When does a UPE become a Div 7A UPE issue?
Div 7A UPE Issue
A trust declares a distribution to a company but doesn’t pay. So the trust now has a UPE liability against the company. And the company has a UPE receivable against the trust. When does this UPE become a Div 7A UPE issue?
This is the question we asked Andrew Henshaw of Velocity Legal in Sydney. Here is what we learned. But please listen to Andrew himself. He explains this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a podcast app on your mobile phone.
UPE
For over 12 years – from 1997 until December 2009 – a discretionary trust used to be a good way around Div 7A. You would run the business through a discretionary trust and then distribute some of the profits to individual beneficiaries – just enough to take advantage of the lower tax brackets – and the rest to a bucket company.
The bucket company would then pay 30% tax (now 27.5%) on that distribution, but never pay a dividend.
The trust would keep the cash as working capital. And Div 7A could do nothing about it as long as the money didn’t find its way into the hands of a shareholder.
TR 2010/3
But on 16 December 2009 all this changed. The ATO came out with draft ruling TD 2009/D8 that later became TR 2010/3. And in this ruling the ATO argues that most UPEs would be financial accommodation in the form of a loan from the company to the trust.
Whenever a shareholder of the bucket company is also a beneficiary of the trust, these two entities become associates in the eyes of the ATO, and hence push the UPE into Div 7A territory.
Control
Even if the shareholders of the corporate trustee and the shareholders of the bucket company are different, there is usually common control. There are exceptions where this is not the case, but these are rare.
The ATO argues that in most of these arrangements the bucket company and the trust are ultimately controlled by the same people. There is generally one person pulling the strings, and so the company and trust are associates.
Payment
Before TR 2010/3 an UPE was ok as long as the money was not paid to a shareholder. But now – since 16 December 2009 – the existence of the UPE itself is the problem if the shareholder is also a beneficiary of the trust.
Solutions
There are several options to fix this issue. The simplest is the trust pays the money to the bucket company’s bank account. Problem solved, the UPE has been paid.
Or the trust buys an asset on behalf of the company and holds it in a sub-trust arrangement for the sole benefit of the company.
Or the trust and company enter into a compliant loan agreement either over 7 years or – with a mortgage – over 25 years.
Summary
So whenever a trust makes a distribution to a company and doesn’t pay, you have a Div 7A problem if a shareholder is also a beneficiary of the trust.
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Last Updated on 01 May 2020
Tax Talks spoke to Andrew Henshaw - Director at Velocity Legal - for more details.
