A recently issued Tax Determination affecting Discretionary Trusts and corporate beneficiaries may have implications for how family groups distribute income.
Discretionary Trusts and corporate beneficiaries – considerations
When a trustee of a trust makes a decision to create an entitlement to income of the trust in favour of a corporate beneficiary (i.e., a privately held company), certain steps need to be taken to ensure that if the entitlement to the distribution remains unpaid (that is, no cash equal to the amount of the entitlement is paid to the corporate beneficiary), that this does not trigger what is called a ‘deemed dividend’ in the hands of the trust.
A deemed dividend is likely to give rise to unwanted taxation consequences for the trust.
Historically, one way to avoid triggering a deemed dividend in such circumstances was to place the amount representing an unpaid distribution in a sub-trust for the benefit of the corporate beneficiary.
With these sub-trust arrangements, the relevant funds are generally being invested in the main trust to be used for working capital or to make plant and equipment or real property acquisitions.
These sub-trust arrangements were typically based on interest only loan arrangements, with the requirement that the principal be repaid at the end of either seven years (i.e., as an Option 1 arrangement) or ten years (i.e., to as an Option 2 arrangement).
The ATO has now formed the view that for entitlements to trust income that come about from 1 July 2022 (effectively from the 2023 income year) that these interest only Option 1 and Option 2 arrangements are no longer sufficient to avoid the potential triggering of a deemed dividend with respect to any unpaid present entitlements.
Broadly speaking, from 1 July 2022, in relation to an unpaid distribution payable to a corporate beneficiary, one way to avoid the unpaid distribution giving rise to a potential deemed dividend is for the unpaid distribution to be replaced with what is referred to as a complying Division 7A loan.
These Division 7A loans are made under S.109N of the Income Tax Assessment Act 1936 (ITAA 1936).
Ordinarily, such a loan is repaid on a principal and interest basis, over seven years, based on an interest rate provided by the ATO for each year of the loan, with annual minimum loan repayments calculated based on a formula provided by the income tax legislation.
If you would like advice as to whether this recently issued Tax Determination has implications for the way your family group distributes its income, please contact our team on 03 9708 8801 or email firstname.lastname@example.org for further information.
Find out more about Family Trust distributions.
Please Note: Many of the comments in this publication are general in nature and anyone intending to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the information’s applicability to their particular circumstances.
The information contained within this document is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. Robinson Voss Partners (RV Partners) strongly suggests that no person should act specifically on the basis of the information in this document, but should obtain appropriate professional advice based on their own personal circumstances.