Private ruling: Application of Division 7A
Published: July 2014
Ruling period: Income year ending 30 June 2014 | Income year ending 30 June 2015 | Income year ending 30 June 2016

Ruling: Q1: Does the entry into the Draft General Security Deed and the granting of the Charge (and its subsistence subsequent to its grant) cause or result in, for the purposes of Division 7A, the pre-16 December 2009 UPE being converted into (or replaced by) a loan from the Company to the Trust within the ordinary meaning of "loan" or within the extended definition of "loan" contained in section 109D(3) of Division 7A? | A1: No | Q2: Does the entry into the Draft Deed of Variation of UPE Investment Loan Agreement and the Draft General Security Deed and the granting of the Charge (and its subsistence subsequent to its grant) cause or result in, for the purposes of Division 7A, the 20XX, 20YY & 20ZZ UPE's, which is being held on Sub-Trust for the sole benefit of the Company, being converted into (or replaced by) a loan from the Company to the Trust within the ordinary meaning of loan or within the extended definition of loan contained in section 109D(3) of Division 7A? | A2: No | Q3: Does the entry into the Draft Deed of Variation of UPE Investment Loan Agreement and the Draft General Security Deed and the granting of the Charge (and its subsistence subsequent to its grant) cause or result in, for the purposes of Division 7A, an assessable dividend taken to have been paid by the Company to the Trust at the end of the Company's year of income in which the Charge is granted or any other income year? | A3: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The Trust was established by deed dated xx ("the Trust Deed"). The Specified Beneficiaries of the Trust Deed are the children of Mr and Mrs X. The Additional Members of the Class of General Beneficiaries include Mr and Mrs X in their own right; any corporation of which Mr or Mrs X is a Director or Shareholder; and any corporation of which at least one share is beneficially owned by Mr or Mrs X or their children. Mr X is the sole director and shareholder of Company A which makes the company an eligible "General Beneficiary" of the Trust under the Trust Deed. Clause 3 of the Trust Deed is titled " Trusts of Income ". Clauses 3.1 and 3.1.1 state: 3.1 The Trustee may at any time before the expiration of any Accounting Period with respect to all or any part or parts of the net income of the Trust Fund for such Account Period determine: 3.1.1 to pay apply or set aside the same to or for any one or more of the General Beneficiaries living or in existence at the time of the determination provided that any payment application or setting aside in favour of a General Beneficiary described in clause 1.9.3 hereof shall on the first occasion on which a payment application or setting aside is made to or for that General Beneficiary be subject to clause 11 hereof. Clause 3.5 of the Trust Deed states: 3.5 Any amount set aside for any beneficiary and any amount held by the Trustee in trust for any person pursuant to sub-clause 3.4 hereof shall cease to form part of the Trust Fund and upon such setting aside or becoming subject to such trust (as the case may be) shall thenceforth be held by the Trustee on a separate trust for such person absolutely with power to the Trustee pending payment over thereof to such person to invest or apply or deal with such fund or any resulting income or realised gain therefrom or any part thereof in the manner provided for in clause 6.5 hereof. Clause 6 of the Trust Deed is titled " Advances and Payments to Beneficiaries ". Clause 6.5 of the Trust Deed states: 6.5 [The Trustee may] invest any amount held by the Trustee as a separate trust pursuant to clause 3.5 hereof on behalf of the person entitled thereto by investing the same and the resulting income thereof in any of the investments hereby authorised and while any such person is under any legal disability at any time or times and from time to time in the Trustee's absolute discretion resort to such amount and the income thereof and pay apply or deal with the same or any part thereof in such manner as the Trustee in the Trustee's absolute discretion thinks fit for the benefit of such person in the terms of the powers contained in sub clauses 6.3 and 6.4 hereof. Company A has the following unpaid present entitlements (UPE's) to amounts from the Trust: • Pre 16/12/2009 UPE of $X • 20XX UPE of $X • 20YY UPE of $X • 20ZZ UPE of $X. Analysis of the balance sheet for Company A record these amounts as separate asset items described as "funds held in trust". Corresponding amounts are recorded in the balance sheet for the Trust which record the 20XX, 20YY and 20ZZ UPE amounts as liabilities being "Beneficiary Entitlements (7 year Sub-Trusts)" and the pre 16/12/2009 UPE as a current liability under the heading "Beneficiary Entitlements". Clause 7 of the Trust Deed is titled " Investments and Other Powers of the Trustee ". Clause 7.3 of the Trust Deed states that "[The Trustee shall have the…power] to borrow and raise moneys from any person whatsoever (including any beneficiary or Trustee) with or without security and on such terms and conditions as the Trustee shall think fit and to secure….howsoever….as the Trustee shall deem fit….and the Trustee may borrow or raise moneys to be used in deriving income or gain in augmentation of the Trust Fund notwithstanding that the Trust Fund may already be wholly invested or applied or that the moneys to be borrowed or raised may exceed the sum or value of the Trust Fund…" Clause 8 of the Trust Deed is titled " Transactions in Which the Trustee is Interested ". Clause 8.2 of the Trust Deed states that the "Trustee shall have the power at the Trustee's absolute discretion: 8.2 …to borrow any moneys from the Trustee in the Trustee's personal capacity or in the capacity of the Trustee as trustee or trustees of other trust funds or otherwise howsoever…." On dd/mm/yyyy an agreement was made between Company B in its capacity as Trustee of The Trust (hereafter referred to as "the Main Trust") (as Borrower) and Company B in its capacity as trustee of the sub-trust holding a UPE for Company A (hereafter referred to as "the Sub-Trust") (as Lender) (hereafter referred to as "the loan agreement"). Clause 1 of the loan agreement provides that the agreement was made in accordance with PSLA 2010/4 to regulate the investment of UPE amounts held by the Sub-Trust into the "Main Trust" by way of UPE loans. The term "UPE loan" is defined in the loan agreement as referring to an interest only loan by the Sub-Trust to the Main Trust of an amount being the funds representing a UPE arising in respect of an income year and includes any accrued but unpaid interest from time to time. In the agreement the Sub-Trust is defined as being the holding of the UPE by the Trustee of the Main Trust upon a separate trust arising in equity, in respect of which a private company is the sole beneficiary and upon which UPE amounts are held solely for the private company's benefit. Clause 5 of the loan agreement states that, unless a UPE Loan is expressly stated in the Tax Working Papers to be a UPE 10 Year Loan, all UPE Loans will be 7 Year Loans. Clause 7.1 of the loan agreement provides that the Borrower will repay any outstanding loan principal to the Lender the day immediately prior to the seventh anniversary of: • 30 June 20YY for the 20XX UPE; or • For all other UPE's arising after 30 June 20XX, the lodgement date of the Main Trust's tax return for the income year in which the UPE arose. The schedule to the loan agreement details that the interest rate payable on the 7 Year Loan will be the Benchmark Rate for the purposes of section 109N(2) of the ITAA 1936. On 30 June 20YY the Trustee resolved to put the funds representing the 20XX UPE payable to Company A on a 7 year loan from the Sub-Trust to the Main Trust in accordance with the loan agreement of dd/mm/yyyy. The Trustee made similar resolutions for the 20YY and 20ZZ UPE's on dd/mm/yyyy and dd/mm/yyyy respectively. As at dd/mm/yyyy the Main Trust had paid interest to Company A in respect of the Sub-Trusts. Additional interest has accrued in respect of the Sub-Trusts for the 20XX, 20YY & 20ZZ UPE's in accordance with the UPE Investment Loan Agreement for the income year ended 30 June 20VV. The taxpayer has advised that this will be paid to Company A by no later than the lodgement day for the Main Trusts 20VV income tax return. Company A has advised that they wish to secure the payment of all current and future UPE's from the Main Trust. The following draft documents have been prepared: • Draft Deed of Variation of UPE Investment Loan Agreement ("Draft Deed of Variation); and • Draft General Security Deed. The Draft Deed of Variation will, once executed, amend the UPE Investment Loan Agreement of dd/mm/yyyy to secure the payment of UPE Loans by: 1. Granting a security interest (ie charge) over