Edited version of private advice

Authorisation Number: 1012626115046

Ruling

Subject: Division 7A

Question 1

Will any post 16 December 2009 unpaid present entitlements (UPEs) that arise from 1 July 2011 between the Unit Trust and any of its unit holders constitute a loan for the purpose of subsection 109D(3) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

This ruling applies for the following periods:

Income years ended 30 June 2012 to 30 June 2017.

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The Unit Trust is an Australian resident fixed unit trust, in which the unit holders have fixed entitlements to all of the income and capital of the trust.

The unit holders of the Unit Trust are private companies in their capacity as trustees of other investment and/or discretionary trusts.

All units on issue in the Unit Trust comprise one class and each unit has equal value.

The Unit Trust's post 16 December 2009 UPEs are on a proportionate basis in accordance with the number of units held by the unit holders.

The post 16 December 2009 UPEs only represent UPEs that arose in the income year ended 30 June 2012, with the post 16 December 2009 UPEs that arose in the income years ended 30 June 2010 and 30 June 2011 being fully repaid.

As part of the Unit Trust's banking covenants, it is required to retain a percentage of its annual net profit, meaning that it is only permitted to pay cash to the unit holders equal to the remaining percentage of its annual net profit.

All cash received by the unit holders is applied on a first-in-first-out basis to the post 16 December 2009 UPEs owing by the Unit Trust.

Whilst the Unit Trust was not profitable in the income year ended 30 June 2013, it is expected to be profitable in the 30 June 2014 and future income years.

All of the assets of the Unit Trust are invested for commercial purposes, whereby a commercial business is operated. The unit holders or related parties have not borrowed any amounts from the Unit Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 109D(3)

Reasons for decision

Summary

Any post 16 December 2009 UPEs that arise from 1 July 2011 between the Unit Trust and any of its unit holders will not constitute a loan for the purpose of subsection 109D(3) of the ITAA 1936.

Detailed reasoning

Subsection 109D(3) of the ITAA 1936 extends the definition of a loan for the purposes of Division 7A of the ITAA 1936 beyond its ordinary meaning (Division 7A loan) as follows:

109D(3) What is a loan?

In this Division, loan includes:

(a) an advance of money; and

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

(c) a payment of an amount for, 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 (whatever its terms or form) which in substance effects a loan of money.

As per paragraph 18 of Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements, the Commissioner is of the view that, in some circumstances, UPEs that arise on or after 16 December 2009 can amount to a Division 7A loan under paragraphs 109D(3)(b) or 109D(3)(d) of the ITAA 1936.

Paragraphs 19 to 25 of TR 2010/3 provide a detailed explanation of when a private company provides financial accommodation or makes an in substance loan, with paragraphs 19 and 25 in particular stating:

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.

…

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

Of relevance, is whether or not there has been (or will be) the supply or grant of some form of pecuniary aid or favour to the Unit Trust by its unit holders.

As per ATO Interpretative Decision ATO ID 2012/74 Income Tax Division 7A: unpaid present entitlements between a unit trust and unit holders, the Commissioner is of the view that the unit holders of a fixed trust will not be supplying or granting some form of pecuniary aid or favour to the trust, and therefore not providing a Division 7A loan under subsection 109D(3) of the ITAA 1936, in the following circumstances:

• All the UPEs are in proportion to the number of units held by the unit holders.

• The unit holders have collectively agreed that all profits are to be retained in the trust for trust purposes.

• This means that the unit holders have collectively agreed to defer receiving their share of profit for the relevant years in favour of an entitlement to receive a return equal to their respective share of funds.

• This is premised on the notion that all future profits (both capital and income) will also be distributed in accordance with the trust deed.

• As such, each of the unit holders will be entitled to receive a return commensurate with the funds that they allow the trustee to use for their sole benefit.

When the principles of ATO ID 2012/74 are applied to the relevant facts provided:

• All of the post 16 December 2009 UPEs are and will be in proportion to the number of units held in the Unit Trust by the unit holders.

• The unit holders have collectively agreed that a specified percentage of profits be retained in the Unit Trust for trust purposes, which in this case is to satisfy the trust's banking covenants.

• This means that the unit holders have agreed to defer receiving the specified percentage of their share of profit for the relevant income years in favour of an entitlement to receive a return equal to their respective share of funds.

• This is premised on the notion that all future profits (both income and capital) will also be distributed to the unit holders in accordance with the Unit Trust's trust deed (i.e. their respective fixed entitlements to all of the income and capital of the trust).

• As such, each of the unit holders will be entitled to receive a return commensurate with the funds that they allow the Unit Trust's trustee to use for their sole benefit.

In conclusion, the Commissioner is of the view that with respect to any post 16 December 2009 UPEs that arise from 1 July 2011 between the Unit Trust and its unit holders:

• the unit holders will not be supplying or granting some form of pecuniary aid or favour to the Unit Trust, and

• the unit holders will therefore not be providing Division 7A loans to the Unit Trust under subsection 109D(3) of the ITAA 1936.