Thinking | 25 February 2022

TD 2022/D1 – Is this the Commissioner’s answer to the lack of targeted amendments to Division 7A?

By Andrew O'Bryan, Michael Parker and Adam Dimac

After many years, the ATO’s draft position on unpaid present entitlements (UPEs) in Draft Taxation Determination TD 2022/D1 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'? should come as no great surprise.

The ATO’s position is that there will be a provision of financial accommodation for the purpose of subsection 109D(3) of the 1936 Act[1] where a private company beneficiary has knowledge of a UPE and does not demand payment.

The ATO’s position is that, where a UPE is placed on a sub-trust arrangement, there will be no provision of financial accommodation unless and until the associated funds are used by the private company beneficiary's shareholder or associate. The practicality, however, is that there will be an immediate Division 7A loan; arguably at 30 June if the associated resolution is made at that time specifying the amount of the present entitlement. This will be the case whether the use of the funds is on commercial terms whereby a return is paid to the sub-trust fund.

As anticipated by many, this effectively puts an end to sub-trust arrangements accepted in PS LA 2010/4, and also puts an end to the endless cycle of updates to PCG 2017/13. If you are looking for a positive to take home, the end of sub-trust arrangements for UPEs will simplify things – leaving complying Division 7A loans, or the use of corporate investment and trading structures, as the only options.

However, the real issue is the lack of clarity on the transitional arrangement.

TD 2022/D1 states that the Commissioner will not devote compliance resources to sub-trust arrangements conducted in accordance with PS LA 2010/4 in respect of trust entitlements arising before 1 July 2022. However, the fact that the Commissioner will not devote compliance resources to something does not mean that the Commissioner will accept it once he becomes aware of it (eg in the course of a review or audit). The important question is whether the Commissioner will be out of time to do anything about historical UPE related issues.

In any event, the purported transitional arrangement in TD 2022/D1 is flimsy, and after many years of waiting for an updated position on UPEs, practitioners and taxpayers should be afforded more clarity. However, the blame for this should not rest with the Commissioner alone. Government has for many years been promising targeted amendments to Division 7A; to no avail!

On 14 October 2010, the ATO released TR 2010/3. This set out the ATO’s position on when a UPE that arose after 16 December 2009 would give rise to a loan or provision of financial accommodation for the purpose of Division 7A. The position in TR 2010/3 was that a UPE could (and often would) give rise to a provision of financial accommodation for the purpose of Division 7A.

On 14 October 2010, the ATO also released PSLA 2010/4 which provided for a number of acceptable sub-trust arrangements for UPEs that have been used for many years. However, it was generally understood that the sub-trust arrangements were intended to operate as a temporary fix until a permanent fix (ie a test case or new legislation) was found to address the question of UPEs in the context of Division 7A.

Ultimately, that permanent fix never arrived.

Targeted amendments to Division 7A were announced in the 2016/17 Federal Budget (following a Board of Taxation Review and Report to the Government in 2014) but no bill was introduced to Parliament. Again, in the 2017/18 Federal Budget it was announced that the start date for targeted amendments to Division 7A would be deferred from 1 July 2018 to 1 July 2019; in order to enable all Division 7A amendments to be progressed as a consolidated package. The most recent announcement was in the 2020/21 Federal Budget, which extended the start date of the Division 7A amendments to the income year commencing on or after the date of Royal Assent of the enabling legislation. Still, no bill has been introduced to Parliament.

However, with sub-trusts arrangements permitted under PSLA 2010/4 coming to an end, the Commissioner had to find a fix. Accordingly, on 19 July 2017 the ATO released PCG 2017/13, under which it allowed a maturing sub-trust arrangement to be placed on complying Division 7A loan terms (effectively providing seven more years to repay the original UPE).

PCG 2017/13 has undergone a number of updates in 2018, 2019 and 2020 to reflect sub-trust arrangements that continued to mature while the Commissioner and taxpayers alike waited for legislative certainty. If finalised, TD 2022/D1 will put an end to this cycle of updates.

