold at which time Trust X would be able to repay the amount invested by the company in cash (providing the property is not sold at a loss, which at this stage appears unlikely).

As such, the original private binding ruling covered three income years.

As this arrangement is ongoing, the taxpayers are seeking a continuation of the ruling so that it will apply until the property is eventually sold and at least cover five more income years.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109D(1)

Income Tax Assessment Act 1936 Section 109D(3)

Reasons for decision

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

Guidance on the administration of TR 2010/3 is contained in Practice Statement Law Administration PS LA 2010/4 Division 7A: trust entitlements (PS LA 2010/4).

One of the purposes of Division 7A is to ensure that private companies are not able to make distributions of profits to shareholders (or their associates) in the form of non-arm's length loans instead of in the form of dividends that would be assessable to the shareholder. To achieve this purpose, subsection 109D(1) generally operates to treat such loans as assessable dividends of the relevant shareholders (or their associates) where:

TR 2010/3 considers in what circumstances a private company is taken to 'make a loan' (within the meaning of subsection 109D(3)) to the trustee of a trust, where:

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 the trust deed to make the beneficiary so entitled. 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). Trust property representing a UPE may be held on ‘sub-trust’ by the trustee for the beneficiary.

TR 2010/3 defines a sub-trust as being a separate trust arising in equity, in respect of which the private company is the sole beneficiary and upon which amounts that the private company is presently entitled to receive from another trust (called the main trust) are held.

TR 2010/3 explains the following in relation to sub-trusts:

Certain criteria need to be met to demonstrate that a valid sub-trust arrangement exists. In this regard, paragraph 55 of PS LA 2010/4 states that the Commissioner will consider that funds in a sub-trust are held for the sole benefit of a private company beneficiary where:

PS LA 2010/4 provides further detail as follows:

In this case, the trustee for Trust X (the Trustee) made a UPE in favour of Company Y (the Beneficiary) during both the income years ended 30 June 20XX and 30 June 20XY.

The Trustee held both UPE’s on sub-trust for the Beneficiary pursuant to the Trust Deed, effected in the income years ended 30 June 20XY and 30 June 20XZ respectively. The funds representing the UPE’s in the sub-trust have been invested in a commercial property.

The terms of the sub-trust are as follows:

From the information provided, it is evident that:

Therefore, the Commissioner considers that the funds in the proposed sub-trust will continue to be held for the sole benefit of the Beneficiary.

Consequently, the proposed sub-trust arrangement will continue to be acceptable to the Commissioner so that the Beneficiary will not be taken to have made a loan to the Trust within the meaning of subsection 109D(3) of the ITAA 1936.


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