the personal property of the Main Trust in favour of the sub-trust; 2. Granting a fixed charge over any other property of the Main Trust in favour of the Sub-Trust; and 3. Requiring the Main Trust to enter into a general security deed on terms required by the Sub-Trust. The Pre-16 December 2009 UPE is not covered by the UPE Investment Loan Agreement as it was not invested under the terms of the Agreement, therefore the proposed variations to the Agreement will not apply to secure payment of that UPE. The Draft General Security Deed grants a "Security Interest" (as defined by the Personal Properties Security Act 2009 (PPSA)) over all of the Main Trust's current and future "PPSA Personal Property" (as defined by the PPSA). The General Security Deed will apply to secure payment of the Pre-16 December 2009 UPE and will also register Company A's security interests in the Main Trust's Property for current and future UPE's.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A of Part III.

Reasons for decision: Summary: While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. As sole beneficiary of the relevant Sub-Trusts, Company A is solely entitled to any return received by the trustee of the Sub-Trusts from its investment back into the Main Trust. The UPE is being invested under terms where the full amount of the UPE and any benefit from its use, including interest on the loan, is held for Company A's sole purpose. The loan agreement meets the requirements under section 109N of the ITAA 1936. The Draft Deed of Variation of UPE Investment Loan Agreement and the Draft General Security Deed and the granting of the Charge (and its subsistence subsequent to its grant) do not change the nature of the UPE Investment Loan Agreement in relation to section 109N of the ITAA 1936. As such they do not cause or result in Company A being taken, under section 109D(1), to pay a dividend at the end of the year of income. | Detailed Reasoning - Detailed Reasoning: Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) deals with trust distributions to entities connected with a private company. It is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates). In particular, advances, loans and other payments or credits to shareholders (or their associates) are, unless they come within specified exclusions, treated as assessable dividends to the extent that a company has a distributable surplus. Section 109D of the ITAA 1936 deals with when loans are treated as dividends. Section 109D(1) provides when a private company is taken to pay a dividend to an entity at the end of a year of income in relation to a loan. Section 109D(3) provides an extended definition of what can constitute a 'loan' for the purposes of Division 7A. A beneficiary can become presently entitled to an amount from a trust pursuant to a direct term of the relevant trust deed, or as a result of the trustee of the trust exercising a power under a trust deed to make the beneficiary so entitled (usually by resolution). In these situations the funds to which the beneficiary is made presently entitled can remain unpaid and continue to be held on trust for that beneficiary until such time as the beneficiary calls for actual payment of the amount. This entitlement is commonly referred to as a UPE. Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements (TR 2010/3) expresses the Commissioner's opinion on circumstances in which a private company with a UPE from an associated trust estate makes a 'loan' to that trust within the meaning of subsection 109D(3), in circumstances where funds representing that UPE remain intermingled with funds of the trust. Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements (PSLA 2010/4) provides guidance on the administration of TR 2010/3. Paragraph 11 of PSLA 2010/4 states that a subsisting UPE 1 is not a loan within the ordinary meaning of loan but may be a loan under the extended definition of a Division 7A loan if it is the provision of financial accommodation or an in-substance loan. TR 2010/3 introduces an entity called a " sub-trust " which is defined as being a separate trust arising in equity, in respect of which a private company is the sole beneficiary and upon which UPE amounts are held solely for the private company's benefit. Paragraph 14 of PSLA 2010/4 provides that a UPE will not be considered a loan if funds representing the UPE are held on sub-trust for the sole benefit of the private company beneficiary. Paragraph 58 