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Division 7A just got Scarier! Tim Olynyk Taxation Partner Banks Group Pty Ltd

Division 7A just got Scarier! Tim Olynyk Taxation Partner Banks Group Pty Ltd. 16/12/2009. Relevant Documents. TR 2009/D8 TR 2010/3 PSLA 3362 (draft) WATCH THIS SPACE!. ATO View (Historically). The ATO had always accepted that a UPE was not a loan.

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Division 7A just got Scarier! Tim Olynyk Taxation Partner Banks Group Pty Ltd

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  1. Division 7A just got Scarier! Tim Olynyk Taxation Partner Banks Group Pty Ltd

  2. 16/12/2009

  3. Relevant Documents • TR 2009/D8 • TR 2010/3 • PSLA 3362 (draft) WATCH THIS SPACE!

  4. ATO View (Historically) • The ATO had always accepted that a UPE was not a loan. • Separate set of rules were introduced (109UB and then Subdivision EA) that related specifically to UPEs’.

  5. ATO View • The ATO are (NOW) of the view that in most instances, UPE’s outstanding to a related party corporate beneficiary will be re-characterised as loans. • Why? • ATO are of the view that a UPE is a form of financial accommodation.

  6. UPE’s created pre – 16 December 2009 • Change in position from draft ruling. • The ATO has allowed taxpayers to quarantine pre – 16 December 2009 UPE’s provided the UPE has not already been converted into a loan. • Accounting treatment of UPE’s is critical to ensure UPE is not converted to a loan.

  7. UPE’s created pre – 16 December 2009 • When will a UPE have already been converted into a loan? • Express or implied loan agreement • Terms of written agreement, terms of Trust Deed or terms of Resolution Minute are forms of Express Agreement. • Accounting Treatment is a form of Implied Agreement

  8. UPE’s created pre – 16 December 2009 IMPORTANT • Does the Trust Deed facilitate the trustee “setting aside” income for beneficiaries? • MOST should but worth checking.

  9. UPE’s created pre – 16 December 2009 • If terms of Trust Deed allow Trustee to pay apply or set aside income and there is evidence from the resolution that moneys have been set aside for the benefit of the beneficiary, this will represent a UPE rather than a loan – even if incorrect accounting treatment. • If Resolution is not specific, could open up the door if accounting treatment is wrong.

  10. UPE’s created pre – 16 December 2009 • If the UPE is recognised in the liability section of the trust, it is critical that it be correctly disclosed as a UPE rather than as a loan (time to review accounts for disclosure errors!) • Recognition of UPE in Equity section of trust’s accounts (as a sub-trust) is the ideal but not a requirement for pre – 16 December 2009 UPE’s.

  11. UPE’s created pre – 16 December 2009 • Refer Example 1

  12. UPE’s created pre – 16 December 2009 • EXAMPLE 1 • Clause 3 allows trust to “set-aside” income. • Trust Resolution is silent as to whether distribution is a UPE or a loan. • Accounts refer to UPE as a loan. • Therefore, UPE will be considered to be a loan under Division 7A.

  13. UPE’s created on or after 16 December 2009 • Section 109D(3)(b) provides that for the purposes of Division 7A, a loan includes the provision of credit or any other form of financial accommodation. • The ATO are hanging their hat on a UPE being a form of financial accommodation and thus a loan.

  14. UPE’s created on or after 16 December 2009 • ATO acknowledge that a UPE will not represent a form of financial accommodation where certain steps are followed: • There is agreement that the UPE will be held for the absolute benefit of beneficiary (i.e. held on sub-trust); and • There is agreement that a rate of return will be provided on UPE.

  15. UPE’s created on or after 16 December 2009 • Terms of UPE need to be agreed between trust and corporate beneficiary. Para 58 of PSLA 3362 specifies that the agreement must be evidenced by the end of the year following the one in which the UPE is first created. Sample agreement is contained in paragraph 145 of PSLA 3362.

  16. UPE’s created on or after 16 December 2009 • Paragraph 145 of PSLA 3362 says: “On 31 July 2010 the Tin Pty Ltd sub-trust invested $10,000 in the Green Discretionary Trust. Green Discretionary Trust to pay to the Tin Pty Ltd sub-trust all the income derived from the $10,000 investment, payable by the end of each financial year during which the investment remains in place. The investment is repayable in full on demand. Annual return on the $10,000 will be equal to the percentage of the trust net income calculated using option 2 outlined in paragraphs 51 to 53 of Draft PSLA 3362”.

