Division 7A and unpaid present entitlements from trusts to corporate beneficiaries

Why UPEs matter for Division 7A

Unpaid present entitlements (UPEs) from trusts to corporate beneficiaries are relevant to Division 7A because they can be characterised as financial accommodation. Division 7A generally treats payments, loans and forgiven debts from private companies as deemed unfranked dividends to shareholders or their associates.

If a trust UPE owed by a trustee to a corporate beneficiary amounts to financial accommodation, it is considered a Division 7A loan. This means the corporate beneficiary may be subject to the Division 7A rules, potentially including imputation restrictions and the application of the dividend impairment rules.

The Australian Taxation Office’s current view on UPEs and Division 7A is outlined in TD 2022/11. This document supersedes TR 2010/3 and PS LA 2010/4 for trust entitlements created on or after 1 July 2022.

When a UPE becomes 'financial accommodation'

A present entitlement becomes ‘financial accommodation’ under Division 7A when a corporate beneficiary is made presently entitled to trust income and that income remains unpaid. This occurs when the company has knowledge of the amount it is entitled to demand from the trustee.

Generally, this knowledge arises once the trust’s financial accounts are finalised. At this point, the company is aware of the income it can claim.

The deemed loan, which triggers Division 7A implications, arises from the time the financial accommodation occurs.

Sub-trust arrangements

The ATO requires sub-trust funds to be held separately from the main trust funds. These funds must also be held 100% for the benefit of the corporate beneficiary.

Failure to adhere to these conditions will result in the creation of a Division 7A loan. This outcome can occur even if the sub-trust operates on commercial terms and returns are made to the corporate beneficiary.

Options under prior PS LA 2010/4, providing 7-year or 10-year treatment, are no longer available for present entitlements created on or after 1 July 2022.

How to avoid the deemed dividend

To avoid the deemed dividend consequences, the trustee of a trust must take action regarding unpaid present entitlements (UPEs) before the corporate beneficiary’s tax return is lodged or due. This involves either paying the UPE to the corporate beneficiary or establishing a Division 7A complying loan agreement.

A complying loan agreement must adhere to specific requirements outlined in section 109N. These requirements include a written agreement, a maximum term of seven years for unsecured loans and 25 years for loans secured by real property, and a minimum yearly interest rate based on the benchmark rate.

The application of Division 7A to UPEs has been subject to legal challenge, notably in the Bendel decision. While this decision questioned the ATO’s view of UPEs as ‘loans’, the ATO continues to apply Taxation Determination TD 2022/11. The legal position remains contested, pending further guidance from higher courts.