Author: Brett Jackson, Tax Partner
24/02/2025
On 19 February 2025, the Federal Court ruled in favour of the taxpayer in Commissioner of Taxation v Bendel [2025] FCAFC 15. The case heard by the Federal Court was an appeal against an earlier decision by the Administrative Appeals Tribunal where a company beneficiary had an unpaid present entitlement (“UPE”) to a share of trust income which the Commissioner argued was a “loan”.
The Federal Court unanimously affirmed the AAT’s earlier decision that a UPE did not constitute a loan for the purposes of applying the deemed dividend rules under Division 7A of the Income Tax Assessment Act, (1936).
Section 109D(3) of the Act states that a loan is defined to include:
“(a) an advance of money; and
(b) a provision of credit or any other form of financial accommodation; and
(c) a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation
to repay the amount; and
(d) a transaction (whatever its terms or form) which in substance effects a loan of money.”
The Commissioner contended that a UPE constituted a “provision of financial accommodation” where the UPE remained unpaid and the funds continued to be available to the trustee for reinvestment.
The Commissioner first expressed his view on UPEs owing to companies In Taxation Ruling 2010/3, a view that had largely been untested by the courts and until the decision in Bendel.
In its decision, the Federal Court said it did not accept the Commissioner’s construction of Section 109D(3) of the ITAA 1936. The court stated:
“The perceived mischief which lies at the heart of the Commissioner’s submission is the creation of a present entitlement which is not paid to a corporate beneficiary and remains in the trust but which benefits from taxation at the corporate beneficiary’s corporate tax rate. Division 7A does not operate to negate that present entitlement. A consequence of the Commissioner’s construction of Div 7A is that a share of net income to which a corporate beneficiary has been made presently entitled and on which the corporate beneficiary has been taxed in one year is again included net income of that same trust in the following year. This has the potential result of an overall tax impost that is higher than if the corporate beneficiary was never made presently entitled at all.”
The court further stated:
“Division 7A is an anti-avoidance provision directed at in substance distributions of private company profits.
… Section109D(3) requires more than the existence of a debtor-creditor relationship. It requires an obligation to repay and not merely an obligation to pay.”
The Commissioner contended in Bendel that the private company had consented or acquiesced to the trustee not paying the present entitlement by making a decision to refrain from calling for payment. However, the consensual arrangement relied upon by the Commissioner did not involve the payment of a sum by or at the direction of the private company that was required to be repaid.
The Court held that in those circumstances, Section 109D is not satisfied. Although a debtor-creditor relationship was created by the trustee resolution and the entry in the trust accounts in Bendel, there was no loan or creation of an obligation to repay an amount as opposed to an obligation to pay.
Where to from here?
The Commissioner has until 28 March 2025 to appeal the decision in Bendel, but may find it challenging in seeking leave to do so given that the AAT and Federal Court found collectively in favour of the taxpayer 5-0.
It is possible that the ATO may in fact accept the decision and when reviewing other cases seek to apply other integrity measures such as Section 100A. We have previously written to clients about the application of Section 100A. See: https://www.blazeacumen.com.au/no-91-ato-draft-ruling-issued-impacting-taxation-of-trust-distributions/
Application to clients
The practice by the team at Blaze Acumen has been to apply the Commissioner’s view since the issue of Taxation Ruling TR 2010/3. Taxpayers who have not taken this approach may have been issued amended assessments, including being charged penalties and interest where they have adopted a contrary position and have been subject to an ATO review. The decision in Bendel opens the door for such taxpayers to potentially seek an amendment to those prior year assessments if they are within time limits to do so (the period of review being 4 years).
If the Commissioner is unsuccessful in seeking leave to appeal the decision in Bendel (or chooses not to do so), this may cause a material shift in future tax planning considerations.
It may be possible for trustees to (once again) distribute income to corporate beneficiaries and retain the funds in the trust for reinvestment, benefitting from the corporate rate of tax on income and deferring any eventual “top up tax” to personal tax rates until such time as a dividend is required to be declared or paid. However, to achieve this outcome, the arrangement between the trustee and the corporate beneficiary would still need to satisfy the “ordinary commercial dealing” exclusion from the application of Section 100A. In these circumstances, we would expect the Commissioner to consider amendments to Taxation TR 2022/4 “Income tax: section 100A reimbursement agreements” to provide further clarity regarding what is an “ordinary commercial dealing” in light of the Federal Court’s decision.
It should also be noted that Subdivision EA of Division 7A is a separate integrity measure that prevents shareholders and associates from accessing funds retained by the trustee unless they are genuinely owed money by the trust. Loans to family members on a non-arm’s length basis can otherwise be caught and treated as a deemed dividend in such circumstances.
Blaze Acumen Comment:
In our opinion, the courts have made the correct interpretation of Section 109D(3) in their decision in Bendel and we welcome the clarity that has been overdue for many years for taxpayers and practitioners seeking greater certainty in advising their clients.
Our recommendation to clients at this stage is to do nothing until it is known whether the ATO will be granted leave to appeal the Bendel decision or will otherwise issue a Decision Impact Statement which clarifies its approach to UPEs owing to companies in light of the loss in this case on appeal.
As always, please contact your Blaze Acumen adviser to discuss your specific circumstances and how any potential changes in the way that UPEs are treated for tax purposes may impact your current and future tax and family planning considerations.
Please do not hesitate to contact your Blaze Acumen advisor if you would like to discuss any of the issues raised in this Client Alert.