A number of our previous articles have discussed the tax, stamp duty and trust law consequences of dealing with debts and unpaid present entitlements (UPEs).
Those articles highlight the differences that can arise between those two amounts – for instance, how the commercial debt forgiveness rules in Division 245 Tax Act 1997 apply to debts but not to UPEs.
One of the most common issues we encounter in this area is that the accounting characterisation of any outstanding amounts is inconsistent with the intended legal treatment of those amounts.
At the risk of stating the obvious, outstanding amounts should ideally either be clearly characterised as either ‘UPEs’ or ‘loans’ in the financial statements, with a consistent language used in the accounts for all entities in the family group.
Unfortunately, there appears to be a tendency to rely on the default labels applied by accounting software without any analysis as to whether that label is correct and as a result, the following issues regularly appear:
- amounts which have been created as a result of unpaid trust distributions and appear to be UPEs, but which are described in the financial statements as ‘Beneficiary loans’
- amounts which are described in the financial statements as UPEs but have a negative balance (meaning they must in fact a loan from the trust to the beneficiary)
- amounts which are described in the financial statements for one party (say, the trust) as a UPE and in the financial statements for the other party (such as a corporate beneficiary) as a loan.
These incorrect characterisations can create confusion around the nature of the outstanding amount, resulting in a range of problems.
For instance, under TR 2010/3, the Tax Office may treat a UPE owed to a corporate beneficiary as a Division 7A loan if there is an implied agreement between the parties to treat the amount as a loan.
The Tax Office considers the characterisation of the amount in the financial statements of the parties as evidence of a such an implied agreement.
As flagged above, the taxation implications of assigning or forgiving an outstanding amount also depend upon whether the amount is correctly characterised as a UPE or a loan, which can be difficult if the financial statements are misleading.
Finally, unintended estate planning consequences can arise where, for instance, a testator’s will purports to gift or forgive a UPE owed to them by a trust, where the financial statements treat the amount owing to the testator as a loan rather than a UPE (or vice versa).
For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.
Comments are closed.