  17. CRITICAL DAY Resolution Finalised Year End Year End Year End 30/06/2010 31/08/2010 30/06/2011 30/06/2012 Need to ensure: - recognised as sub-trust - terms of UPE documented First “return” required to be paid

  18. UPE’s created on or after 16 December 2009 • Corporate Beneficiary needs to receive a commercial rate of return on the investment. • UPE can either be invested by trust separately (eg separate bank account) or blended into the working capital of the trust.

  19. UPE’s created on or after 16 December 2009 • If UPE is invested in a separate bank account, the corporate beneficiary will be required to receive all returns of income and capital relating to the bank account. • If UPE is invested in a separate asset, the corporate beneficiary will be required to receive all returns of income or capital relating to the asset.

  20. UPE’s created on or after 16 December 2009 • If UPE is blended into the working capital of the trust, there are 2 options the trust has to determine a suitable rate of return: • Division 7A benchmark interest rate option; or • % share of Net Income option.

  21. UPE’s created on or after 16 December 2009 • Division 7A benchmark interest rate formula: UPE * Benchmark Rate * Days invested

  22. UPE’s created on or after 16 December 2009 • Benchmark interest rate option: • Based on prevailing Division 7A interest rate • UPE needs to be repaid within 7 years; and • Doesn’t matter how and when paid off. • No need for Division 7A loan agreement.

  23. UPE’s created on or after 16 December 2009 • Benchmark interest rate option. • Return will be assessable to Corporate Beneficiary as interest; and • Interest SHOULD be deductible to trust.

  24. UPE’s created on or after 16 December 2009 • % Share of Net Income formula UPE * Net Income * Days Invested Gross Commercial Assets

  25. UPE’s created on or after 16 December 2009 • It appears that it doesn’t need to be repaid at the end of 7 years. • The higher the net income of the main trust, the higher the return to the corporate beneficiary. Conversely, if no net income, no return required.

  26. UPE’s created on or after 16 December 2009 • % Share of Net Income option • In effect, the corporate beneficiary will be receiving a cut of the overall net income of the trust. • Distribution is not deductible to trust.

  27. UPE’s created on or after 16 December 2009 • Refer Example 2

  28. UPE’s created on or after 16 December 2009 • Example 2 • Correct sub-trust has been created. • Assume book value of assets equals market value of assets. • Documentation creating sub-trust was created on 31 July 2010. • Benchmark return for 2011 year based on 335 days.

  29. UPE’s created on or after 16 December 2009 • IMPORTANT - returns must actually be paid each year to the corporate beneficiary. Otherwise unpaid return will represent a loan from sub-trust to main trust and could be subject to Subdivision EA.

  30. UPE’s created on or after 16 December 2009 • It appears that the first full year return only needs to be paid two years after which UPE first created. • For 2010 UPE’s documented on 30 June 2011: • 2011 return based on 1/365 calculation. • 2012 onwards based on 365/365 calculation.

  31. UPE’s created on or after 16 December 2009 • If ATO are of the view that the UPE is a loan (eg not accounted for correctly or not documented correctly), the UPE will be a deemed dividend if not repaid / put on commercial loan terms by lodgement due date of corporate beneficiary.

  32. Lodgement due date of 2011 ITR 30/06/2010 30/06/2011 30/06/2012

  33. UPE’s created on or after 16 December 2009 • If no NDS in corporate beneficiary, may be preferable for UPE to be re-characterised as a loan (as amount of deemed dividend will be nil). • Loan could subsequently be forgiven subject to application of CDF rules.

  34. Concluding Comments • Ensure Trust Deed permits holding of funds as UPE. • Need to account for UPE’s correctly. • Quarantine pre – 16 December 2009 UPE’s as no rate of return needs to be paid on these. • For UPE’s created on or after 16 December 2009, will need to document agreements and start paying a rate of return.

  35. Concluding Comments (cont) • If the return is not actually paid, Subdivision EA can apply. • UPE’s still better than loans because of timing. • In some instances, it may be preferred that the UPE is re-characterised as a loan. • WATCH THIS SPACE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

  36. Value adding opportunities • Review of prior year accounts for pre 16 December 2009 UPE’s. • Review of Trust Deeds. • Drafting of written agreements. • Valuations. • Calculation of returns.

  37. QUESTIONS

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