13 October 2023

A recent decision by the Administrative Appeals Tribunal (AAT) has challenged the Australian Taxation Office’s (ATO) long-standing treatment of unpaid present entitlements (UPEs) as loans under Division 7A.

Background

Contrary to the view of tax professionals, the ATO has considered UPEs (i.e. distributions from trusts to corporate beneficiaries which have not yet been paid by the trust) to be in-substance loans under the Division 7A deemed dividend provisions. This ATO view was released by way of a Tax Ruling in December 2009 and was a shift of interpretation from its position taken prior to 2009.

In summary, the ATO’s view is that a corporate beneficiary with a UPE provides financial accommodation to a trustee if the company has knowledge of an amount owed by the trustee but does not demand payment, and therefore is effectively consenting to the trustee using the retained amount for trust purposes.

As a result, the ATO provided for concessional treatment of UPEs whereby the UPE could be put on a 7-year interest-only investment arrangement for the sole benefit of the company. As of 1 July 2022, such arrangements have been phased out by the ATO, requiring trustees to place UPEs on 7-year principal and interest complying loan arrangements.

It is worthwhile noting that the ATO’s views are not binding on taxpayers. Although there is no compulsion on a taxpayer to follow a Public Ruling, those who ignore and disregard Public Rulings may face severe penalties and interest. Accordingly, as the application of the law to UPE’s was contentious  and unclear, the majority of trust taxpayers decided it prudent to follow the ATO Rulings and guidance on this matter.

The Bendel Case

In the recent case of Bendel v FCT [2023] AATA 3074, the AAT challenged the ATO’s stance on UPEs. The key consideration was whether a UPE constitutes a loan under subsection 109D(3) and if Subdivision EA, which contains specific integrity rules that deal with UPEs, affects this interpretation.

Case Background

Mr Steven Bendel and his group of entities, which included the 2005 Trust (the Trust) and Gleewin Investments Pty Ltd (the Company), were at the centre of the case. 

The Trustee distributed the trust income for the 2013 to 2017 years to the Company and/or Mr Bendel. This is represented in the below diagram:

The distributions to the Company remained unpaid as at the Trust’s lodgement date. The financial statements of the Trust showed the UPEs as liabilities, and did not report or account for any separate sub-trust.

As part of a 2017 audit of the Bendel Group, the Commissioner issued amended assessments contending that the UPEs were loans within the meaning of subsection 109D(3) from the Company to the Trust, and thus were deemed unfranked dividends to the Trust, which in turn were assessable to the relevant beneficiaries.

As the Commissioner disallowed Mr. Bendel’s objections to the amended assessments, Mr. Bendel appealed to the AAT.

The AAT’s Verdict

The AAT ruled in favour of the taxpayer, asserting that a UPE to a corporate beneficiary is not a loan under subsection 109D(3).

The AAT’s decision went to the statutory context, which included the enactment of Subdivision EA:

• If the AAT was to accept the Commissioner’s contention that section 109D embraces UPEs, this ‘raises the spectre’ of taxing two taxpayers in respect of the same UPE (the trust beneficiary via Division 6, and the company shareholder under section 109D).
• Subdivision EA was introduced to tackle the issue of UPEs to corporate beneficiaries, where the trustee also made a loan or payment to the shareholder of the corporate beneficiary:
  • Subdivision EA was not intended to create a second dividend in addition to a section 109D dividend;
  • As Subdivision EA applies to particular circumstances, it is the lead provision;
  • Subdivision EA requires particular additional criteria to be present before taxable dividends can arise, such that not all UPEs are to be taken to be dividends
  • Notably, a corporate beneficiary’s knowledge of the UPE is not a criterion.

Accordingly, the statutory context is that the Government must not have intended section 109D to capture UPEs as loans.

Next Steps

The vast majority of trust taxpayers have in the last decade conformed with the ATO’s views on UPEs. The AAT’s decision casts doubt on the ATO’s current stance.

For now the matter is unresolved:

• The AAT is an administrative merits review tribunal, and must be contrasted with judicial review in a court. AAT decisions are not law, and as such the ATO is not bound by this decision.
• The ATO may issue a Decision Impact statement reinforcing the ATO’s alternative views.
• It is more than likely the ATO will appeal this decision.

The Bendel decision will continue to shape discussions on UPEs and corporate beneficiaries in the tax landscape. Unless there is a change in legislation or an appeal to the AAT’s decision, taxpayers and their advisors find themselves in a state of uncertainty. For the ATO, a UPE remains a loan for the purposes of Division 7A, while for the AAT, a UPE is not a loan.

Relevantly, the potential application of section 100A to UPEs was not under review in this case. The ATO, as outlined in their PCG 2022/2, have indicated that where a corporate beneficiary’s UPE is left outstanding and made available for trustee retention of funds other than by way of commercial loan, the arrangement would not be considered low risk (green zone).

In the meantime, we will monitor the actions of the Commissioner closely, and for that matter, the Government – keeping in mind that the recommendations made by the Board of Taxation’s 2018 review into Division 7A has yet to be enacted into legislation.

Cooper Partners regularly advises on Div 7A and UPEs. If you would like assistance in navigating what the AAT’s findings in the Bendel case may mean for you and your arrangements, please contact your Cooper Partner’s engagement team to determine what if any action is required.

Author:
Maddy Watt, Principal

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This newsletter is current as of 13 October 2023, however, please note that announcements and changes are being made by the Government and the ATO regularly, and we expect that the tax and business-related responses will continue to evolve.  Before acting upon the content of this newsletter, please contact us to discuss how the above applies to your specific circumstances.

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