In dealing with Family Groups, there may be occasions where a beneficiary who is owed a UPE from a Trust decides to release or forgive the trustee from that obligation. We see this arise when parents are retiring from a business operated in a Trust and are handing over control of the Trust to their children. They don’t want to burden with the business with this obligation, nor do they want the UPE to become an asset of their estate once they pass.
The parent, with assistance from their solicitor, execute a Deed of Release or Forgiveness, releasing the trustee of their obligations to pay over the UPE. However, what are the tax consequences of such an action?
Section 100A of the ITAA 1936 has attracted significant attention amongst tax professionals in recent years. The ATO’s much heralded ruling of December 2022, gave rise to a Practical Guidance note (PCG 2022/2) that provided a traffic signal approach to various actions undertaken by trustee with respect to distributions.
Section 100A of the ITAA 1936 provides that where a beneficiary of a trust estate, who is not under a legal disability, is presently entitled to trust income, and that present entitlement is linked either directly or indirectly to a reimbursement agreement, the beneficiary is deemed not to be presently entitled to the income. Trust distributions which fall within section 100A of the ITAA 1936 are assessed to the trustee under section 99A of the ITAA 1936.
Subsection 100A(7) of the ITAA 1936 defines a reimbursement agreement to include:
…the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or persons.
Section 100A (8) to (13) contains other provisions that are of relevance in the interpretation of the term reimbursement agreement. These provisions are to the following effect:
For the purpose of the definition of reimbursement agreement, the payment of money includes:
a) the payment of money by way of loan (s100A (10)), and;
b) the release, abandonment, failure to demand payment, or the postponement of payment, of a debt (s100A (12)).
Based on the above, the release or forgiveness of a UPE could be within the scope of section 100A and could potentially result in the trustee being assessable on the amount forgiven/released.
However, a key part of the term Reimbursement Agreement is its timing, in that the agreement must be present when the trustee resolves to make the initial distribution and not at a later time.
As a result, whilst the forgiveness of a UPE carries a risk of the application of section 100A, evidence of a reimbursement agreement must exist at the time the entitlement was created. That is, when the trustee resolves to make the distribution to the beneficiary, at that time, there must exist a reimbursement agreement that is undertaken for a purpose, not necessarily the sole purpose, of generating a tax benefit.
Whilst the later forgiveness or release of a UPE will require consideration of section 100A, it is not the act of release or forgiveness on its own that is important, but whether it can be seen to part of the agreement entered into at the time of the original distribution.
In our view where a parent later chooses to forgive or release a UPE from many years ago, and one that may have been partially paid down, it would be very unlikely that it would be considered to be part of a reimbursement agreement, entered into when that distribution was initially resolved. This would especially the case where the forgiveness was undertaken as part of their will.
As always, the tax implications of a forgiveness of a UPE will depend upon its own factual circumstances and whether section 100A could apply must be considered at that point. It is interesting to note that the ATO in PCG 2022/2 state that a forgiveness or a release of a UPE will not fall within their low risk, Green Zone, regardless of its factual circumstances. Importantly though, it is not, on its own, a high-risk Red Zone action.
If you would like to discuss the tax consequences of releasing or forgiving a UPE please contact Sean Pearce.