Legal Tip 161: Avoiding Unpaid Present Entitlements (UPEs)

Legal Tips: Avoiding Unpaid Present Entitlements (UPEs)


What are UPEs? They are basically trust distributions which are not actually paid out of the trust to the beneficiary. The Trust retains the money and may further invest it.

I gave a quick summary here:

Legal Tip 87: Trusts and Unpaid Present Entitlements

https://propertychat.com.au/communi...-trusts-and-unpaid-present-entitlements.4718/



Example

Johnny is a director of ABC Pty Ltd which is the trustee for the DEF Trust. Johnny is also a beneficiary of the trust. The Trust makes say $100,000 profit from, say, the sale of a property.



Johnny causes ABC Pty Ltd to resolve to distribute $100,000 to Johnny. Johnny never gets paid the $100,000. The trust uses this to buy $100,000 worth of shares. Johnny is still taxed on the $100,000 though.


Legal Issues

There are many different legal issues, some of which are:


a) Debt

The trust basically owes money to Johnny still as he has not been paid.


b) Limitations Act Doesn’t apply

A UPE is a debt but it is not really a loan. Johnny has an entitlement in equity to the money. Because it is not a loan under contract or deed the Limitations Act will probably not apply. The debt doesn’t go stale.


c) Death

These UPEs can cause massive amounts of problems to family on the death. In this example if Johnny dies his executor MUST do everything possible to recover the money. This includes suing the trustee if necessary. (seen this happen).

Where there are no or missing records this can create a nightmare, especially where the trust is controlled by different parties to the estate.


This also puts a large legal strain on the executor as they are personally at risk when undertaking litigation.


d) Cash flow

The longer the trustee doesn’t distribute the money the greater the effect on cash flow and access to money will be.


For example if Johnny above was owed $1mil by the trust and the trustee had used this to purchase a $1mil commercial property there would be huge issues if Johnny suddenly died and the trustee had to pay out $1mil to Johnny’s estate in the next 6 months.


e) Sudden tax issues

Selling assets to pay the entitlements over would also potentially trigger further taxes. For example if the $1mil property referred to above was sold for $1.2 Mill that may be another $200,000 capital gain that would need to be distributed.


f) f) Other tax Issues

I will cover these in the tax section under a new thread in the tax section.



Avoiding problems

Consider ways to avoid these problems such as by

a) Causing the trustee to actually pay the money over to the beneficiary

b) Beneficiary can then either:

a. Gift back to the trust or

b. Lend back to the trust

c) Document any loan or gift back to the trust

d) Consider forgiving any loans to the trust at death (there are many arguments for and against this)

e) Incorporate this into your will

f) If you must keep the money in the trust consider creating a sub-trust for the beneficiary, especially where the beneficiary is a company

 

Many family trusts can have UPE with adult kids. Paying uni costs, wedding expenses and other amounts that benefit the adult child beneficiary etc can assist to discharge UPEs. UPE's can become a issue if the adult child divorces as the trust debt is a personal asset. This can then drag a parent controlled family trust into the adult childs divorce. Best avoided and discharge of the UPE with legal advice at the earliest opportunity is recommended.

 

Suppose I am a trustee for a family trust which say received $10,000 in dividends. The beneficiaries include myself and two siblings.

The dividends is paid directly into my bank account. During tax time, in order to minimise total income tax payable by the family unit, I decide to distribute $5000 to each of my siblings and none to myself.

In this scenario, are you saying that I need to transfer $5000 from my bank account to each sibling?

 

Who is the trustee distrubuting to?

 

The $10,000 in dividends is paid directly from the companies which the trust has invested directly into my bank account. I am the trustee and wish to distribute $5000 to each of my two siblings. Is this something that can be done on paper when lodging the trusts tax return or do I need to physically transfer the $5000 to each of my siblings bank accounts?

 

Sounds hairy...do you have a separate bank account as trustee?

you as trustee should actually distribute the money. If you don't you could be liable f9r it at some future date.

 

No I dont have a separate bank account as trustee. I just use my bank account where I normally have my salary paid into as well. Although it may be messy, is it something that goes against tax rules or rules of a trust? Would it be wise establish a new business account for the trust?

Thanks

 

Breach of duties as trustee possibly.

Yes best to establish a new account and keep trust money separately to your own.

 

That sounds more sensible. Thanks for your reply

 

How coincidental. This is the issue I have been discussing with the other Director of the Corporate Trustee which administers a T/Trust.

They were looking at the level of cash and contemplating investing it until I reminded them it would be a good idea to deduct from the apparent cash the liabilities, such as the UPE, to get a better idea of the "true" cash level available. It also dawned on them, with a bit of prompting on my part, if the T/Trust is participating in DRP's, at some stage those may need to be stopped to avoid the UPE's exceeding the cash level unless they sell assets.

The UPE's have been reduced as the beneficiaries have been using the funds for personal matters, probably going on a holiday. Well, I think that's what is being done. I never asked as it's their funds and I simply transferred the money as requested. I take the position what they do with it once it's in their hands is none of my business.

 

If the dividends went into the trust bank account then the resolution/s of the trustee may credit a entitlement to trust income. Thats what tax law will be based on - entitlement rather than actual payment. Then at that time or later that entitlement may be discharged by paying the $$$.

Defective distributions arent a mere formality.

If the trust income is credited to YOUR bank account there may be a serious tax issue already. Trust income should be paid into the TRUST bank account. Just because you are trustee doesnt mean its YOUR account.

 

"c) Document any loan or gift back to the trust"

Where and how do you actually document gifts to the trust? Is it enough just to put it in the bank transfer message "gift to the trust"?

 

It will depend on who the trustee is.

If not yourself then ideally just a deed of gift witnessed
If you are the trustee then you cannot gift to yourself but would have to make a declaration of trust via a deed and get this witnessed.

Undocumented gifts can be valid too, but there could be questions as to whether it was a loan or a gift so best to properly document.

 

A corporate trustee where I'm the director.

A witnessed deed of gift each time I want to transfer funds to the trust account sounds like a hassle!

 

Nowhere near as much of a hassle (and expense) as potential future legal action with a negative outcome!

 

1) Would the deed of gift only be required once at EOFY? Eg. At tax time you tally up all distributions that were transfered back to trust account.

2) for corporate trustees of Disc trusts- is there some agreement between the trustee and beneficiary that could be written to allow all current/future UPE's to that beneficiary be considered as gifts by said beneficiary? Just thinking this would avoid actually transfering funds back and forth and the need for the deed of gift.

 

The only point of a deed of gift is to document the intention of the gift giver, without one there is uncertainty of intention.

 

Thanks Terry.
So if a trust owes a beneficiary in the form of an UPE, ( the beneficiary has paid tax on money it didn't get). Could the beneficiary provide the trust/trustee with a deed of gift for the amount owed and that would remove the UPE, and no funds would actually need to be transfered back and forth?

 

Yes or a deed to forgive the debt

 

Can a UPE be converted to a loan?