In TD 2022/D1, the position on UPEs is stated with little ambiguity.

The ATO’s position is that:

  • there will be a provision of financial accommodation for the purpose of subsection 109D(3) of the 1936 Act where a private company beneficiary has knowledge of a UPE and does not demand payment; and
  • where a UPE is placed into a sub-trust arrangement, there will be no provision of financial accommodation unless and until the associated funds are used by the private company beneficiary's shareholder or associate (in most cases, this will be immediate). This will be the case whether the use of the funds is on commercial terms whereby a return is paid to the sub-trust fund.

A key to the position in TD 2022/D1 is the existence of a ‘consensual arrangement’ and the private company beneficiaries’ ‘knowledge of an amount that it can demand immediate payment of from the trustee’. In this regard, the ATO states in TD 2022/D1 that:

73. For financial accommodation to be provided, there must be a consensual arrangement between the parties. A consensual arrangement can only arise where a private company beneficiary with a UPE:

  • has knowledge of an amount of trust income that it can demand immediate payment of from the trustee (see Circumstance one at paragraphs 6 to 11 of this Determination), or
  • has knowledge of the use of a sub-trust fund (see Circumstance two at paragraphs 12 to 17 of this Determination).

74. Corporate Initiatives[2] illustrates that if both the trustee and the private company beneficiary are controlled by the same person, knowledge of an amount of trust income may be imputed by virtue of the relationship.

It is accepted in TD 2022/D1 that where a sub-trust is created in respect of a UPE:

  • the amount set aside by the trustee ceases to be an asset of the main trust and forms the corpus of the sub-trust;
  • the trustee would no longer have active duties under the terms of the main trust in respect of that entitlement, and a UPE does not remain outstanding;
  • the sub-trustee would have a different equitable obligation by holding the sub-trust fund for the absolute benefit of the private company beneficiary and the private company beneficiary would have a new present right to direct the trustee to transfer the sub-trust property to it.

The primary change to be found in TD 2022/D1 is the position that the use of funds in a sub-trust arrangement by a private company beneficiary's shareholder or associate will give rise to a financial accommodation for Division 7A purposes, even where there is a commercial return to the sub-trust.

In this regard, the ATO appears to indicate that the shift in this position is the result of more recent case law, and states as follows in TD 2022/D1:

138. It has been raised with us that, contrary to the views in this Determination, certain aspects of the former advice and reasoning in TR 2010/3 remain correct. Paragraphs 113 and 114 of TR 2010/3 provide:

...

140. As referred to at paragraphs 55 to 70 of this Determination, the weight of case law authority, including Court and Tribunal decisions following the publication of TR 2010/3, demonstrates that the statutory expression 'any other form of financial accommodation' is capable of having a wide meaning. In 2012, the majority of the High Court in ILP noted as examples of the wide meaning of 'any form of financial accommodation' an agreement by a bank to lend its name to a bill of exchange for the accommodation of its customer, the provision of the guarantee of the obligations to the creditor of the principal debtor and the extension by a bank to a customer of an overdraft facility.[37] A vendor can provide financial accommodation to a purchaser where a title is transferred without waiting for actual receipt of the full purchase price.[38] The case law examples do not support an argument that financial accommodation will not happen where the party who provides the accommodation obtains a commercial rate of return.

For the purposes of paragraph 109D(3)(b) of the 1936 Act, a private company beneficiary makes a loan to the trustee of a trust, or another shareholder or their associate, when financial accommodation is provided.

In TD 2022/D1 the ATO states that where there is a UPE, financial accommodation is provided at the point when the private company beneficiary has knowledge of an amount of trust income that it can demand immediate payment from the trustee, and does not exercise its right.

Key to the issue of timing seems to be whether the private company beneficiary is made presently entitled to a precise amount, or a percentage/portion of trust income:

84. If a private company beneficiary is made presently entitled to a fixed amount from the trust income, it has a right to demand immediate payment of that amount from the trustee.

