Tax Bites: Putting UPEs on sub-trust terms

As we are now all aware, via tax ruling TR 2010/3, the ATO has outlined its position that a UPE from a trust to a corporate beneficiary represents a loan for the purposes of Division 7A of the Income Tax Assessment Act 1936.  In TR 2010/3 however, the ATO provide specific exclusion for UPEs created prior to 16 December 2009 which have not otherwise been converted to ordinary loans.

In PSLA 2010/4 which was issued at the same time as TR 2010/3, the ATO then outline mechanisms for UPEs to be put on complying terms to avoid them being treated as deemed unfranked dividends under Division 7A.  The mechanisms are to put the UPE on complying sub-trust terms, or to put the UPE on complying Division 7A terms.

In PSLA 2010/4, the 3 types of complying sub-trust arrangement outlined are (i) 7 year interest only loan (at the Division 7A benchmark interest rate); (ii) 10 year interest only loan (at the Reserve Bank of Australia’s indicator lending rate for small business variable overdrafts); or (iii) invest the UPE in a specific income producing asset or investment.

Where a sub-trust arrangement is being used in relation to UPE arrangements to comply with PSLA 2010/4, it needs to be remembered that the sub-trust remains as a UPE and is not being converted to a loan from the corporate beneficiary back to the trust.  What this means is that notwithstanding the UPE is on complying sub-trust terms, Subdivision EA of Division 7A still applies where the trust provides loans or payments to shareholders or associates of shareholders of the corporate beneficiary.  Effectively, Subdivision EA can still treat any loans or payments from the trust to a shareholder or associate of a shareholder of the corporate beneficiary as a deemed unfranked dividend.  This issue is specifically raised in paragraph 106 of PSLA 2010/4.

In comparison, where the UPE from the trust to the corporate beneficiary is converted to a loan and put on complying Division 7A terms, Subdivision EA of Division 7A cannot apply as there is no UPE in existence.  Furthermore, in determining whether any loans or payments from the trust to a shareholder or associate of a shareholder of the corporate beneficiary could be subject to the interposed entity arrangement provisions in Division 7A by reason of the trust having a loan payable to the corporate beneficiary, TD 2011/16 confirms that the interposed entity arrangement provisions will not result in any adverse tax outcome where the loan from the corporate beneficiary to the trust is on complying Division 7A terms.

If you have any further questions, please do not hesitate to contact Tim Olynyk on (03) 9810 0700 or at t.olynyk@banksgroup.com.au.

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