On 19 February 2025, a pivotal Full Federal Court decision in respect of trust law and Division 7A was handed down in favour of the taxpayer.
In Commissioner of Taxation v Bendel [2025] FCAFC 15, the Court ruled that an ‘unpaid present entitlement’ (UPE) resulting from a trust allocating income to a corporate beneficiary does not constitute a “loan” for Division 7A purposes.
The Court’s decision affirms the earlier decision of the Administrative Appeals Tribunal (now the Administrative Review Tribunal) on this matter, albeit for different reasons.
The decision
The ruling found that the ATO’s long-held position that a UPE between a trust and a company can constitute a loan for Division 7A purposes to be incorrect. That is, the Court disagreed with the ATO’s interpretation of how a UPE is treated under Division 7A, noting that it did not reflect Parliament’s intention, and further commenting that “…the construction we have adopted does not give rise to absurd or irrational outcomes or leave unaddressed an obvious drafting error”.
What it means for private business owners
Almost all taxpayers over the last 15 years have complied with the ATO’s position, albeit under protest, as to do otherwise invited the ATO to assess deemed unfranked dividends under Division 7A.
However, conducting one’s tax affairs in accordance with the ATO’s position necessitated executing documents governing arrangements (eg a ‘sub-trust agreement or complying loan agreement’) between the trust and corporate beneficiary, with the trust making payments of interest and principal (if required) to the corporate beneficiary.
The practical outcome for many private business owners from complying with the ATO’s position over the years has been to incur ‘top-up’ tax – being the balance of tax from the company tax rate up to the owners’ personal marginal tax rate – on profits they have not drawn, but in fact have retained and reinvested in their business.
While the Full Federal Court decision may represent good news, the outcome gives rise to uncertainty including what to do with arrangements put in place in accordance with the ATO’s guidelines. One practical consequence of applying these has been a reduced risk of a deemed dividends arising for transactions between trusts and related parties. This will be among the elements to watch as the situation unfolds.
Some private business owners who have been adversely impacted from historical ATO engagement or reviews should consider whether they should prepare preventative objections to protect their positions.
The case is an important reminder that guidance and interpretation issued by the ATO is not law but rather the Commissioner’s interpretation of the law. And on occasion, such as this one, the courts have found the Commissioner’s interpretation to be wrong.
ATO’s likely next steps
The ATO will almost certainly seek special leave to appeal this decision to the High Court. Further, we expect that the ATO will issue a further interim Decision Impact Statement affirming their long-standing position and stating that they will continue to administer the law on that basis while the judicial process continues.
Even if the High Court were to similarly rule against the ATO, we anticipate that considerable uncertainty will remain, including determining what to do with pre-existing arrangements entered into in compliance with ATO guidelines. While that would need an administrative solution, we consider that legislative reform is necessary.
It is likely that Treasury and Parliament will revisit the proposed reforms to Division 7A that were announced in the 2018-19 Federal Budget. In this regard, it might be a situation of ‘be careful what you wish for’ as numerous aspects proposed as part of that reform were considered unacceptable for private business owners.
It is also important to remember that there are other integrity measures that the ATO has available, including s100A for trusts specifically and the general anti-avoidance regime in Part IVA, which are alternative avenues the ATO has in addition to Division 7A.
Next steps
As the Bendal case remains subject to potential appeal, the final resolution of how to treat unpaid present entitlements for corporate beneficiaries seems quite far off. This continued uncertainty is challenging, particularly as trustees need to decide how they approach dealing with UPEs arising from at least the 2023 year before lodging their 2024 company returns – a date looming if not already passed.
Further, there’s quite a lot of detail to unpack from the Full Federal Court’s decision in Bendal when applying it to other trusts. One shouldn’t conclude that every trust will benefit from the decision.
Should trustees ‘roll the dice’? If one applies the Bendal approach instead of the Commissioner’s guidelines, it will almost certainly help defer ‘top up’ tax for shareholders until a later year, which could provide a valuable saving. However it is likely that an unfranked dividend will arise if the Commissioner is successful on any appeal, which would clearly be an adverse outcome.
The main practical option for many private business owners in the meantime would be to continue complying in accordance with the ATO’s position until further notice, although that might not suit all situations.
We will continue to monitor developments as they unfold and will return to this significant matter in due course.
Please contact your trusted Grant Thornton advisor to discuss these developments, especially if you are directly affected by the decision.
Article contributed by Ben Peoples - Tax
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