Taxation Issues on Release of a Company’s Unpaid Present Entitlement

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Taxation Determination TD 2015/20, released by the ATO on 25 November 2015, explains the Commissioner’s view on whether a release by a private company of its unpaid present entitlement (UPE) constitutes a “payment” under the Div 7A shareholder loan rules, contained in Pt III of the Income Tax Assessment Act 1936 (ITAA 1936). The TD was issued to address uncertainty about the ATO’s position on whether the “release” or waiver of a UPE amounts to a deemed dividend.

The Commissioner’s view, as outlined in TD 2015/20, is that Div 7A can apply where a private company with a UPE from a trust releases all or part of that UPE, and the trustee is either a shareholder or an associate of the private company. That is, the ATO considers the crediting of an amount to be a payment under Div 7A if the release represents a benefit to an entity.

This article examines the application of Div 7A in the context of UPE releases and payments based on TD 2015/20. It does not cover Div 7A rules more broadly.

Division 7A

The Div 7A rules in Pt III of ITAA 1936 state that unless they come within specified exclusions, certain private company payments, loans and forgiven debts are treated as dividends paid. The rules can apply to payments by a private company to a shareholder or their associates.

A payment is not treated as a dividend where, for example:

  • it is fully repaid or converted to a complying loan by the company’s lodgment day for the income year in which the payment occurs; or
  • it is assessable income (or is specifically excluded from being assessable income) under another part of the Act.

Principles outlined in TD 2015/20

TD 2015/20 provides that if a company releases a UPE, the release will typically be a payment under Div 7A, and therefore a potential deemed dividend, if the release is a benefit to the entity.

A UPE is a beneficiary’s right to receive trust income or capital that:

  • arises due to the beneficiary being made presently entitled to the amount; and
  • has not been satisfied, paid or effectively disclaimed.

According to TD 2015/20, there is a deemed dividend to a shareholder (or an associate of a shareholder) under Div 7A if:

  • there is a payment (according to the meaning in s 109C of ITAA 1936); and
  • that payment constitutes the release of a UPE as the result of an amount credited by the company for the benefit of the trust.

There must be a payment

Broadly, a private company is taken to have paid a dividend to a shareholder at the end of an income year if the company pays an amount to the entity during that year (s 109C(1) of ITAA 1936). For the purposes of Div 7A, a payment includes a credited amount to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity (s 109C(3) of ITAA 1936).

The release involves crediting

Two requirements must be satisfied for the release of a UPE by way of a credit to be considered a “payment” and therefore a deemed dividend under the Div 7A rules:

  1. Credit must have been provided by the private company. The income tax legislation does not define the term “credit”, so it must be interpreted according to its ordinary meaning. The Macquarie Dictionary defines “credit” as “enter[ing] upon the credit side of an account; giv[ing] credit for or to; giv[ing] the benefit of such an entry to (a person, etc)”. Based on this, the Commissioner views the forgiveness of a debt in a company’s accounts, accompanied by an intention not to recover the debt to constitute “crediting of an amount”, which falls within the Div 7A meaning of “payment”. Crediting does not need to be formally recorded in the company’s books of account.
  2. The credit must be applied for the benefit of the entity. According to TD 2015/20, a UPE is an asset that stands as a debit entry in a private company’s accounts. The Commissioner’s position is that a “benefit” is provided where a UPE is released by the private company, because it leaves the other entity (eg the trustee of a trust) with full ownership of the UPE. A UPE release is considered a payment irrespective of whether it is held in the main trust or in a subtrust, or whether the UPE is released voluntarily or at the direction of a court order.

Exceptions: where the release of a UPE does not give rise to a benefit

The release of a UPE does not give rise to a benefit and would not be considered a payment under the Div 7A rules if:

  • the trustee cannot satisfy the UPE due to circumstances beyond its control, and the beneficiary has no cause of action against the trustee to recover that loss; or
  • the UPE is already a Div 7A loan or has previously been converted to a debt (s 109F of ITAA 1936).

Conclusion

The Commissioner’s position, according to TD 2015/20, is that the deemed dividend rules in Div 7A can apply where a private company with a UPE to the income or capital of a trust releases all or part of the UPE, and the trustee is either a shareholder of the private company or an associate of a shareholder.

When writing off or releasing a UPE, corporate beneficiaries should therefore be careful to ensure no benefit is provided through the release and a payment under Div 7A does not arise. As TD 2015/20 applies both before and after its date of issue, taxpayers should review the information carefully to manage any possible Div 7A risk.