Follow on from last week, in this week’s edition we discuss Division 7A options available for trustees.
The 5 main options available are as follows:
Option 1 – Interest Only 7 Year Loan
The trustee may put the funds representing the UPE on a 7-year interest only loan. The trust must pay an annual return on the funds equal to the Benchmark interest rate. (The ‘benchmark interest rate’ is the Indicator Lending Rates-Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income – 5.30% for the 2018 financial year). This interest is assessable income to the company, and a deductible expense to the trust. The liability to pay the first year’s interest will arise on 30 June 2018 in respect of distributions made for the 2016 financial year. The first interest payment by the trust is due by lodgement day of its tax return (generally 15 May). The principal, along with the final interest payment, must be repaid at the end of the 7-year term.
Option 2 – Interest Only 10 Year Loan
The trustee may put the funds representing the UPE on a 10-year interest only loan. The trust must pay an annual return on the funds equal to the Prescribed interest rate. (The ‘prescribed interest rate’ is the Reserve Bank of Australia’s indicator lending rate for small business variable (other) overdraft for the month of May immediately before the start of that income year – currently 10%). This interest is assessable income to the company, and a deductible expense to the trust. The liability to pay the first year’s interest will arise on 30 June 2018 in respect of distributions made for the 2017 financial year. The first interest payment by the trust is due by lodgement day of its tax return (generally 15 May). The principal, along with the final interest payment, must be repaid at the end of the 10-year term.
Option 3– Invest in a Specific Income Producing Asset or Investment
The trustee may invest the funds representing the UPE in a specific investment, such as an interest- bearing account or the acquisition of an interest in an income producing asset. This will mean that the asset will need to be held on ‘sub trust’ for the company, and any income derived from the investment must be declared by the sub-trust in a tax return each year. So a separate sub-trust tax return will be required, along with the usual main trust and company tax returns. The principal must be repaid by lodgement day of the tax return of the private company for the year in which the investment ends, (i.e. on disposal of the asset). There may also be CGT consequences upon disposal of this asset.
Option 4 – Interest & Principal 7 Year Loan
The trustee may put the funds representing the UPE on a 7-year Division 7A (principal & interest) loan. The trust must pay an annual return on the funds equal to the Benchmark interest rate. (The ‘benchmark interest rate’ is the Indicator Lending Rates-Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income – 5.30% for the 2018 financial year). This interest is assessable income to the company, and a deductible expense to the trust. The liability to make the first year’s repayment will arise on 30 June 2018 in respect of distributions made for the 2017 financial year. The first interest payment by the trust is due by lodgement day of its tax return (generally 15 May). The principal, along with the final interest payment, must be repaid at the end
of the 7-year term.
Option 5– Interest & Principal 25 Year Loan
The trustee may put the funds representing the UPE on a 25-year Division 7A (principal & interest) loan. This loan must be secured by a mortgage over real property. The trust must pay an annual return on the funds equal to the Benchmark interest rate. (The ‘benchmark interest rate’ is the Indicator Lending Rates- Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income – 5.30% for the 2018 financial year). This interest is assessable income to the company, and a deductible expense to the trust. The liability to make the first year’s repayment will arise on 30 June 2018 in respect of distributions made for the 2017 financial year. The first interest payment by the trust is due by lodgement day of its tax return (generally 15 May). The principal, along with the final interest payment, must be repaid at the end of the 25-year term. Please note that any reference made to meeting the minimum yearly repayment on each type of loan, does not necessitate a physical payment of cash. A dividend may be declared to cover the minimum repayment in each case. Please also note that these UPE provisions apply to each annual trust distribution made by a trust to a company.
For more information on Division 7A, please contact us any time.