The ATO will be paying special attention to Division 7A of the Income Tax Act 1936 this year, an integrity measure that attempts to ensure that private companies cannot make tax free distributions of profits to shareholders or their associates in the form of debts forgiven, loans or payments. Make sure not to fall afoul of these measures during the end of year tax process.
In July 2010, a new ATO tax ruling indicated that unpaid present entitlements (UPE) from trusts to corporate beneficiaries can now be treated by the ATO as Division 7A loans, broadening the range of transactions that can be taxed under the Division.
An ‘unpaid present entitlement’ occurs when a trustee makes a beneficiary entitled to some or all of the income of the trust for that particular income year, but also continues to hold those funds on trust for that beneficiary.
A loan by a private company will be a Division 7A loan when:
- The company has a UPE and an agreement as to a loan can be implied.
- The company has an UPE and there’s an express loan agreement to the trustee.
- The company owns a UPE and there’s a loan within the extended meaning, in that the company provides a loan to the trustee but does not call for payment or simply authorizes the trustee to use those funds for trust purposes.
- Instead of paying money to the company, a trustee pays or applies an amount of the UPE for the benefit of the beneficiary.
This change affects small businesses that use private companies as beneficiaries in order to limit tax on trust distributions. Be sure to review the ruling and get advice on how it will impact on trust positions before the end of the financial year.