Birchstone Brief for the week ended 22 July 2022

Dan’s Deliberations

Sub-trusts are dead!

On 13 July 2022, the ATO finalised its tax determination (TD 2022/11) which sets out the Commissioner’s view on when an unpaid present entitlement (UPE) constitutes the provision of financial accommodation for Division 7A purposes (and therefore is a loan for Division 7A).

Those of you that have been following the saga of the application of Division 7A to UPEs will know that the ATO first released guidance on this issue back in 2009 (finalised as TR 2010/3 and PS LA 2010/4) that a UPE owing from a trust to a corporate beneficiary is a loan for Division 7A purposes unless held on sub-trust, and provided some options on what would be an acceptable sub-trust arrangement. The now common 7-year and 10-year interest free loans were 2 of the 3 acceptable options provided by the ATO. It is these sub-trust arrangements that will no longer be acceptable.

From 1 July 2022, only the most vanilla sub-trust arrangements remain acceptable (i.e. funds kept in a separate bank account for the sole benefit of the corporate beneficiary). As such, UPEs to corporate beneficiaries will either need to be paid in cash to the corporate beneficiary or put on a complying 7/25 Division 7A loan agreement (which requires the repayment of principal as well as interest). We’ll still see the 7/10 year interest free loans remaining in the system for some time though, as these have been effectively grandfathered and are allowed to run their course (and then can be converted to complying Division 7A loans at the end of their term – see PCG 2017/13 for that one).

On a more positive note, the ATO has backflipped on their view (set out in draft TD 2022/D1) on the time at which a UPE will become a loan for Division 7A purposes. The draft required a distinction between whether the beneficiary was entitled to a fixed dollar amount from the trust or a calculated amount (e.g. X% or the balance of the trust’s income). The final version abandons this distinction and instead concludes that the UPE will generally become a loan in the following financial year, regardless of how it is expressed.

The new ATO view on sub-trusts is reminiscent of the changes proposed in the 2018 Treasury Consultation Paper on targeted amendments to Division 7A. Where those reforms now sit following a change of Government is unclear, but the ATO has gone part way to achieving the effect of those reforms so far as UPEs to corporate beneficiaries are concerned. Sub-trusts are dead.

ATO Updates

Taxpayer Alert on treaty shopping arrangements

Taxpayers should be aware that the ATO is currently reviewing treaty shopping arrangements designed to obtain the benefit of a reduced withholding tax (WHT) rate under a double-tax agreement (DTA) in relation to royalty or dividend payments made from Australia, as stated in TA 2022/2.

Such a benefit is usually sought through the interposition of one or more related entities (in  treaty partner jurisdictions) between an Australian resident and the ultimate recipient of a royalty or dividend (which is usually located in a jurisdiction that does not have a DTA with Australia or has a DTA with a less favourable treaty benefit than the jurisdiction in which the interposed entities are located).  

The ATO is concerned some taxpayers have entered into, or may be considering entering into, such arrangements for the principal or main purpose of obtaining a treaty benefit to which they would not otherwise be entitled. The ATO contends such taxpayers may not be entitled to benefit from the relevant DTAs due to the operation of anti-avoidance rules such as:

• a Principal Purposes Test contained in some of Australia’s DTAs or in Article 7(1) of the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting;
• a Main Purposes Test contained in the dividend and royalty articles of a number of Australia’s other DTAs; or
• the general anti-avoidance rule and/or the diverted profits tax in Pt IVA of the ITAA 1936.

The consequence of one of these anti-avoidance rules applying is that the reduced WHT rate under the relevant DTA is denied and the Australian domestic rate of WHT is imposed in its place. Penalties may also apply to participants in and promoters of treaty shopping arrangements.

The ATO encourages taxpayers who have entered into (or are considering entering into) a treaty shopping arrangement to discuss their situation with them.

Class Rulings issued

The ATO has issued the following class rulings:

• CR 2022/65 – National Australia Bank Ltd – NAB Capital Notes 6; and
• CR 2022/66 – Amalgamated Australian Investment Group Ltd – Demerger of Halo Technologies Holdings Ltd.

Legislation

Exposure drafts of remade ACNC regulations released

The Treasury has released Exposure Draft Regulations which propose to remake the Australian Charities and Not-for-profits Commission Regulation 2013 (Cth) (which are due to automatically sunset on 1 April 2023) as the Australian Charities and Not-for-profits Commission Regulations 2022 (Draft Regulations). The Draft Regulations contain minimal substantive changes, with any amendments having been made to reflect current drafting practices, improve clarity, and remove provisions that are no longer required.