Michelle Bromley CFP®, Director – Strategy & Advice
Discretionary trusts, sometimes referred to as Family Trusts, are a popular vehicle for managing family wealth. Their longevity and the potential tax benefits from the streaming of income amongst family members and associated entities make them a go-to option for wealthier family groups. But how do these trusts interact with private company beneficiaries, and what are the tax implications of Unpaid Present Entitlements (UPEs)? Let’s dive in!
- Flexibility: Distribution of income and capital in the most advantageous way.
- Tax Benefits: Distributed to low-income individuals or to a corporate beneficiary at a maximum tax rate of 30%,
- Franking Credits: The Family Trust election allows pass-through of franking credits attached to dividends, which means potentially no additional tax for a corporate beneficiary.
- Retain distributions: To the extent that beneficiaries don’t require physical payment, funds can remain invested in the trust, giving rise to an Unpaid Present Entitlement.
- Division 7a Loan: Structuring a UPE owed to a corporate beneficiary as a Div 7a loan can avoid the amount being declared a deemed dividend.
Discretionary Trusts and Private Companies
A discretionary trust allows the trustee the flexibility to distribute income and capital to beneficiaries as they see fit. This flexibility can be advantageous for tax planning and asset protection.
,Why use a private company as a corporate beneficiary?
- Lower Tax Rates: A private company beneficiary can receive distributions of trust income that are taxed at the corporate tax rate of 30%, which is often lower than individual rates.
- Franking Credits: When a company receives fully franked income, the franking credits attached to the distribution represent tax already paid. The receiving company includes the grossed-up amount (distribution plus franking credit) in its assessable income but gets a tax offset equal to the franking credit. This means no additional tax is on fully franked income, providing a tax deferral until the company issues its own dividend to shareholders.
Unpaid Present Entitlements (UPEs) as Deemed Dividends
What is a UPE? An Unpaid Present Entitlement (UPE) arises when a trust distributes income to a beneficiary for tax purposes but the physical payment remains outstanding. This can be a strategic move if the beneficiary doesn’t need the funds immediately, allowing them to be retained and invested in the Trust.
- The Catch: If the UPE is owed to a corporate beneficiary, it can be considered that the company is providing a financial accommodation to the Trust. Division 7a of the Income Tax Assessment Act prohibits companies from making tax-free distributions of profits to shareholders or associates, including as a loan. The Australian Tax Office (ATO) views that UPEs owning to a corporate beneficiary constitute a loan.
- Risk a Deemed Dividend: If the UPE amount is not physically distributed to the company and is utilised for Trust purposes, particularly if payments are made to other Trust beneficiaries with those funds, the amount can be deemed an unfranked divided, carrying significant tax implications.
Complying Division 7a Loans
To avoid a deemed dividend, the UPE can be restructured as a Division 7a Compliant Loan. This involves a written agreement between the Trust and Company, specifying terms for repayment. The agreement must be in place by the lodgement day of the company’s tax return in the year in which the UPE arose.
Key Terms:
- First repayment: Required in the year following the year of loan origination.
- Interest Rate: Must be greater than or equal to the benchmark interest rate (currently 8.77%).
- Loan Term: Maximum of 7 years, or up to 25 years if secured by a registered mortgage over real property.
Case Study: The Bendel Decision
The Bendel case involved a dispute over whether UPEs owed by a trustee to a corporate beneficiary constituted loans under Division 7A. This is the first time that the ATO’s view on UPEs owing to corporate beneficiaries has been considered by the courts. In February 2025, the Full Federal Court ruled that UPEs are not loans for Division 7A purposes.
Implications: Given this contradicts the ATO’s long-held view, the decision has significant and broad tax implications and the ATO has sought special leave to appeal the decision to the High Court. At the time of writing (May 2025), the ATO is yet to hear whether special leave to appeal will be granted. Meanwhile, the ATO continues to apply the law as detailed in Taxation Determination TD 2022/11.
Conclusion
Navigating the tax implications of discretionary trusts and private company beneficiaries requires careful planning and a thorough understanding of the relevant tax laws. By effectively managing Unpaid Present Entitlements and structuring them as Division 7A compliant loans where necessary, trustees can avoid the pitfalls of deemed dividends and maximize the benefits of these arrangements. The Bendel decision highlights the importance of staying informed about legal precedents and ATO guidelines. With the right strategies in place, discretionary trusts can continue to be a powerful tool for wealth management and tax planning.
The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG (www.primefinancial.com.au/fsg) for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.
