The ATO released Draft Taxation Determination 2019/D9. This came out over 7 months since it withdrew ATO ID 2003/589 on 6 February 2019.
In TD 2019/D9, the ATO now takes the view that the exclusion for debts forgiven for natural love and affection are only between human beings – not companies or trusts.
The ATO’s new view is that “the creditor cannot be a company or an individual acting in the capacity of a trustee”.
As part of the explanation of the ATO’s view, it notes that “the notion of forgiveness is confined by the use of ‘natural love and affection’. That term serves to identify the motivation for forgiveness. The required connection between that motivation and forgiveness is only satisfied when the creditor feels natural love and affection.” It is a human trait. While you can love your car and your dog, perhaps you cannot love your company and your trust! The ATO has made its way into your home and now into your bedroom. The ATO now claims to know your inner thoughts.
TD 2019/D9 turns on its head the ATO’s old interpretation of section 245-40(e) ITAA 1997.
Have a read of section 245-40(e). There is no requirement that a creditor is a natural person. The only reason for forgiveness is ‘natural love and affection’.
However, the ATO does not “devote compliance resources to debt forgiven prior to 6 February 2019″. However, Deeds of Debt forgiveness for companies and trust after that date may well be legal, but incur the wrath of the ATO. Tread carefully. Family Court decisions since 6 February 2019 may have to be reconsidered if there was forgiveness of debt.
Note the ATO’s position is that neither a trust nor a company, as the creditor, can express ‘feelings’ such as ‘love’ and ‘affection’. It may still be possible for a human being, such as a beneficiary to forgive a debt to a company, or, as is more usually a family trust. We will see what the ATO has in store for us, in due course.
Question: How do you see the repetitive use of a deed of debt forgiveness? Can I sign it every year and not fall fowl of the ATO? How does signing it every year interact with section 100A of the Income Tax Assessment Act 1936? Do you think the ATO’s may be more onerous with the repetition? Could the ATO consider that a debt forgiveness for an UPE is effectively enriching the controller of the trust. And therefore, potentially invalidate the distribution or assess tax to the controller of the trust?
Answer: Your question brings up two issues:
The first issue as to ‘repetition’ relates to Part IVA of the Income Tax Assessment Act 1936. This is the anti-avoidance provision in the tax legislation. Now just the making of a Family Trust or a 3-Generation Testamentary Trust could be perceived to be saving tax and be a ‘scheme’. However, I doubt that the ATO would win on that. And it has never been suggested by the ATO.
Similarly, is the forgiving of a debt a ‘scheme’ under Part IVA? No one can answer that question. As Part IVA is based on the individual circumstances of each client.
However, we have never seen the ATO wishing to attack a repetitive forgiveness of a debt each year. Centrelink may be interested with this, but the ATO does not seem to be concerned. And in any event where is the tax advantage? Part IVA attacks the ‘tax advantage’ of the transaction. It does not attack or stop the transaction itself. There is no gift duty or taxes in Australia.
As to the taxation consequences of gifting, especially when the gifts come from overseas, see here.
You may wish to print out and sign the Deed of Debt Forgiveness less frequently. Rather than every year. Speak with your accountant.
The second issue is the ATO’s withdrawal of its old authorities as to ‘love and affection’. And the now aged Draft Taxation Determination 2019/D9.
I don’t think signing the Deed of Debt Forgiveness each year to be of great interest to the ATO. Whether you sign it once in a life-time or once every year I don’t think that has bearing on the ATO’s TD2019/D9.
I, however, disagree that the trustee or the ‘controller of the trust’ (by which I assume you mean the Appointor) benefits from the forgiving of the debt. I would have thought it was the beneficiaries that benefit when someone puts money into the Family Trust. Family Trusts are started by a Settlor putting $10 into the Family Trust. This is to prime it. Throughout the life of the Family Trust, Mum and dad may often gift money into the Family Trust. I don’t see the mischief in the gifts being regular in nature.
I think TD 2019/D9 is a problem. But I don’t see ‘repetition’ as adding to the problem.
Your Family Trust distributes $30,000 to your daughter each year for 10 years. Your Family Trust pays the tax of $2,000 per year on behalf of your daughter. Therefore, there is an ‘Unpaid Present Entitlement’ (like a debt). Your Family Trust owes your daughter $280,000. An ‘Unpaid Present Entitlement’ is the money that the Family Trust owes the beneficiary. You must get her to forgive Family Trust UPEs regularly.
Your daughter, of course, never gets any of this money. You just used her low marginal tax rates to pay less tax. Your accountant reminds you that your daughter (or her ex-husband or trustee in bankruptcy) can now ask for that money. After all, it is her money.
To get rid of the debt she signs a Deed of Debt Forgiveness. Get her to sign the same Deed of Debt Forgiveness each financial year. Therefore, if your daughter goes bankrupt, feral, divorces or dies your Family Trust owes her nothing.
Have a son? Have other children? Distributed to yourself? Build a separate Deed of Debt Forgiveness for each of you.
Yes. You need a separate Deed of Debt Forgiveness for each beneficiary. If you want Dad, Mum, Child and Auntie to forgive the debt that the Family Trust owes them, then you need to build four separate Deeds of Debt Forgiveness.
However, that is all you need. Every year just print the Deed of Debt Forgiveness and get Dad to sign and date it. You never need to build another Deed of Debt Forgiveness for Dad again.
So, for example, you have 7 children. Then you need to build and pay for 7 Deeds of Debt Forgiveness. But that is it. For each child, each year, you just photocopy their Deed of Debt Forgiveness for that particular child.
