The Full Federal Court has dismissed the ATO’s appeal on the interpretation of whether an unpaid present entitlement (“UPE”) between a trust and a private company is a loan for Division 7A purposes.
In making its decision, the Full Federal Court affirmed an earlier decision of the Administrative Appeals Tribunal (AAT) which found that an unpaid present entitlement arising from a trust’s distribution to a private company was not a loan for Division 7A. This is a significant decision overturning the longstanding views of the Australian Taxation Office (ATO).
What did the Full Federal Court Decide?
The Full Federal Court confirmed that:
• A “loan” for the purpose of Section 109D requires a transaction which creates an obligation to repay an amount or which in substance effects an obligation to repay. A loan therefore differs from a UPE under which only an obligation to pay an amount arises.
• The term “financial accommodation” (included in the definition of a loan in Section 109D) does not include a UPE for Division 7A purposes.
What circumstances will the decision in Bendel apply?
The impact of the decision in Bendel is generally limited to circumstances where:
• The trust makes a company presently entitled to income of trust; and
• The entitlement remains unpaid;
• The trust has retained the funds for investment or other purposes.
The decision in Bendel’s case does not apply if the trust has lent the funds to a shareholder or an associate of a shareholder of the company. Division 7A may also apply if a chain of trusts is involved and a loan is made by one or more of the trusts to an associate or a shareholder of the private company.
What does this all mean for private groups?
This decision has created a large amount of uncertainty for private group’s as it unwinds the ATO’s long standing guidance. Most private groups have been following the Rulings and Practical Compliance Guideline provided by the ATO such that UPE’s have generally been put on compliant sub-trusts and/or have been converted to Division 7A compliant loans.
The ATO issued an Interim Decision Impact Statement following its loss at the AAT (no update has been released at the time of writing) stating that it would continue to administer the law in line with its long-held view pending the outcome of the appeal process. Whist the Full Federal Court has ruled on the matter, this may not be the end of the line.
Given the scale of this issue, it is anticipated that the Commissioner will seek special leave to appeal the decision to the High Court. Whether this is granted is another matter, however, given the uncertainty created it would be a helpful resolution. The ATO may also engage with the Federal Government to address the matter through a change in the law to clarify its application.
Private groups may wish to discuss the potential application of the decision in Bendel’s case with their professional advisers generally as well as in relation to the preparation of their 2024 income tax returns and financial statements. The chances of the current uncertainty being resolved quickly and prior to the 2024 lodgement deadlines is low, however, the 2025 position may be more attainable.
If you have any questions in relation to the potential application of Bendel’s case to your circumstances or in relation to Division 7A more generally, please reach out to your Engagement Partner.
