Trust Distributions and Division 7A

Commissioner of Taxation v Bendel: UPEs are not loans

While Bendel may not currently be a household name, for those family groups that use a trust and distribute income from that trust to a company, read on and find out more about what the decision in Bendel might mean for you.

In a significant win for some taxpayers, the Full Federal Court in Commissioner of Taxation v Bendel has recently unanimously rejected the Commissioner of Taxation’s appeal against an earlier Administrative Appeals Tribunal (now Administrative Review Tribunal) decision that, contrary to the ATO’s longstanding view, an unpaid present entitlement (“UPE”) owing to a company beneficiary is not a loan for the purposes of Division 7A.

By way of recap, Division 7A was introduced in 1998 to prevent profits or assets of a private company being provided to shareholders and their associates tax-free.  It can apply to loans, payments (which includes allowing the use of assets) and a forgiveness of debts, either by the company or through an interposed entity.  It is an anti-avoidance provision to counter arrangements that naturally arise due to there being a significant difference between the small business corporate tax rate of 25% and the highest marginal tax rate of 47%.

For over a decade it was universally understood that UPE’s owing by a trust to a company were not subject to Division 7A, unless the trust made a loan or payment to, or forgave a debt owing by, a shareholder or associate of the company after the company became presently entitled to an amount from the trust.

However, on 16 December 2009 the Commissioner changed his view and has since considered that an unpaid present entitlement is itself a loan under s109D and subject to Division 7A.  The Commissioner set out administrative practices on how taxpayers should deal with UPE’s in various rulings from TR 2010/3, PSLA 2010/4, through to TD 2022/11 where the Commissioner expects UPE’s owing to company beneficiaries to be put on 7-year complying loan agreements requiring minimum payments of principal and interest. 

The Commissioner’s view has now been ruled to be incorrect by the Full Federal Court.  The Court held that the definition of a loan in s109D contains an obligation on the debtor to repay an amount.  The agreement by a corporate beneficiary to refrain from calling for payment of the UPE did not involve the payment of a sum by or at the direction of the corporate beneficiary that would require repayment and therefore was not a loan under s109D.

However, it is too early for taxpayers and advisers to celebrate and ignore the Commissioner’s view in finalising 2024 income tax returns (or those for earlier years not yet completed).

The Commissioner has filed a special leave application with the High Court in respect of the Full Federal Court’s decision and does not intend to revise his current views relating to private company entitlements to trust income until the appeal process is finalised.

The Coalition government announced as part of the 2019 Federal Budget that UPE’s would come within the scope of Division 7A, following release of the Targeted Amendments to the Division 7A Integrity Rules Consultation Paper in October 2018.  Our submission to those proposed amendments is here.  That position has not been legislated and the Labor government could resurrect it in the upcoming Federal Budget scheduled for 25 March.

It should not be forgotten that Division 7A can still apply where a trust makes a loan or payment to, or forgives a debt owing by, a shareholder or associate of the company that has a UPE owing by the trust.

And finally, there are still other anti-avoidance provisions that can apply to what the Commissioner may see as inappropriate arrangements in relation to trust distributions.  The Commissioner has reiterated in its Interim Decision Impact Statement on the Bendel case that where a trustee retains funds that a corporate beneficiary has been made entitled to without converting that entitlement to a loan at least as commercial as the terms set out in Division 7A, there is a risk of section 100A (which deals with reimbursement agreements) applying to make the trustee liable to tax at the top marginal rate on that distribution.

Please do contact PVW Partners to discuss how the Bendel decision may impact you.