As most tax practitioners would be aware, the Australian Taxation Office (“ATO”) long standing position has been that an unpaid present entitlement (“UPE”) of a corporate beneficiary from a trust is regarded as a loan for the purposes of Division 7A of the Income Tax Assessment Act 1937 (Cth) (“the 1936 Act”). However, many tax practitioners have privately held that this application of Division 7A is incorrect and, for the first time, it appears that there may be some movement in their favour.
On 28 September 2023, the Administrative Appeals Tribunal (“AAT”) in the case of Bendel & FCT [2023] AATA 3074 determined that a UPE arrangement did not constitute the giving of a ‘loan’ and therefore, did not fall under Division 7A. This case came as a surprise to the ATO and many commentators and tax practitioners in this area and is a much-needed opportunity to correct a long running error in the administration of taxation in Australia. In this bulletin, we give this case a detailed examination.
The Case
The case concerned the Bendel Group which consisted of the following three entities: Gleewin (“Gleewin 1”), Gleewin Investments (“Gleewin 2”) and a Mr B. Gleewin 1 was the trustee of a trust called the ‘2005 Trust’ (“the Trust”) in which Gleewin 2 and Mr B were beneficiaries. Mr B controlled the Trust, Gleewin 1 and Gleewin 2.
The trustee of the Trust made distributions to Mr B and Gleewin 2 as a UPE. The UPE to Mr B was offset against loans he owed the Trust and therefore, was not in issue. However, the UPE to Gleewin 2 was treated by the ATO as loan for the purposed of Division 7A from Gleewin 2 to the Trust and was taxed accordingly.
Gleewin 2 appealed the ATO’s decisions to the AAT and the matter was heard before O’Loughlin DP. Both parties asserted that the UPE created a separate trust arrangement between the Trust and the Gleewin 2 which involved the Trust having a fiduciary duty to pay Gleewin 2 the amount of the UPE at some point in the future. As the UPE had not been made paid, the separate trust was still continuing and had not come to an end. Where the parties disagreed was whether the fact that that separate trust had not come to an end meant it was a loan for the purposes of Division 7A of the 1936 Act. Gleewin 2 stated that it was not, whilst the ATO said that it was.
However, O’Loughlin DP disagreed with both parties and stated that the UPE did not create a separate trust at all. Rather, the UPE created an equitable obligation to an amount of income and not a separate asset in itself. As such, the separate trust could not be created as there was no asset for that separate trust to hold.
O’Loughlin DP then went on to say that if the equitable obligation created by the UPE was taxable, then this would mean that the amount of income promised by the UPE would be taxed twice: once under Division 6 and then again under Division 7A. He then examined the wording and intention behind Division 7A in detail and stated the following:
- The section does not expressly state that it could allow for multiple taxable dividends to arise from the same UPE;
- The section does not contain a ‘tie-breaker provision’ which dictated how an amount is to be taxed if it is found that it can be taxed in more than one way; and
- Based on the wording of the section, the intention of the section was to clearly create a pathway towards the UPE being taxed in one particular way over another if prescribed circumstances have been met.
On this basis, O’Loughlin DP concluded that the definition of “loan” in Division 7A does not reach so far as to include an equitable obligation that had not been fulfilled as doing so would result in double-taxation. Further, the wording and intention behind Division 7A indicated that this was not the desired outcome of the section.
ATO to Appeal
Unsurprisingly, the ATO has appealed the AAT’s decision. In the interim, the ATO has released an interim Decision Impact Statement (“DIS”) stating that it will continue to apply its current position until the appeals process is completed. The DIS also contains a word of warning to practitioners in this area that the ATO will continue to assess taxpayers under Section 100A of the 1936 Act and that all objections in relation to Division 7A will be decided using the legislative interpretation accepted at the time of lodgement.
Possible Legislative Changes
Another possibility that has not been discussed as much yet is that should the ATO’s appeal be unsuccessful, then the ATO may decide to advise the government to amend Division 7A to suit its purposes including varying the definition of “loan” to specifically include UPEs.
Next Steps for Practitioners
As can be seen, the case of Bendel has triggered a re-examination of Division 7A the outcome of which we will not know for some time. The appeals process itself will take some years to be completed and, even once that is complete, the ATO may still decide to advise government to amend the legislation if it is unhappy with the outcome of the appeal.
In the meantime, practitioners should keep up-to-date with changes to Division 7A and carefully discuss with their clients how they wish to proceed with UPE arrangements and when they should be lodging objections to Division 7A decisions. It may that many clients may decide to err on the side of caution and apply the ATO’s current position until at least the outcome of the appeal is known.
We will keep an eye on this space and keep our clients and readers informed of any further updates on the ATO’s appeal.
If you have any questions or require any further information or assistance about Division 7A, please do not hesitate to contact our office on (02) 9687 3755.