provides that the ATO will consider that the funds in the sub-trust are held for the sole benefit of the private company beneficiary if the funds are invested in the main trust using one of the following investment options: • Option 1 - invest the funds representing the UPE on an interest only 7-year loan (where the trustee must pay an annual return on the funds equal to the benchmark interest rate); • Option 2 - invest the funds representing the UPE on an interest only 10-year loan (where the trustee must pay an annual return on the funds equal to the Prescribed interest rate); • Option 3 - invest the funds representing the UPE in a specific income producing asset or investment. Section 109N of the ITAA 1936 provides that a private company that makes a loan to an entity is not taken to pay a dividend under section 109D in relation to a loan if, before the lodgement day for the year of income: a) There is a written loan agreement; and b) The rate of interest payable on the loan for years of income after the year in which the loan is made equals or exceeds the benchmark interest rate for the year; and c) The term of the loan does not exceed the term for that kind of loan as defined under section 109N(3). | Detailed Reasoning - Application to circumstances: The Trustee has made distributions to Company A for the 20XX, 20YY & 20ZZ income years. As at the date of this ruling the distributions are subsisting UPE's. The UPE's have been held in Sub-Trusts as per the Main Trust Deed and are held for the sole benefit of Company A. The Sub-Trusts have then loaned the funds back to the Main Trust under an investment agreement which provides that interest is paid to the Sub-Trust and that the principal must be repaid to the Sub-Trust within 7 years of the date of the loan. All of the income earned on the funds loaned back to the Main Trust is applied for the purposes of Company A as sole beneficiary, and the interest is repaid back through the Sub-Trust. Company A is the sole beneficiary of the Sub-Trusts and is solely entitled to any return received by the trustee of the Sub-Trust from its investment back into the Main Trust. The loan agreement meets the criteria for minimum interest rate and maximum loan term under Section 109N of the ITAA 1936. As such Company A is not taken to pay a dividend because of the loan under Section 109D. The Draft Deed of Variation amends the UPE Investment Loan Agreement of dd/mm/yyyy to secure the payment of UPE Loan by granting security interests over the assets of the Main Trust. The changes to the loan agreement that will occur after execution of the Draft Deed of Variation do not change the nature of the subsisting UPE's for the 20XX, 20YY & 20ZZ years and do not cause Company A to be deemed to pay a dividend under Section 109D because of the loan agreements. The Pre-16 December 2009 UPE is not covered by the loan agreement. Paragraphs 16 to 26 of TR 2010/3 provides the Commissioner's view of when a subsisting UPE may be a loan for the purpose of Division 7A, however these do not apply to UPE's arising before 16 December 2009 due to public statements that the Commissioner of Taxation made prior to issuing this Ruling in draft form as TR 2009/D8 on 16 December 2009. Per paragraph 29 of TR 2010/3, those previous public statements evidenced a prior general administrative practice contrary to that outlined in paragraphs 16 to 26 of TR 2010/3, including a fact sheet published prior to February 2009 that advised that the retention on trust of a UPE was not a loan for Division 7A purposes. The Pre-16 December 2009 UPE is a subsisting UPE and there is no evidence that Company A has made an ordinary loan to the Main Trust in relation to this UPE. The Draft General Security Deed merely grants a "Security Interest" (as defined by the Personal Properties Security Act 2009 (PPSA)) over all of the Main Trust's current and future "PPSA Personal Property" (as defined by the PPSA). It does not cause or result in, for the purposes of Division 7A, the Pre-16 December 2009 UPE being converted into (or replaced by) a loan from Company A to the Main Trust within the ordinary meaning of "loan" or within the extended definition of "loan" contained in section 109D(3) of the ITAA 1936. 1 A subsisting UPE means a UPE that has not been satisfied by being paid out, or being converted into (or replaced by) an ordinary loan.

Reasons for decision: These reasons for decision accompany the Notice of private ruling for The Group.