The ATO has recently released its final practice statement in respect of the treatment of unpaid present entitlements (UPEs) under a trust in favour of a private company.

The ATO released TR 2010/3 earlier this year, which set out the circumstances in which a present entitlement in favour of a private company which remains unpaid will constitute a “loan” for Division 7A purposes.

Broadly, Division 7A is designed to ensure that private companies distribute profits to shareholders (or associates of shareholders) as taxable dividends, rather than by way of non-arm’s length payments or loans.

Where Division 7A applies, such payments and loans are treated as unfranked dividends in the hands of the shareholders or their associates, provided the private company in question has sufficient distributable surplus at the time at which the payment or loan is made.

The ATO’s ruling broadly states that a private company will be taken to have made a loan to a trust where the private company has a present entitlement to a distribution made by the trust, and this entitlement remains unpaid for a period of time, or the UPE is specifically converted into a loan.

As a result, if the trust is an associate of a shareholder of the private company, such a deemed loan will be subject to Division 7A.

Generally, a trust will be an associate of an individual shareholder if the shareholder stands to benefit under the trust.

However, consequences under Division 7A may be avoided if the “loan” is either put on a commercial footing, or the UPE is set aside in a sub-trust for the exclusive benefit of the private company.

The practice statement sets out:

• When a UPE that came into existence in previous years will have been subsequently converted into a loan.

• Self corrective mechanisms to reclassify such loans as UPEs where amounts have been misclassified or treated incorrectly.

• When a subsisting UPE may be converted into a loan.

• How to set such a UPE aside on a sub-trust for the exclusive benefit of the private company so that it does not convert into a loan.

Taxpayers that have tax affairs involving a family trust and related company should seek advice from us to ensure that an UPE under the trust in favour of the company has not resulted in a deemed dividend that is required to be included in the taxpayer’s assessable income.

TIP: If you are a beneficiary under a trust which has an unpaid present entitlement in favour of a private company of which you are a shareholder, you should consult with Platinum Accounting & Taxation to ensure that you don’t have to include any deemed dividends in your assessable income.