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ATO stands by its views on UPEs and Division 7A following AAT loss
Technical article

ATO stands by its views on UPEs and Division 7A following AAT loss

The ATO has issued an interim decision impact statement following the AAT’s decision in Bendel v FCT, currently on appeal to the Federal Court.

In that case, the AAT held that a corporate beneficiary’s entitlement to trust income that remained unpaid did not give rise to a loan (and therefore no deemed dividend) for Division 7A purposes. The ATO states that it stands by its views and will continue to administer the law in accordance with existing published views pending the outcome of the appeal and also warns of potential section 100A implications in respect of unpaid present entitlements (“UPEs”).

What is the ATO doing about UPEs?

Since 16 December 2009, the ATO have considered that a UPE to a corporate beneficiary gives rise to a loan for Division 7A purposes from, the company to the trust, where the UPE remains outstanding. In the recent decision in Bendel v FCT [2023] AATA 3074 (“Bendel”), the AAT has determined that no deemed dividend arose from the failure of a trust to satisfy a UPE to a corporate beneficiary by the company’s lodgment day. This decision is directly at odds with the ATO’s published views and administration of the law for the past 14 years. A more comprehensive summary of the case is contained further on in this article.

In its interim decision impact statement (“DIS’) (click here), the ATO confirms that it will not change its views on the application Division 7A to UPEs while the case is on appeal. As such, it will stand by its long-standing view, which was recently revised and updated in TD 2022/11.

As any appeal process (which may go beyond the Federal Court) is unlikely to be finalised by May 2024, this means that no additional judicial clarity is likely to be provided by the time trust entitlements arising for the 30 June 2023 year may need to be dealt with.

The ATO also states that it will not finalise any open objections relating to this issue while the appeal is on foot, but if forced to, will decide objections based on existing published views rather than based on the AAT’s decision in Bendel.

Can taxpayers rely on the decision in Bendel?

Practically, the answer is no – at least, not for now.

Given the ATO’s stance, taxpayers need to be careful about placing significant reliance on the decision in Bendel until any appeal is finalised. The recent decision, coming from a Tribunal, does not create authority that is binding on the Commissioner.

Furthermore, even if the AAT’s decision is upheld in the Federal Court (or any further appeal court), a legislative change may be sought. Of course this cannot be known with any certainty. However, to this end, an announced but enacted measure of the previous Government (from the May 2018 Federal Budget) was to ensure that UPEs come within the scope of Division 7A by clarifying the law. The current Government has remained silent on this proposed measure, whilst having publicly relegated a number of other announced but enacted measures to the scrap heap.

What should taxpayers be doing?

Taxpayers should seek specialist tax advice if they intend to rely on the authority in Bendel in respect of either ongoing disputes in respect of past UPEs or in respect of recent and future UPEs that have not yet to be dealt with. This may involve a consideration of a taxpayer’s objection rights and timeframes for making an objection.

Taxpayers should be extremely careful about adopt practices such as leaving UPEs to corporate beneficiaries unpaid, forgiving UPEs, ignoring obligations under existing interest-only sub-trust arrangements entered into in accordance with former PS LA 2010/4 or going back to seek refunds for prior year deemed dividends. Based on the ATO’s DIS, such positions are  likely to attract the ATO’s attention.

Further, if the ATO is unable to apply Division 7A to arrangements involving UPEs, it may be forced to seek to apply section 100A (as it has not so subtly warned in the DIS) which may result in a more adverse outcome (i.e. a trustee assessment at the top marginal rate rather than a deemed dividend which may be taxed at a lower rate). Under their section 100A guidelines in PCG 2022/2, an arrangement involving the trustee retention of funds does not fall into a Green Zone where a UPE to a corporate beneficiary is not put on complying Division 7A terms.

What were the facts in Bendel?

The facts in Bendel involved a discretionary trust that resolved to distribute a large share of its income for the 2013 to 2016 income years to a corporate beneficiary, totalling approximately $1.66 million. The taxpayer controlled both the trust and the corporate beneficiary.

