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ATO ruling will have tax implications for corporate trust beneficiaries

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On 2 June 2010, the ATO issued taxation ruling TR 2010/3 in response to the highly publicised Bamford case. The ruling will have serious tax implications for corporate beneficiaries of discretionary trusts.

Many small and family businesses use trust structures for tax minimisation and asset protection purposes. One method of reducing the tax liability for beneficiaries, is to form a company to receive the distributions from the trust, which are then “parked” in the company. These funds are either then distributed to its shareholders as a dividend or alternatively, loaned back to the trust. In many instances however, the distribution is never actually paid by the trustee to the company and instead are treated as a debt owing from the trustee to the company or a loan from the company back to the trustee (both treatments have the same effect). When a payment of a distribution is not made immediately, this gives rise to an “unpaid present entitlement” (or “UPE”). It is the use of UPE’s which has attracted the attention of the ATO.

A common way to keep track of monies owing under this arrangement is to create a perpetual loan account between the trust and the beneficiary company. The loan account is then adjusted according to distributions and drawings over time. In the past, under this structure the company beneficiary was only liable to pay tax on the distribution at the company rate of 30% and the amounts distributed were then made available for the use by the trust.

The recent ruling by the ATO aims to put a stop to this practice. The ruling states that a loan or debt of the type described above will be treated as a “Div 7A Loan” for income tax purposes. Accordingly, it will be taxed at the highest marginal income tax rate. This is a significant change in policy from the ATO, which will nullify any tax advantage which was previously available through structures of this kind.

Importantly, this ruling takes effect retrospectively from 16 December 2009, the date on which the draft ruling was released. This means that any loan activity since that date may be captured by the new ruling.

Any business which operates through a trust will need to review its structure before the end of the financial year to assess the effect of this ruling. Legal and accounting advisors with expertise in this area will be able to advise on alternative structures to mitigate the effect of this ruling.

If you need advice on how this ruling will impact on the suitability of your trust structure, please contact one of our Corporate Advisory lawyers.

Authors: Darren Sommers & Nick Rimington