If you had an 8th child then you need to go back online and build, yet another, Deed of Debt Forgiveness.
The Borrower owes you money. In the Deed of Debt Forgiveness, you forgive the debt for ‘love and affection’. The debt has gone. The borrower no longer owes the lender any money.
Issues when you forgive Family Trust UPEs:
* is a deduction for the release of debt available?
* do the commercial debt forgiveness penalties apply?
* any FBT?
Up until the ATO changed its mind with TD 2019/D9 the answer to all questions is ‘no’. See the Sample to read our letter of advice.
Division 245 ITAA 1997 sets out the tax for a debtor. This is when a commercial debt is forgiven.
However, when you forgive Family Trust UPEs for ‘natural love and affection’ the commercial debt rules don’t apply (section 245-40). Our Deed of Debt Forgiveness is drafted by us on that basis.
We do not use Reimbursement Agreements to forgive Family Trust UPEs. They don’t work. See the Sample above to read our letter of advice on this.
The case McCarthy v Saltwood Pty Ltd  TASSC 19 is a Tasmanian Supreme Court decision. It is a dispute between a beneficiary and the trustee of a discretionary trust. It arises from a dead beneficiary loan account.
It highlights the poor habits of some clients. Make sure that trustee resolutions and director minutes are legal prepared. Journal entries are a waste of time. This is especially if the journal entries mean little if there is no legal basis for the transaction they are purported to evidence.
Saltwood Pty Ltd is the trustee of the McCarthy Family Trust. The Family Trust carries out farming. The same Family Trust also owns the farming land. To own both the trading business and the land in the same trust is poor asset protection.
John McCarthy runs the farm and controls the Family Trust. John is married to Eunice McCarthy. They have 6 children.
Andrew, a son, works on the farm all his life. Andrew claims his Dad said:
When I die, Andrew, you take over the farming business and get part of the farming property.
John ran the farm. John controlled the family trust accounts.
John distributes the family trust profits to himself and his wife and Eunice. But, as is usually the case, the family trust does not actually pay the money to John and his wife. Instead, a type of loan called an ‘unpaid present entitlement is created. This results in a joint ‘loan’ account. The family trust owes money to John and his wife.
On John’s death, Eunice claims that John’s share of the loan passed to her. This is under John’s Will. Like a car or a house, a UPE is an asset of the deceased estate.
The family trust, now controlled by Andrew, rejects Eunice’s claim. The family trust disputes the ‘loan’ balance on the family trust financial statements. The family trust claims that income distributions made to John and Eunice were invalid. This is because there was no annual family trust distribution statement. Therefore, the annual trust distribution meetings did not satisfy the requirements. This is under the Trustee company’s constitution.
Warning: do not use journal entries for family trust distributions. Instead, get legally prepared family trust distribution statements.
John’s accountant quickly puts together some journal entries after John dies. The Court looks at the accountant’s journal entry for $791,698.
This reduces the money that the family trust owes Eunice. The journal entry claims that Eunice had forgiven the loan account.
The accountant claims the forgiving of $791,698 by Eunice allows the transfer of the farmland from the family trust to Andrew. But in effect, the accountant has aided and abetted an attempted theft of $791,698 from Eunice. Smells like elder abuse.
The accountant correctly notes that family trust assets do not form part of John’s estate. The accountant’s journal entries made the loan accounts to other beneficiaries “disappear and seem to be absorbed into the joint loan account of [Eunice] and John”. The Court sees no legal basis for such transactions.
The Court holds that the trust income distributions are valid. The family trust must pay the ‘loan’ amount owing to Eunice. Andrew seemed a little shocked by this. Andrew hoped to inherit the farming operations on this father’s death. This is without the debt.
Andrew is a trusting fool. The accountant while a good servant to his dead master, stuffed it up.
What makes a journal entry effective? There must be a legal basis for the transaction. This requires documents and deeds that support that legal basis.
Question: Some of our family trust clients have children approaching 18 years of age. (Therefore, the minor’s 66% penalty tax rate no longer applies.)
The Family Trust’s Trustee is often Dad (the man or straw) or his corporate trustee. Dad wants to now start distributing serious amounts of money to his 18 year old child. This is generally between $18,200 to $180,000.
In effect the Family Trust will owe the child this money. Or, as you like to call it, an Unpaid President Entitlement (UPEs).
I am concerned, as I can remember attending one of your lectures, you mentioned, that this undistributed beneficiary loans, are counted as assets for divorce and bankruptcy.
Trustee Dad distributes $20k pa to his daughter. This is for 10 years. This is between 18 and 28 years old. The girl is owed $200k at 28 years old.
Should we, therefore, recommend to Family Trust trustees that all credit balances of beneficiary unpaid entitlements, be paid out to the young adult?
So that this credit balance is not an asset for bankruptcy and divorce.
Further, most of the Family Trusts do not have the ready cash to actually pay out the Family Trust distributions.
Answer: I agree with the problem. I do not agree with your solution.
It is a great idea to use up the 18 year old’s low marginal tax rates. But if the Family Trust physically pays the money to the child then the Bankruptcy Court and Family Courts end up getting it. All you have done is move the deck chairs on the Titanic.
Whether the child is owed $200K from the Family Trust, or the child has $200K in their bank account is the same thing.
You do not need to lodge this document in the ACT, WA, VIC, NSW, TAS, NT, QLD or SA. There is no duty payable in those States.
When you forgive Family Trust UPEs there is neither income nor a taxable capital gain. They have no tax consequences. The forgiven amount ends up in the trust corpus. For the accounts, to be true and useful, the accounts should reflect this. The letter of advice provides the Journal Entries.
Adj Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
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