In family trusts, a beneficiary can be “presently entitled” to trust income. This means the trust has allocated income to the beneficiary but it has not been paid. This is called an unpaid present entitlement (UPE). In simple terms, this means the trust owes money to the beneficiary.
Sometimes, a beneficiary may choose to forgive or release a UPE. This often happens in family businesses when parents retire and hand control of the trust to their children. They may want to reduce obligations for the business or ensure the UPE does not become part of their estate.
To do this, a Deed of Release or Forgiveness is usually used to formalise this arrangement. However, there are potential tax consequences, particularly under Section 100A of the ITAA 1936. Section 100A is an anti-avoidance rule. It can apply where a beneficiary’s entitlement to trust income is linked to a “reimbursement agreement,” such as:
- Payments or benefits going to someone other than the beneficiary
- Loans or advances
- Release or forgiveness of a debt, including a UPE
If Section 100A applies, the beneficiary may be treated as not presently entitled to the income, and the trustee could be taxed on it instead.
A key factor is timing: the reimbursement agreement must exist when the trust originally resolves to distribute the income, not when it is forgiven later. This means the tax risk usually depends on whether the forgiveness is connected to arrangements made at the time of the original distribution.
In many cases, where a UPE is forgiven years later, such as part of retirement or estate planning, it is unlikely to be considered part of an earlier reimbursement agreement. Nevertheless, each situation depends on the facts.
The ATO’s PCG 2022/2 notes that forgiveness of a UPE is not low risk, so it may attract closer review, but it is not automatically high risk either.
Given these rules, any forgiveness or release of a UPE should be carefully considered to assess potential tax implications.