The ATO has published a Practical Compliance Guideline PCG 2017/13 for those who used a 7-year sub-trust arrangement to deal with unpaid present entitlements (UPE) owed by a family trust to a related entity.
The guideline provides assistance on the administration of these sub-trust arrangements once the 7-year loan period expires. As many entered into these sub-trust arrangements on or before 30 June 2011, the period is close to expiry for many no later than 30 June 2018.
The sub-trust arrangement formed as an option to deal with unpaid present entitlements. A UPE is an amount of trust income which the trustee of a trust appoints, but does not pay, to a private company beneficiary.
Under this arrangement, UPE funds in the sub-trust are held for the sole benefit of the private company beneficiary if they are lent to the main trust under a 7-year interest only loan with the principal of the loan repayable at the end of the 7-year interest only loan.
The terms of the sub-trust arrangement compromised that the terms of the investment agreement must be legally binding and documented, and that the trustee had an obligation to repay the principal of the loan at the end of the loan term.
This means the trustee must repay the principal of the loan before the 7-year period expires. If the trustee fails to do so, any unpaid principal of the loan will be treated by the Commissioner as the provision of financial accommodation and therefore a Division 7A loan.
The trustee of the sub-trust would then need to enter into a 7-year complying loan agreement by the private company’s lodgment day. This provides a further period for the amount to be repaid with periodic payments of both principal and interest.
If the 7-year complying loan is not put in place between the sub-trust and the private company prior to the private company’s lodgment day, a deemed dividend will arise at the end of the income year in which the loan expires.
Furthermore, where the facts and circumstances indicate there has never been an intention to repay the principal of the loan at the end of the 7-year interest only loan, the Commissioner may consider that the arrangement was a sham, and/or that there was a fraud or evasion.
In these circumstances, the Commissioner may go back beyond the period of review and deem a dividend in the income year in which the provision of financial accommodation originally arose.