85. If the private company beneficiary is made presently entitled to a percentage of trust income, there is no amount that it can demand immediate payment of from the trustee. The private company beneficiary will only be able to demand immediate payment of an amount from the trustee when the trust income is determined, typically after the end of the relevant income year.

The ATO provides a number of examples, as well as flow charts, that illustrate this timing difference. In effect, it may mean that, in circumstances where a private company beneficiary is made presently entitled to a percentage of trust income, there will be no financial accommodation until after 30 June of the relevant year; which is when the amount of the UPE can be accurately determined. However, in many cases the amount will be known at the time of the trustee resolution.

TD 2022/D1 states that the Commissioner will not devote compliance resources to sub-trust arrangements conducted in accordance with PS LA 2010/4 in respect of trust entitlements arising before 1 July 2022.

This is somewhat inconsistent with the comments that can now be found in TR 2010/3 and PSLA 2010/4 since the release of TD 2022/D1, where the ATO states that both will ‘continue to apply to trust entitlements arising before 1 July 2022’:

  • TR 2010/3 – Our proposed view in draft Taxation Determination TD 2022/D1 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'? differs from the views in this Ruling. This Ruling will continue to apply to trust entitlements arising before 1 July 2022 and is then proposed to be withdrawn.
  • PSLA 2010/4 – Our proposed view in draft Taxation Determination TD 2022/D1 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'? differs from the views in this Practice Statement. This Practice Statement will continue to apply to trust entitlements arising before 1 July 2022 and is then proposed to be withdrawn.

The ATO’s transitional statements in TD 2022/D1 do not give taxpayers any certainty that the Commissioner will apply TR 2010/3 and PSLA 2010/4 to sub-trust arrangement for trust entitlements arising before 1 July 2022; his statements simply indicate that he will not devote compliance resources to such arrangements.

The risk is that, under an engagement with taxpayers (ie assurance review, review, audit), the ATO will make enquiries regarding Division 7A compliance, and refuse to accept the validity of sub-trust arrangements conducted in accordance with PS LA 2010/4.

If finalised, TD2022/D1 will put an end to sub-trust arrangements accepted under PS LA 2010/4.

However, some opportunities remain:

  • Timing – as noted above, in circumstances where a private company beneficiary is made presently entitled to a percentage of trust income there may be no financial accommodation until after 30 June of the relevant year. However, the onus will be on taxpayers to show that this is the case.
  • Sub-trusts – Sub-trusts can still operate as an effective tool for deferring the provision of financial accommodation for Division 7A purposes. The ATO accepts that where a sub-trust is created in respect of a UPE, the UPE will not remain outstanding, and that it isn’t until the time when the private company beneficiary has knowledge of the use of an amount of the sub-trust fund and does not call for payment of that part that there will be a provision of financial accommodation. However, the use of sub-trust arrangements will need to be allowed for under the relevant trust’s deed, and the arrangement must be accounted for and documented accurately.

Conclusion

While the position in TD 2022/D1 should come as no great surprise, it is disappointing that long standing issues with Division 7A have not been addressed in a more comprehensive manner.

Effectively, the end of traditional sub-trust arrangements accepted under PS LA 2010/4 leaves few options; the use of a complying Division 7A loan, or a corporate investment or trading structure. Practitioners and taxpayers will need to prepare for this change.

More immediately, practitioners and industry bodies should consider advocating for more clarity from the Commissioner on the transitional arrangements. In this regard, submissions on TD 2022/D1 are open until 25 March 2022.

Finally, it is important to note that TD 2022/D1 was released on 23 February 2022 along with a raft of other updates related to section 100A of the 1936 Act (23 February Updates). Namely, TR 2022/D1, PCG 2022/D1 and TA 2022/1.

Anecdotally, it seems that the 23 February Updates signal a targeting of the use of trust arrangements by the Commissioner.


[1] Income Tax Assessment Act 1936.
[2] Corporate Initiatives Pty Ltd v Commissioner Of Taxation [2005] FCAFC 62.

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