One issue which is frequently overlooked in the context of any relationship breakdown is the treatment of any loan accounts or unpaid present entitlements (UPEs) from family trusts to the individual spouses.

These amounts may arise from:

• a beneficiary having advanced (or been deemed to have advanced) an amount to or from the trust – in which case the amount will usually be a loan;
• the trustee having declared a distribution of income to a beneficiary without actually paying the amount to them – in which case a UPE will arise in favour of that beneficiary.

At the commencement of any family law proceedings, it is important to ensure the financial statements for each entity in the group are carefully reviewed to identify any loan accounts or UPEs which exist, as they will likely need to be addressed in the final binding financial agreement or consent orders.

For instance, any order requiring an individual to renounce their interests as a beneficiary of the trust will not, of itself, extinguish a pre-existing entitlement that individual may have to a UPE that has arisen from historic distributions.

This means the individual may be entitled to demand repayment of the UPE from the trust at a later date, even where they have renounced their interest as a beneficiary.

The most common strategies are to require any loan account or UPE to be either forgiven or assigned to the party who is retaining control of the trust.

The tax implications of this approach must be addressed and the most relevant provisions are likely to be:

• the general CGT provisions, both in relation to the initial assignment or forgiveness of the UPE or loan, and any subsequent satisfaction of the outstanding amount by the debtor, where an assignment occurs;
• Division 7A of the Tax Act 1936, which includes ‘look-through’ provisions where a trust which has a UPE owed to a company, pays an amount to or forgives a debt owing by a shareholder or associate of the company;
• the reimbursement agreement provisions of section 100A Tax Act 1936. These provisions apply where trust income has been distributed to a low-income taxpayer while the economic benefit of the income is ultimately received by another entity, usually a taxpayer who would be taxed at a higher tax rate; and
• the commercial debt forgiveness rules in Division 245 Tax Act 1997. These rules can trigger adverse tax consequences where a ‘commercial debt’ (defined as being a debt on which any interest which is or might notionally be charged would be deductible to the debtor) is assigned or forgiven.

Additional care is required when assigning a UPE, as the Property Law Act in some jurisdictions (such as Queensland) do not appear to allow the assignment of a chose-in-action and instead, require that the UPE is converted to a loan before it is assigned.

For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.