The ATO has published its final tax determination regarding the application of Division 7A to trust entitlements arising on or after 1 July 2022.
This revised view, which replaces the now withdrawn TR 2010/3 and PS LA 2010/4, brings all UPEs to corporate beneficiaries within Division 7A and no longer accepts interest-only sub-trust arrangements for new UPEs. Following consultation with Pitcher Partners, the ATO has simplified the timing rules that were proposed in the draft determination such that in almost all cases, a UPE will be considered to give rise to the provision of financial accommodation in the income year following the conferral of the entitlement.
What are the rules about?
The ATO released draft Taxation Determination TD 2022/D1 (“draft TD”) on 23 February 2022 setting out their proposed revised view on the application of Division 7A to UPEs to corporate beneficiaries.
Refer to our earlier bulletin (click here) for further information.
In summary, the ATO set out two circumstances in which trust distributions to corporate beneficiaries give rise to the provision of financial accommodation, and thus a Division 7A loan, by the company:
- Circumstance one (UPEs) – the failure of a corporate beneficiary to demand payment of an unpaid trust entitlement gives rise to the provision of financial accommodation to the trust.
- Circumstance two (sub-trust) – where the trust sets the corporate beneficiary’s entitlement aside on separate sub-trust there is no UPE, but the use of those sub-trust funds by an associated entity (e.g. the main trust) constitutes the provision of financial accommodation from the company to the user of the sub-trust funds.
This approach broadly remains unchanged in the final determination Tax Determination TD 2022/11 (“final TD”).
What was the timing of the Division 7A loan under the draft TD?
The position taken in the draft TD was that the corporate beneficiary provided financial accommodation (that is, made a loan within the meaning of Division 7A) when the beneficiary had knowledge of the amount of its entitlement.
Where the trust resolution used a fixed amount of trust income, the draft TD stated that this would give rise to the immediate provision of financial accommodation (i.e. in the same year as the present entitlement).
Where the trust resolution used a percentage, of trust income, the draft TD stated that this would give rise to the provision of financial accommodation at a later point in time once the amount of the entitlement was ascertained (i.e. generally in the year following the year of the present entitlement).
What is the final view of timing?
Following submissions made by Pitcher Partners, ATO representatives consulted and were receptive to the concerns raised regarding the dual approach to timing. The final TD takes a simpler and more uniform approach to timing by concluding that, other than in limited circumstances, the relevant Division 7A loan will arise in the income year following the year to which the trust distribution relates.
For example, even if a trust resolves to distribute $100,000 to a corporate beneficiary on 30 June 2023, it may ultimately turn out that the trust has expenses for the year (or will incur further expenses for the year) such that it will not have $100,000 of income to distribute. As such, the company can only take action to provide financial accommodation in respect of its entitlement once accounts are finalised and it has a reasonable opportunity to call for payment which will typically be after year-end.
The limited circumstances where the financial accommodation is said to be provided in the same year as the entitlement are where the corporate beneficiary’s entitlement is known and it could have demanded payment of the amount before the end of the income year. As examples of this, the final TD mentions situations where a trust is wound-up mid-year or otherwise ceases operations mid-year and distributes income during the year in the course of doing so.
This final view and the ATO’s approach to public consultation is welcome and significantly simplifies compliance with Division 7A for the 2022-23 and later income years.
What are the next steps?
Clients should contact their Pitcher Partners representative to review their existing arrangements and determine what action is required in light of the changes.
While TR 2010/3 and PS LA 2010/4 were withdrawn with effect from 1 July 2022, these continue to apply to present entitlements created on or before 30 June 2022 with PCG 2017/13 applying to allow for the potential refinancing of any option 1 and option 2 maturing sub-trust arrangements.
The 2022-23 income year is the first year for which the final TD will apply and further guidance and supporting materials will be provided during the income year to support clients in complying with the new ATO view.