The issue of unpaid present entitlements pops up pretty much every time you deal with a discretionary trust that has made a family trust election. Not necessarily, but in most cases.
Unpaid Present Entitlement
An unpaid present entitlement is a present entitlement whose payment remains outstanding. And that is very common around trusts. The trust earns income and allocates it to the beneficiaries. But the beneficiaries don’t need the cash and leave the money in the trust. And so now there is an unpaid present entitlement.
Present Entitlement
Let’s start with a present entitlement as such. Neither ITAA97 nor ITAA36 define present entitlement. So case law it is.
A present entitlement means the entitlement to immediate payment of a share in the trust and the right to demand payment from the trustee or require that the trustee properly reinvest, accumulate or capitalise those funds in the trust according to FCT v Whiting (1943) 68 CLR 99.
It means the enjoyment of a right to demand and receive payment according to Harmer v FCT 89 ATC 5180.
When a beneficiary holds a vested and indefeasible interest in the income of a trust estate but no present entitlement as such, the beneficiary is deemed to be presently entitled. Indefeasible means that the right can’t be made void.
s95A (2): …where a beneficiary has a vested and indefeasible interest in any of the income.. but is not presently entitled…, the beneficiary shall be deemed to be presently entitled to that income.
But a merely contingent interest is not enough.
A presently entitled beneficiary remains presently entitled to their allocated income even after payment has occured.
s95A (1): …where a beneficiary …is presently entitled…, the beneficiary shall be taken to continue to be presently entitled to that income notwithstanding that the income is paid to or applied to the benefit of the beneficiary.
Unpaid Present Entitlement
It is a common occurence that a trust distribution to a beneficiary is unpaid. The unpaid amount is referred to as an unpaid present entitlement (UPE). The fact that the amount remains unpaid does not impact whether the amount is assessable to the beneficiary.
Equitable Obligation
An unpaid present entitlement is not a common law obligation, but an equitable obligation. A UPE is therefore not a debt, since a debt is a common law obligation.
So when tax law refers to a debt, it doesn’t include a UPE. And that has tax consequences in several areas.
s 109 F ITAA36
Section 109F ITAA36 about forgiven debt uses the term ‘debt’ and hence does not apply to UPEs.
s 25-35 ITAA97
The bad debt provision in s25-35 of ITAA97 does not cover writing off an unpaid present entitlement (TD 2015/D5).
Div 245 ITAA97
The rules around commercial debt forgiveness inDiv 245 ITAA 97 use the term ‘debt’ and hence don’t apply to UPEs.
Div 7A ITAA36
Division 7A includes the provision of financial accommodation. And so a deemed loan per s109D includes a UPE.
A company forgiving a UPE constitutes a “payment” for the purposes of Division 7A through TD 2015/20.
Putting an unpaid distribution to a company into a sub-trust arrangement will overcome the implications of TR 2010/3.
Div 152 ITAA 97
A UPE is a CGT asset. This is important for the the small business CGT concessions. A UPE is ordinarily regarded as a sub-trust carved out of the main trust for the purposes of s152-20 (TR 2015/4).
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Last Updated on 23 March 2020
