Trust Distribution, Div 7A and the Unpaid Present Entitlement
The Nguyen Family Trust runs a hardware wholesale business with $1.2m profit before distributions. The trustee resolves to distribute $400,000 to Kim (adult daughter, marginal rate 47%), $300,000 to Ben (adult son, marginal rate 32%), and $500,000 to a bucket company wholly owned by the trust. The trustee does not pay the bucket company's entitlement; instead it records a $500,000 unpaid present entitlement (UPE) and lends the cash to Kim's husband's business interest-free. Separately, Kim received $150,000 from the trust last year as a 'loan' that remains on the balance sheet. The trust deed requires distributions to be resolved by 30 June and permits streaming of capital gains. The accountant is also aware the trust has a $200,000 capital gain from a property sale eligible for the 50% CGT discount.
1. Explain the tax consequences of the bucket company UPE and the loan to Kim's husband.
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UPE and Div 7A. A UPE owed to a corporate beneficiary is treated as a loan for Div 7A purposes under s 109XI ITAA 1936 where it is not paid or put on complying terms. Two safe options exist: (1) pay the entitlement in cash before the lodgment day; or (2) convert it to a complying Division 7A loan with a written agreement, minimum benchmark interest and a maximum 7-year (unsecured) or 25-year (secured) term, with principal and interest payments each year.
If the trust instead lends the $500,000 to Kim's husband's business, that is a further deemed dividend exposure. The trust is the lender; the borrower is an associate of a beneficiary. Div 7A applies to loans to shareholders and their associates of private companies - but the trust itself is not a company. The risk is different: the trust's use of the bucket company's money may be a loan from the company to the trust (already captured by s 109XI) and the on-lending to Kim's husband may itself be a separate deemed dividend from the bucket company if the company is treated as the lender. The cleanest analysis: the UPE creates a deemed dividend to the trust unless subordinated, and the interest-free on-lending generates a fringe benefits or Div 7A issue depending on the borrower's status.
Kim's $150,000. A loan to a beneficiary who is a shareholder or associate of the corporate beneficiary is a Div 7A loan. If it was not documented as a complying loan by the lodgment day, it is a deemed dividend of $150,000 in the year the loan was made, included in Kim's assessable income and taxed at her marginal rate, with no franking credit unless the company franks it.
2. Advise how the trustee should stream the $200,000 capital gain and distribute the remaining income to minimise tax, noting the deed requirements.
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Streaming the gain. The deed permits streaming, so the trustee can make a specific entitlement to the capital gain in favour of a beneficiary. The 50% CGT discount ($100,000) flows with the gain only if the beneficiary is an individual or trust, not a company (companies cannot use the discount). Streaming to Kim would be inefficient at 47%; streaming to Ben at 32% saves tax but the trustee should consider whether Ben is under 18 (div 6AA) - he is an adult, so no issue.
Bucket company. Distributing the discounted gain to the bucket company forfeits the 50% discount, so the trustee should not stream the gain there. The company is better used for ordinary income at the 25% base rate entity rate (turnover under $50m).
Proportionality. The trustee must ensure the distribution resolution is made by 30 June and that the streaming is recorded in the accounts and resolution. If the deed requires a recorded entitlement, a failure makes the gain taxable to the trustee at 47%.
Overall structure. Suggested: stream $200,000 gain (discounted $100,000) to Ben; distribute ordinary income to Ben up to the top of the 32% bracket, to the bucket company at 25%, and only residual to Kim. The unpaid UPE should be converted to a complying loan before lodgment to avoid a deemed dividend. The $150,000 prior loan should be reviewed for Div 7A compliance and, if non-compliant, a voluntary disclosure considered to reduce penalties.