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.