Division 7A Win for Taxpayers: Unpaid Present Entitlements Not Loans for Division 7A Purposes

On 28 September 2023, the AAT handed down its landmark decision in Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 (Bendel) in which it decided that UPEs are not loans for Division 7A purposes.

Summary of Bendel’s case

Facts

Bendel involved Gleewin Pty Ltd as trustee for the 2005 Trust (2005 Trust) making a corporate beneficiary – Gleenwin Investments Pty Ltd (Gleewin Investments) – presently entitled to a share of the income of the trust estate for the 2013 to 2017 income years, leading to the emergence of UPEs for those years.

The entitlements of Gleenwin Investments were not fully paid by the lodgment day of the 2005 Trust’s tax returns for the income year immediately following the year in which the relevant entitlements were created. The Commissioner contended that the UPEs constituted ‘loans’ (as defined in section 109D(3) of Division 7A) made by Gleewin Investments to the 2005 Trust in the 2014 to 2017 income years and that, to the extent that they remained unpaid by the relevant lodgement day, were deemed to be dividends under Division 7A.

Decision

The AAT decided in that case that the UPEs owing to Gleenwin Investments were not loans for the purpose of Division 7A. The AAT reached its decision having regard to a number of factors, including that:

• Subdivision EA of Division 7A contains specific rules relating to UPEs owing to corporate beneficiaries and the circumstances in which these will be deemed to be dividends under Division 7A. The existence of these specific rules indicates that a particular path has been chosen to deal with the tax effects of UPEs owing to corporate beneficiaries and therefore supports the position that UPEs are not regarded as loans for the purpose of Division 7A; and
• if the UPEs were loans for Division 7A purposes, this would effectively result in double taxation to the corporate beneficiary as the beneficiary would be assessed on its share of the net income of the trust in the year in which the present entitlement arose (under section 97 of the Income Tax Assessment Act 1936 (Cth)) and again in the following year by operation of Division 7A because the entitlement remained unpaid by the relevant lodgment day. The AAT noted that no relief from this double taxation would be available under either section 6-25 of the Income Tax Assessment Act 1997 (Cth) or under the discretion contained in section 109RB of Division 7A.

Appeal

On 26 October 2023, the Commissioner lodged an appeal against the AAT’s decision to the Federal Court of Australia.

Game changing decision

The decision in Bendel is a game changer as it is contrary to the Commissioner’s longstanding views as expressed in the following public rulings and accompanying guidance materials (dating back to 16 December 2009) that UPEs owing to corporate beneficiaries constitute loans made by the corporate beneficiaries to the relevant trust for Division 7A purposes:

• Taxation Ruling 2010/3 ‘Division 7A loans: trust entitlements’. The ruling finalised draft Taxation Ruling TR 2009/D8 (issued on 16 December 2009) in which the Commissioner first expressed his view that UPEs were loans for Division 7A purposes. While the ruling has since been withdrawn, it still applies to UPEs emerging from trust entitlements created on or before 30 June 2022;
• Practice Statement Law Administration PS LA 2010/4 ‘Division 7A: trust entitlements’. As with TR 2010/3, while PS LA 2010/4 has since been withdrawn, it still applies to UPEs emerging from trust entitlements created on or before 30 June 2022;
• Practical Compliance Guideline PCG 2017/13 ‘Division 7A - PS LA 2010/4 sub-trust arrangements maturing in or after the 2016-17 income year’; and
• Taxation Determination TD 2022/11 ‘Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'?’

Bendel serves as a timely reminder that the Commissioner is a mere participant in the tax system and that his rulings and views are not law.

Where to from here?

In it unclear how the Commissioner will administer the law given the decision in Bendel, particularly while the decision is under appeal. Further, strictly speaking, the decision in Bendel is not binding in law as the AAT is not a court, so the Commissioner is not bound to follow it. For that reason, our expectation is that the Commissioner’s rulings will not be withdrawn until such time as the Bendel litigation is resolved (which may involve a subsequent Full Federal Court or High Court appeal).

The application of the Division 7A rules where UPEs are concerned is therefore currently in a state of flux.

The decision results in a renewed focus on the application of Subdivision EA. In general, Subdivision EA is not particularly well understood and has had little to no application in recent times (other than for UPEs arising prior to 16 December 2009). UPEs owing to corporate beneficiaries still give rise to consequences under Division 7A depending on the circumstances even if Bendel is correct. However, where funds are retained within a trust, Subdivision EA will not apply.

Taxpayers that have UPEs owing to corporate beneficiaries arising from entitlements created on or after 16 December 2009, including where action has been taken in line with the Commissioner’s views (e.g. by entering into Division 7A compliant loan agreements or sub-trust arrangements or by making section 109RB applications), should seek advice on the appropriate strategy to take in view of the decision. Where taxpayers have previously been issued with amended assessments by the Commissioner (and potentially penalty assessments) on the basis that the UPEs are loans and therefore deemed to be dividends under Division 7A, the taxpayer may be able to challenge those assessments and obtain refunds of the tax and penalties paid. Any advice would also have to involve consideration of the potential application of Subdivision EA to ensure that the UPEs are not caught by those rules.

The Bendel decision is a significant win for taxpayers. However, it will take time to obtain judicial authority on the operation of Division 7A to UPEs and, if he chooses to do so, for the Commissioner to issue any materials on how he will administer the law in the interim. Care will therefore need be taken in formulating and implementing an appropriate strategy to deal with UPEs owing to corporate beneficiaries until then.