The ATO’s basic argument is that an unpaid distribution (“trust entitlement”) from a trust to a corporate beneficiary may be regarded as a “loan” under the deemed dividend rules.  A loan from a company to a shareholder or associated trust can potentially be treated as an unfranked dividend.  This can occur in two basic ways:

1. The unpaid distribution may have always been a loan.  This is a serious risk if the unpaid distribution has been reflected as a loan in the financial accounts of the trust and company.  Particularly if the trust deed allows a distribution to be booked as a loan from the corporate beneficiary to the trust;

2. Even an unpaid trust entitlement which has been correctly accounted for can still eventually become a loan under the “extended definition” of loan that applies for deemed dividend purposes (i.e. Division 7A).  By not calling upon the unpaid trust entitlement, the ATO argues that the company may provide “financial accommodation” or an “in-substance” loan to the trust (i.e. a loan for Division 7A purposes).  The trustee must take further steps to avoid this outcome.

Importantly, the ATO will generally not disturb unpaid trust entitlements arising before 16 December 2009 where those distributions have been properly reflected as beneficiary entitlements (not loans) in the financial accounts of the trust and company.  It is CFMC policy to quarantine these earlier unpaid entitlements in the 2010 financial accounts to avoid any unnecessary tax exposure.