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Division 7A: Part 1

Division 7A is one of those items that can sneak up on a company or a group of companies, often unintentionally. The consequences can be severe:

  • The potential additional tax impost can be as high as 62.55% of the income earned
  • The potential cash flow consequences of having to repay the funds to the company.
  • The potential exposure of the funds taken, to a liquidator and/or unsecured creditors who may potentially make a claim on the company that is exposed.

We have developed a list of strategies and structures to help mitigate the potential exposure to Division 7A and the ripple effect that it may have on the business and its stakeholders and help those affected manage the process.

Unpaid Beneficiary Entitlements

Below you will find a brief summary of the Unpaid Present Entitlement (UPE) rules and the various options available to Trusts that make distributions to beneficiaries from 16 December 2009 onwards, according to Taxation Ruling TR 2010/3:

Distributions Prior to 16 December 2009

Any distributions made prior to 16 December 2009, and not yet paid to beneficiaries, are not required to be paid out or dealt with in any way. For TR 2010/3 purposes, these UPEs may continue to be outstanding entitlements. These will include any distributions made but not physically paid, up to 30 June 2009.

The Mischief

In situations where a private company does not call for payment of a trust distribution to which it is entitled, and instead leaves that money outstanding in the trust to continue to be used within the trust, the ATO’s concern is that the company is accommodating the trust by not asking for money to which it is presently entitled, or ensuring that it is getting a reasonable return on that money. Not actually paying
out the entitlement to the company enables income to be retained in a trust and taxed only at the corporate rate of 30%, rather than the higher rate of 49% (including 2% temporary budget repair levy) which generally applies when income is accumulated in a trust or may apply when income is distributed to individuals. In this case, by retaining the income to which the private company is presently entitled, the trust is effectively able to enjoy the use of company profits which have only been taxed at the company tax rate.

Distributions Subsequent to 16 December 2009

[Please note that this only applies to trusts which distribute to companies. Trusts which distribute to other trusts are not caught by the new provisions, and any UPE may continue to be ‘unpaid’.] For example; the annual trust distributions made to unit holders which are also trusts are not caught by these provisions.

Otherwise, any distributions made from the 2015 financial year and onwards, need to be ‘dealt with’ by 30 June 2016. ‘Dealing with’ the distribution does not necessarily mean physically paying out the entitlement each year, although it is one of the options available. If you opt to pay out the entitlement in cash, you must do so by 30 June 2016 for distributions relating to the 2015 financial year. The trustee will pay out as much of the total annual distribution as it practically can during each year. However, eventually, the entitlement must be paid out to the company, or the funds held for the benefit of that company.

There are other options available for trustees, but we will touch on them next week in our second instalment on Division 7A.

To learn more about Division 7A please contact us anytime.