This piece looks at some of the more important issues for dealing with unpaid present entitlements of discretionary trusts (UPEs) which arose at the end of the 2010 tax year in favour of corporate beneficiaries within the same family groups.
This article is aimed at explaining the investment options set out in the Commissioner’s Practice Statement PS LA 2010/4 (Practice Statement) as it stands at 2 June 2011.
The view of the operation of the law which is assumed by the Practice Statement is not necessarily the view which is taken by Riordans Lawyers. The issue at hand is to analyse the Commissioner’s statement as it stands.
However, taxpayers should be aware that to follow a practice statement which turns out to be incorrect as a matter of law does not provide completer protection from a subsequent adverse assessment if the practice statement is found to be wrong in law – the protection is merely against penalties and interest on underpayment.
The concentration of the analysis below is on how to deal with the Practice Statement’s 7 and 10 year investment loans alternatives under “Option 1” and “Option 2” for UPEs arising in that tax year, and the timing for doing so. “Option 3” (investments in specific assets) is not dealt with in any detail.
With regard to timing issues, it is suggested Practitioners should assume that the (relatively) “nice cop” ATO attitude at the time of introducing the new regime, may well become a “tough cop” attitude when dealing with individual taxpayers in later year audits. This new regime is not based on legislated concessions and therefore there may be limited scope for appeal to a court or to the AAT if confronted with a “tough cop” ATO auditor in a later year.
UPEs arising in the 2010 tax year
With effect from 16 December 2009, the Commissioner of Taxation has ruled that, except in limited circumstances, he will treat a UPE created after that date by a discretionary trust in favour of a related corporate beneficiary of the trust as being a loan made by the corporate beneficiary back to the trust for the purposes of Division 7A.
A UPE which arose in the period between 16 December 2009 and 30 June 2010 will therefore potentially be caught unless it falls within the required circumstances.
The basis for treating UPEs as Division 7A loans
The basis for that treatment arises out the ATO’s conclusion (effective from 15 December 2009) that, notwithstanding prior understandings to the contrary, a UPE can fall within the extended definition of “loan” in section 109D(3)(b) (as a form of financial accommodation from the corporate beneficiary to the trust) or 109D(3)(d) (as an in substance loan from the corporate beneficiary to the trust).
The ATO’s reasoning and its approach to assessment are set out in TR 2010/3 (Ruling) and PS LA 2010/4 (Practice Statement).
UPEs as “section three” loans
UPEs arising on or after 16 December 2009 are dealt with under section 3 of the Ruling and are called “section three loans” in the Practice Statement. (“Section two loans” include both pre and post-16 December 2009 UPEs which the Commissioner considers to have been converted by the parties into “loans” in the ordinary sense of that word. Section two loans require separate consideration and are not dealt with in this Information Brief.)