Practical Compliance Guideline (PCG) 2017/13 has been released by the ATO to deal with Division 7A UPEs under sub-trust loans which are likely to mature in the coming year.
The PCG enables the conversion of a “7-year option 1 investment” sub-trust arrangement (Option 1 Loan) into a compliant loan, pursuant to section 109N of the Income Tax Assessment Act 1936. The refinancing of an UPE for an additional 7 years could provide certain planning opportunities for those taxpayers who would otherwise have to repay the principal on maturity.
PCG 2017/13 applies to a private company beneficiary of a trust or sub-trust where the trustee:
- has, in accordance with Law Administrative Practice Statement PS LA 2010/4, validly adopted Option 1 to place funds representing an UPE under a sub-trust arrangement on a 7-year interest only loan with the main trust;
- does not repay the principal of the loan when it matures;
- only applies to the refinancing of UPEs into 7-year complying 109N loans.
PCG 2017/13 states that:
- if the trustee fails to repay the Option 1 Loan at the end of the loan term, any unpaid principal of the loan will be treated by the Commissioner as the provision of financial accommodation, and therefore a Division 7A loan;
- where all, or part, of the principal loan is not repaid on or before the date of maturity, and a complying section 109N loan is not put in place between the sub-trust and the private company beneficiary prior to the private company’s lodgement day, a deemed dividend will arise to the extent of the unpaid amount;
- the Commissioner will not allow the Option 1 Loan to be rolled into a new investment option described in PS LA 2010/4 - that is, the Commissioner will not allow the trustee to invest the funds representing the UPE on an interest only 10-year arrangement, or in a specific income producing asset or investment;
- the Commissioner will not seek to apply section 109R to the principal of an Option 1 Loan that is not repaid and is the subject of a complying section 109N loan in accordance with the guideline; and
- the Commissioner may consider the arrangement a sham, and/or that there was fraud or evasion, if there was never an intention to repay the principal on the Option 1 Loan. The Commissioner could open up the amendment period and deem a dividend in the year in which the Option 1 Loan arose.
The following are examples of relevant dates where an Option 1 Loan is entered into with a maturity date of 30 June 2018:
- 30 June 2018: loan and final interest must be repaid by this date. Failure to do so amounts to the provision of financial accommodation and therefore constitutes a Division 7A loan.
- 15 May 2019: the trustee of the sub-trust must enter into a seven-year complying loan agreement by the private company’s lodgment day (if principal is not repaid by 30 June 2018). Failure to do so results in a deemed dividend arising in the 2018 income year. Note: the date may be different depending on the lodgment day of the private company’s return.
- 30 June 2019: the liability to make the first minimum yearly repayment to private company under the seven-year complying loan arises.
Taxpayers who have entered into an Option 1 Loan should consider the possibility of converting their arrangement into a section 109N compliant loan prior to the private company’s lodgement day. This will provide the affected taxpayers with a further 7 years to repay the amount by periodic payments of both principal and interest.