Your Unpaid Trust Entitlements Could Be Taxed

Your Unpaid Trust Entitlements Could Be Taxed

On July 13 2022, the ATO finalised a Determination that changes how they view unpaid present entitlements (UPE) sitting in a trust with a private company beneficiary. In short, it now views them as a loan from the company to the trustee, requiring a complying loan agreement to avoid a tax liability.

This explanation is simplified to give you a general picture so you can decide if you need to find out more. In particular, the sub-trust arrangements mentioned below have layers of complexity, so if that applies to you, contact us to talk you through it.

The ATO has determined that if you let what they call an Unpaid Present Entitlement (UPE) sit in your trust rather than actually paying it out in cash, the beneficiary of that UPE is effectively lending it to the trustee.

You create a UPE when your company is entitled to a share of the income from your trust and you:

  • Let that entitlement remain unpaid so it is still held by the trust, or
  • You set aside an amount from the main trust and hold it on a new separate trust (sub-trust) for the company.

If your company does this, the ATO considers it to be a type of financial accommodation to the trust as shareholder or to the trust’s associate. Financial accommodation is the term in legislation that the ATO has determined now applies to this situation.

A company that has a UPE provides financial accommodation to the trustee when the company:

  • Knows it can demand immediate payment of an entitlement from the trustee
  • Consents to the trustee retaining the amount and using it for its own purposes, and
  • Fails to demand payment of the amount.

What Happens if you Provide Financial Accommodation?

The ATO holds that your company will have made a loan to the trustee under Division 7A of the Income Tax Assessment Act. You may be familiar with this Division applying to companies that make loans to their directors. In this case it results in similar problems.

It means that your trustee and the beneficiary company will need to manage the loan on complying terms, or the trust will have to repay the loan. This requires a written loan agreement, annual repayments of principal and interest and at most a seven-year term. If the loan is secured by a mortgage, the term can be up to 25 years.

Deemed Dividend If Not Treated As A Loan

If you have a UPE that meets these criteria, and you don’t put a complying loan arrangement in place, the ATO may deem the UPE amount as a dividend from the company to the trustee shareholder. That may create a tax liability for the trust. Not good.

UPEs for a Company after 1 July 2022

Thankfully, all this only applies to Unpaid Present Entitlements for companies that arise on or after 1 July 2022. There are some tweaks and grandfathering for specific circumstances. For example, if a UPE arose before 16 December 2009, this doesn’t apply at all. The superseded UPE rules apply from then up to 1 July 2022.

When and How Will It Apply?

In the Determination, the ATO held that an entitlement can only arise after the Financial Statement accounts are finalised for the year. So an entitlement for 2022-2023 year can only be known after the accounts are done in July/August 2023. If that entitlement is unpaid, only then will the company provide financial accommodation to the trustee. That is, sometime in the following tax year, 2023-2024.

What this means is we have plenty of time to sort it out with a loan agreement if necessary.

What Should You Do?

Review your trust arrangements and if you are not sure of your situation, contact us well before year end for effective Tax Planning.

If you have or are considering sub-trust arrangements, it’s even more important to contact us now, because these changes limit the benefits to sub-trusts.

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