In brief
On 19 February 2025, the Full Federal Court dismissed the Commissioner of Taxation’s appeal in Commissioner of Taxation v Bendel [2025] FCAFC 15 finding that an unpaid present entitlement (UPE) arising from a trust’s distribution to a private company was not a loan for the purposes of the deemed dividend rules (Division 7A). This is a landmark decision effectively overturning the longstanding views of the Australian Taxation Office (ATO).
In detail
The Division 7A deemed dividend rules broadly apply to treat certain loans, payments (including the provision of assets for private use) and debt forgiveness by private companies to their shareholders (or associates) as taxable dividends, subject to certain exceptions.
The key issue in this case before the Full Federal Court was whether a private company beneficiary had made a loan to a trust that was taken to be a deemed dividend under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) for the relevant tax year(s), by virtue of having a UPE outstanding (payable by the trust to the private company beneficiary).
At first instance, the Administrative Appeals Tribunal (AAT) found that the UPEs to income or capital of the trust estate payable to the private company beneficiary did not constitute loans for Division 7A purposes. On appeal by the Commissioner of Taxation, the Full Federal Court has confirmed that position finding that a “loan” for the purpose of section 109D(3) of the ITAA 1936 requires a transaction which creates an obligation to repay an amount or which in substance effects an obligation to repay. The creation of only an obligation to pay an amount without an attendant obligation to repay, as is the case with a UPE, is not sufficient.
For many years, the vast majority of private groups have been following the Commissioner’s position in its Rulings and Practical Compliance Guideline that a UPE payable to a private company will fall within the extended meaning of the term “loan” for Division 7A purposes. As such, these have generally been put on compliant sub-trusts and/or governed by a compliant Division 7A loan agreement.
The Full Federal Court also dismissed the Commissioner’s assertion that the mischief lay in the fact that a corporate beneficiary was presently entitled to the income of the trust, tax was paid at the corporate tax rate on that income, but no payment was made by the trust to the corporate beneficiary. Sub-division EA was inserted to deal with the situation where that income found its way to an individual who was taxed at personal tax rates. That was the mischief that concerned the legislature.
After the AAT decision, the ATO had issued an Interim Decision Impact Statement where it stated pending the outcome of the appeal process, the ATO would administer the law in accordance with its published views relating to private company entitlements and trust income outlined in Tax Determination TD 2022/11.
The application of the outcome in Bendel’s case is generally limited to circumstances where:
- a trust makes a company presently entitled to income of trust; and
- the entitlement remains unpaid on the basis that the trust has retained the amount for investment or other purposes; and
- the trust has not provided and will not provide a loan to a shareholder or an associate of a shareholder of the private company which has the UPE with the trust.
There is also the question of the relevance of the decision to those historic UPEs that have been placed under a complying Division 7A loan agreement, such that an obligation to repay has been created by virtue of that loan agreement.
While the Full Federal Court decision has dealt with the issue of a trust entitlement to a private company beneficiary, it remains important to not lose sight of the fact that there is still the ability for Division 7A to apply in other cases such as where a private company actually makes a loan to a trust that is either a shareholder or associate of a shareholder. Or as mentioned above, where a trust has lent money to a shareholder (or their associate) of a private company that has an outstanding UPE with the trust (sub-division EA of Division 7A).
The takeaway
The outcome of Bendel’s case as it currently stands is the position that existed prior to the Commissioner introducing Taxation Ruling 2010/3: Income tax: Division 7A loans: trust entitlements, which was accompanied by Practice Statement Law Administration 2010/4: Division 7A: trust entitlements.
It is important to note that given the Court’s decision is contrary to long held ATO published views, this may not be the end of the matter in that the Commissioner may seek special leave to appeal the decision to the High Court. Whether the High Court would grant special leave is another matter entirely. The Government may also consider the need to amend the law to ensure that UPEs are taken to be covered by Division 7A.
In the meantime, affected private groups should closely consider their options in relation to any distributions that were previously made or expected to be made to a private company beneficiary.
It would be desirable if the uncertainty could be fully resolved quickly, particularly given the impact on UPEs in respect of the 2024 year where relevant tax returns are not yet due for lodgment and before any new UPE arrangements might be made for the 2025 income year.
It will also be important to monitor the ATO’s next steps in responding to this decision.
This decision might also just be the prompt to re-open the case for a legislative review and reform of the deemed dividend rules, which was once on a past government agenda.
Michael Dean
Simon Le Maistre
Samantha Vidler
Angela Reid
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