Private ruling: Division 7A – financial accommodation – sub-trust arrangement
Date of advice: 30 January 2019
Published: May 2019
Ruling period: Year of income ended 30 June 2019 | Year of income ended 30 June 2020 | Year of income ended 30 June 2021 | Year of income ended 30 June 2022 | Year of income ended 30 June 2023
Date scheme commenced: 1 July 2018

Ruling: Q1: Do the sub-trust arrangements entered into by the trustee of the Head Trust in relation to all post 16 December 2009 unpaid present entitlements owing to the private company beneficiary ensure that the private company beneficiary does not provide financial accommodation to the trustees for the trust for the purposes of the extended meaning of ‘loan’ in subsection 109D(3) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: Yes

Relevant facts and circumstances: The trustees for the main trust acquired a parcel of land on which a building was constructed. The purchase of the land and subsequent construction of the building was financed by way of: ● unpaid present entitlement (‘UPE’) amounts owing to an associated private company beneficiary, where those UPEs arose before and after 16 December 2009, and ● a commercial bill facility. As at 30 June 2017, the main trust had UPEs owing to the private company beneficiary consisting of a pre 16 December 2009 UPE amount, and post 16 December 2009 UPE amounts which arose during several income years. A lease agreement has been entered into between the trustees for the main trust and an associated entity (which carries on a business under a business name) for an annual rental. All the post 16 December 2009 UPE amounts have been placed on a sub-trust arrangement. The terms of the sub-trust are: ● The sub-trust will be paid a percentage of the net rent and other investment income of the main trust before the interest expense applicable to the commercial bill facility is taken into account. This percentage will be equal to the proportion of the amount invested by the sub-trust compared to the other sources of funding for the main trust. This percentage return will be paid in cash to the sub-trust, and in turn to the private company beneficiary by the lodgement due date for the income tax return for the main trust for each applicable income year. ● On withdrawal of the investment, the sub-trust and in turn the private company beneficiary will be paid an amount equal to the principal of the sum originally invested. ● Separate financial statements and income tax returns will be prepared for the sub-trust for each applicable income year. Following repayment of the commercial loan, trust distributions from the head trust to the beneficiary company are now paid in cash by the due date for lodgement of the trust’s income tax return following the year in which the trust distribution is made. Because the funds that are the subject of the sub-trust arrangement were invested in land and buildings, the sub-trust arrangement will continue until the investment of the beneficiary company is withdrawn, that is, until the land and buildings are eventually sold. At this time the head trust will have sufficient funds to enable it to repay the UPE amounts invested by the company.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 Section 109D(1) | Income Tax Assessment Act 1936 Section 109D(3) | Income Tax Assessment Act 1936 Section 109N

Reasons for decision: Summary: Summary As a result of the sub-trust arrangement entered into by the trustees of the Head Trust, there is no provision of financial accommodation between the private company beneficiary and the trustee for the purposes of subsection 109D(3) of the ITAA 1936. Detailed reasoning Division 7A of Part III of the ITAA 1936 (Division 7A) operates to treat certain loans and other payments made by a private company to a shareholder or their associate as assessable income (unfranked dividends) of the shareholder or associate. Section 109D provides that where a private company makes a loan to a shareholder or their associate in an income year, and the loan is not fully repaid by the lodgement day of that income year, the loan is taken to be a dividend paid to the shareholder or their associate at the end of that income year, unless the provisions in subdivision D of Division 7A prevent the loan from being treated as a dividend, including entering into a complying loan agreement under section 109N. For the purposes of Division 7A, a loan includes ‘the provision of credit or any other form of financial accommodation’ (paragraph 109(3)(b)). As discussed in Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements , financial accommodation includes where there is an unpaid present entitlement (UPE) and a consensual agreement between the private company beneficiary and the trustee of the trust that: ● the private company supplies or grants some form of pecuniary aid or favour to the trust; and ● a principal sum or equivalent is ultimately payable to the private company (paragraph 19). As explained in TR 2010/3, by not calling for payment of its present entitlement to trust income, the private company beneficiary is effectively allowing the trustee to use those funds for trust purposes. As such, there is effectively a loan of money from the company to the trustee of the trust. However, where funds representing the UPE are held on sub-trust by the trustee for the sole benefit of the private company beneficiary, the Commissioner accepts that there is no financial accommodation for the purposes of subsection 109D(3) and Division 7A will have no application. As outlined in Law Administration Practice Statement PS LA 2010/4 Division 7A: trust entitlements , the Commissioner accepts that a valid sub-trust arrangement exists where: ● there is a resolution by the trustee to set aside the UPE funds for the sole benefit of the private company beneficiary ● the sub-trust maintains separate accounts ● the funds representing the sub-trust are invested on commercial terms with all benefits from the investment flowing back to the sub-trust and the private company beneficiary ● all the benefits (for example the annual return on investment) are paid to the private company beneficiary by the lodgement day of the tax return of the main-trust for the year in which the return arises. In the current case: ● A written sub-trust agreement has been entered into between the trustee of the Head Trust and the private company beneficiary in relation to each of the UPE amounts. ● The funds representing the UPE amounts have been invested in the Head Trust on commercial terms. ● Separate financial statements are prepared and income tax returns lodged for the sub-trust. ● The annual returns on the sub-trust investment are paid in cash to the private company beneficiary by the lod gement day of the tax return for Head Trust. ● The sub-trust arrangement will continue until the principal of the investments made (that is, the funds representing the UPE amounts) are repaid to the sub-trust and in turn to the private company beneficiary. ● The funds that are the subject of the sub-trust arrangement are invested in land and buildings. These funds will be repaid in full, once the land and buildings are eventually sold. At this time the Head Trust will have sufficient funds to enable it to repay the UPE amounts invested by the beneficiary company. Therefore, the Commissioner accepts that the sub-trust arrangement is in accordance with TR 2010/3 and the UPE amounts that have been placed under the sub-trust arrangement will not be financial accommodation under paragraph 109D(3)(b), and accordingly not a loan to which Division 7A will apply.