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Our People in Taxation Consulting
DON’T BE DUPED BY THE TAX OFFICE!
The facts about Trusts and Unpaid Present Entitlements (UPE’s)...
Where a trust makes a distribution of income to a beneficiary that is a company, an unpaid present entitlement ("UPE") arises at year end.
The Tax Offi ce view is that this UPE subsequently becomes a Division 7A loan unless the amount of the UPE is actually paid to the company.
In a typical case, if a Division 7A loan arises, the trustee of the trust is taxed as if the amount of the UPE is an unfranked dividend it has received. The means that the trust distribution is effectively taxed at 76.5%.
This 76.5% bullet can be dodged if the trust pays the UPE amount (plus interest) to the company under a loan agreement over a 7 year period (commonly referred to as a Division 7A loan agreement).
According to the Tax Office, a UPE arising in the hands of a corporate benefi ciary at 30 June 2011, becomes a Division 7A loan when the trust lodges its 2010/11 tax return (say, in May 2012). This means that a Division 7A loan from the company to the trustee is taken to exist as at 30 June 2012
As a result, to avoid the draconian consequences of Division 7A, the trustee must pay out the UPE by the date the company lodges its 2011/12 tax return (say, in March 2013) or otherwise enter into a Division 7A loan agreement by that date. The first payment (usually about 20% of the UPE amount) under such an agreement must then be made by 30 June 2013.
While the Tax Office view dictates that UPEs become Division 7A loans for tax purposes under the above timeline, that conversion is a tax fiction and is not required to be reflected for accounting purposes.
From an accounting perspective, the better view is to continue to record UPEs as UPEs, with UPEs for each year recorded separately to ensure proper tracking of Division 7A loans as required by the Tax Office view.
As the Tax Office view has not been tested before the courts, conversion of UPEs to loans for accounting purposes may result in them unnecessarily becoming actual loans (and no longer UPEs) caught by Division 7A even if the Tax Office view on UPEs being Division 7A loans is ultimately shown to be wrong.
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