The trust paid some small amounts on behalf of the corporate beneficiary (e.g. tax instalments and ASIC fees) and the ATO determined that the remainder of the entitlement that remained unpaid resulted in the corporate beneficiary making a loan to the trust by way of the provision of financial accommodation in each income year following the creation of the present entitlement. As these amounts were not repaid or put on complying loan terms by the company’s lodgment day for each of those income years, the ATO determined that a deemed dividend arose under section 109D of the Income Tax Assessment Act 1936 (“ITAA 1936“). The ATO included the deemed dividend in the trust’s net income for the years in question and assessed the beneficiaries based on their proportionate shares of the trust’s distributable income under section 97 of ITAA 1936.

The taxpayer objected and appealed to the AAT on the basis that the UPEs did not give rise to loans within the meaning of subsection 109D(3).

What did the taxpayers argue?

Much of the case considered the nature of a beneficiary’s entitlement to the income of a trust estate. In particular, large reliance was placed on the judgment of Gageler J in the High Court decision in Fischer v Nemeske [2016] HCA 11.

This analysis was important, as the ATO had argued that the creation of a sub-trust meant that the UPE was actually discharged or paid so that Subdivision EA had no application to any amounts subsequently lent by the trust. Therefore, according to the ATO, there was no apparent conflict between the existence of Subdivision EA (dealing with UPEs) and the characterisation of the UPE as itself giving rise to a section 109D loan from the corporate beneficiary to the trust (i.e. because the UPE stopped being a UPE once a sub-trust came into existence). According to the ATO, the section 109D loan was said to have been made by the company as a result of it not bringing the sub-trust to an end as the sole and absolute beneficiary of that sub-trust.

By contrast, the taxpayer relied heavily on the statutory context of Subdivision EA (and its predecessor section 109UB) to argue that UPEs to corporate beneficiaries only result in a Division 7A deemed dividend where the trust makes a contemporaneous loan (or makes certain payments or forgives debts) to a shareholder (or an associate of a shareholder) of a private company while a UPE to the private company subsists. The taxpayer argued that the mere existence of the UPE without anything more cannot result in a deemed dividend.

What did the AAT Decide?

The decision was handed down by two members of the AAT, Deputy President O’Loughlin KC and Senior Member James who agreed with the taxpayer’s arguments.

Their decision includes an extensive analysis of the legislative history of Division 7A and relevant extrinsic materials, in particular those relating to former section 109UB and Subdivision EA which expressly deal with UPEs to corporate beneficiaries.

Regarding the sub-trust issue, the AAT found that despite a power in the relevant trust deed allowing the setting aside of amounts for any beneficiary resulting in those amounts ceasing to form part of the trust fund, the mere creation of a right to income in the favour of the corporate beneficiary did not result in there being a separate trust. There was no certainty of subject matter of any such trust as no specific assets were separately held for the beneficiary, nor were separate trusts recorded in the trust’s books. While the beneficiary may have had an absolute beneficial entitlement to some part of the trust fund, the nature of the interest gave rise to an equitable obligation of the trustee, rather than any property becoming the subject matter or corpus of any separate trust (or sub-trust) held by the trustee.

However, the main reasoning of the AAT went beyond a consideration of the particular trust deed and was based on a broader examination of the legislative history and context of Division 7A. The AAT held that the evident legislative intention is that UPEs only give rise to Division 7A deemed dividends where Subdivision EA is enlivened. This requires additional circumstances to be present beyond the mere existence of a UPE (e.g. where the trust makes a loan). The legislation should not be read as resulting in a second taxable dividend under section 109D arising from the exact same UPE. The AAT held that this is the case whether or not the amount owing to the beneficiary by the trustee was held on a separate trust.

Other than in respect of some smaller amounts found to be an ordinary loan from the company to the trust (where the trust banked the company’s income tax refunds), the AAT allowed the taxpayer’s objection by holding that no deemed dividends arose out of the UPEs that existed between the corporate beneficiary and the trust.

This content is general commentary only and does not constitute advice. Before making any decision or taking any action in relation to the content, you should consult your professional advisor. To the maximum extent permitted by law, neither Pitcher Partners or its affiliated entities, nor any of our employees will be liable for any loss, damage, liability or claim whatsoever suffered or incurred arising directly or indirectly out of the use or reliance on the material contained in this content. Pitcher Partners is an association of independent firms. Pitcher Partners is a member of the global network of Baker Tilly International Limited, the members of which are separate and independent legal entities. Liability limited by a scheme approved under professional standards legislation.

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