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The Commissioner of Taxation intends to treat unpaid present entitlements as loans in certain circumstances. This can have serious consequences for funds, particularly those that have invested in property through ungeared trusts. The Commissioner's approach is not surprising and is consistent with the ATO's recent revelations that many unpaid trust distributions to companies will be treated as loans under Division 7A.

 

In our view, trust distributions should be paid within a reasonable time (1-2 months) after the accounts and tax returns are finalised.   

Loans to related trusts are likely to be in-house assets under section 71 of the Superannuation Industry (Supervision) Act 1993 (SIS Act). If the loan comprises more than 5% of the value of the fund's assets at the end of the financial year, the SIS Act requires the fund trustee to come up with a plan to dispose of it within 12 months. However, the Commissioner has indicated a willingness to work with fund trustees and might allow the loan to be paid down or further contributions to be made to bring the loan within the 5% limit.

 

The SIS Act defines 'loan' to include credit 'and other forms of financial accommodation'. The Commissioner argues in the rulings that financial accommodation can include a deferred amount that is ultimately payable, and uses unpaid entitlements as an example. In his view, there doesn't need to be an intention to derive interest or profit for an arrangement to be a loan. If the factors surrounding the non-payment of trust distributions indicate the provision of credit or financial accommodation, the Commissioner will treat the unpaid distribution as a loan.

The most drastic consequence of unpaid trust distributions being treated as a loan is where a fund invests in an ungeared unit trust that holds commercial property under SIS regulation 13.22C as the fund will hold two assets in the unit trust: the loan and the units. The loan can be managed, but the unit-holding will cause headaches. The trust will no longer comply with regulation 13.22C because it's geared. If the trustee of the unit trust can't pay down the loan (or distribute the entitlements) to bring the trust within regulation 13.22C; the investment in the trust is now an in-house asset, even if the loan is repaid. 

 

Assuming the units comprise more than 5% of the value of the fund's assets (which is likely if the trust holds property), the fund trustee will have to dispose of the units. If the fund wants to maintain its interest in the property, a new unit trust will have to be established and the property transferred, which will incur stamp duty and possibly capital gains tax.  

If the trust doesn't have the cash flow to pay out the distribution within a reasonable time, it may be preferable for the fund to elect to have the entitlement invested as further capital. Contributing further capital does not prevent the trust from complying with SIS regulation 13.22C.

 

The terms of the trust deed are also important; they should provide that the unpaid entitlement is held on a separate trust pending distribution, rather than leaving it open to be characterised as a loan.

The Commissioner is clearly looking at substantial distributions that remain unpaid for years on end that appear to be used as trust capital to fund other projects. He doesn't seem to be as concerned about minor delays in payment when the trust's financials show a practice of paying the distribution (in the ruling the Commissioner accepts that a distribution declared on 30 June may not be paid until the following May once the accounts are finalised). Fund trustees with interests in related trusts should consider whether they need to make any distributions, or issue units, to ensure that any unpaid entitlements are not treated as a loan.