Australia: Division 7A – Where to from now for Trusts creating sub-trusts for corporate beneficiaries?

Other than complying legacy sub-trusts created prior to 1 July 2022, it is highly arguable that creating new sub-trusts between Trusts and companies is not sensible.

If you wish to pay your income or capital to a corporate beneficiary of the Trust then you should preferably pay it out to the company and therefore delete the creation of a sub-trust or alternatively enter into a complying Division 7A loan agreement. You may also create a separate sub-trust for an asset that is not used by the Trust.

Legacy sub-trusts can continue but note the Option 1 and Option 2 arrangements set out in PSLA 2010 / 4 are now withdrawn as of 1 July 2022.

The use of a corporate beneficiary by a Trust is still very much possible, however retaining the monies in the Trust has been problematical since 2010 and the ability to retain any distribution made after 1 July 2022 in the Trust that is used for the benefit of the Trust in any way is now considered to be financial accommodation by the ATO.

Going forward, for a sub-trust of a Trust for the benefit of a company created after 1 July 2022 you will need to invest the funds in a specific income-producing asset or investment which is not used by the Trust in any way otherwise it will be considered to be financial accommodation according to TD 2022/1. This will include where a commercial interest rate is paid by the Trust on the sub-trust as if the money or sub-trust asset is used by the Trust for itself then it is considered to be financial accommodation.

The ATO released in February 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'? and it set out a number of examples that are self-explanatory relating to the ATO's proposed new approach to Div 7A and unpaid present entitlements (UPEs).

Following the February 2022 release of Draft TD 2022/D1 the ATO has now withdrawn TR 2010/3, its previous ruling on the matter. The withdrawn Ruling treated a UPE that was not called for by a corporate beneficiary as a Div 7A loan unless the funds were held on sub-trust for the beneficiary's sole benefit.

Further Practice Statement PS LA 2010/4 withdrawn on 1 July 2022 outlined 3 safe harbour investment options to prevent a Div 7A loan arising:

A key component of the ATO's revised approach (which will apply to present entitlements created after 30 June 2022) is that a Div 7A loan can arise if a sub-trust fund is on commercial terms, with a return paid to the fund (i.e. Options 1 and 2 will no longer be acceptable).

The ATO confirmed that taxpayers can continue to rely on the withdrawn documents in respect of trust entitlements conferred before 1 July 2022, even if the sub-trust or a further complying loan is put in place after 30 June 2022.

Pointon Partners has extensive experience with assisting clients with matters that are being investigated or queried by the Taxation Office. If the ATO is querying an existing sub-trust arrangement we are happy to assist.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.