The way that unpaid present entitlements (‘UPEs’) to ‘bucket’ companies were dealt with by trusts was completely overhauled by the ATO from 16 December 2009 when it released Taxation Ruling TR 2010/3 and the accompanying PS LA 2010/4.
In accordance with the ATO’s views, UPEs owing to ‘bucket’ companies will be treated as a loan to the trust for Division 7A purposes, where the UPE remains outstanding by the time the trust lodges its tax return for the year in which the distribution was made.
Specifically, the ‘bucket’ company will be taken to have ‘loaned’ the funds representing the UPE to the trust, which will constitute the provision of ‘financial accommodation’ under the extended definition of a ‘loan’ for Division 7A purposes.
One of the options available to the trust in order to avoid a deemed dividend in these circumstances is to enter into a sub-trust arrangement, as provided for in PS LA 2010/4.
Of the three ‘safe harbour’ options of sub-trust arrangements provided by the ATO, Option 1 provides that the sub-trust ‘invests’ the UPE funds by way of a seven-year interest only loan to the main trust.
Payments of interest calculated with reference to the Division 7A benchmark interest rate are physically required each year by the main trust’s lodgment day.
The final interest payment must be made together with the repayment of the principal when it is due.
Significantly, once the current sub-trust arrangement matures, it ceases to exist and, therefore, cannot be rolled into a new sub-trust arrangement.
As the sub-trust arrangements are progressively maturing, the ATO has provided concessional treatment to avoid a deemed dividend from being triggered if a trust fails to comply with the principal repayment requirement.
The concessional treatment applies to sub-trust arrangements entered into on, or before, 30 June 2012, which may mature in either the 2017, 2018 or 2019 income year.
Furthermore, the ATO has warned that the concessional treatment is only afforded to genuine sub-trust arrangements entered into, and maintained, in good faith.
If the surrounding facts and circumstances indicate that there has never been an intention to repay the sub-trust principal at the end of the sub-trust arrangement, then the arrangement will not be considered to be genuine.
In fact, where this is the case, the ATO may conclude that the arrangement is a sham, or that there was fraud or evasion.