Whether an UPE to income or capital of a trust estate is a loan?

We have been fielding questions over the last couple of weeks on an Administrative Appeals Tribunal (AAT) decision that occurred at the end of September 2023.

This AAT decision (Bendel v FCT) in effect overturned a decade or so of the ATO’s current position on unpaid present entitlements (UPEs) between a Trust and in this specific case a corporate beneficiary.

The ATO has long regarded UPEs between a company and a Trust as loans, and therefore Div7A-type loan agreements were needed to avoid additional taxes being levied (Read our earlier article on Understanding Div7A-type loans). It was choosing between making the loan agreements or the Trust paid the monies to the company, and then either the Trust or an individual taxpayer borrowed the money from the company. In some circumstances, individuals took the monies directly from the Trust and the UPE to the company remained unpaid for many years.

The facts of Bendel were that a discretionary trust distributed profits at year end to a corporate beneficiary over a number of years, and this distribution of profits remained substantially unpaid.

This is a common occurrence for many Trusts each year, so clients have been following this outcome with interest, especially since the decision landed on the side of the taxpayer.

The ATO’s view was the amount unpaid was “financial accommodation” and therefore a loan caught under Division 7A legislation.

The AAT held that UPEs were not considered to be loans and therefore were not deemed to be Div7A dividends.

The AAT concluded, the balance of an outstanding UPE of a corporate beneficiary of a trust, whether held on a separate trust or otherwise, is not a loan to the trustee of the trust for the purposes of s109D(3).

The Bendel decision casts significant doubt over whether the Commissioner’s views in previous issued taxation rulings and practice statements are correct.

The Bendel decision is an administrative decision, not a judicial authority, and therefore does not change the law. This is important for taxpayers to remember as any appeals process may take years to conclude.

The ATO has issued a decision impact statement in relation to this case. The ATO has also stated that it will appeal the decision of the AAT.

In the decision impact statement, it states that the until the appeal process is finalised, the Commissioner does not intend to revise the current ATO views relating to private company entitlements to trust income, as set out in TD 2022/11.

In addition to the application of s109D, the basis on which private company beneficiaries deal with unpaid entitlements to trust income may have implications under other taxation law, such as s100A.

S100A is a piece of legislation relating to reimbursement agreements. This legislation has had some bite recently added to it, for which certain conditions need to be satisfied in order to avoid additional tax being allocated to Trustees of a trust. These agreements will need to have a Div7A-type loan in place anyway.

For clients that have similar circumstances to the Bendel decision, it creates uncertainty as to the correct treatment under the law for UPEs.

Taxpayers do have time on their side to decide on the treatment of any UPEs to corporate beneficiaries. For distributions made for the 2023 year to corporate beneficiaries, the decision will be required by the time the corporate beneficiary needs to lodge its tax return for FY24, the earliest being October 2024. Hopefully the appeal process is completed by then.

Even if the ATO loses this case, there is always the potential for legislation to be enacted to match the ATO preferred interpretation.

For More Information

In the meantime, any questions on the above position and/or s100A “reimbursement arrangements”, please contact your Archer Gowland Redshaw adviser on (07) 3002 2699 | info@agredshaw.com.au.

Ian Walker

Written by Ian Walker

As Executive Chairman, Ian is a trusted Professional Services practitioner with over 25 years’ experience within the Accounting industry. Working closely with his clients to form long-term partnership, Ian provides high-level strategic advice across all areas of Accounting, Business Advisory, Superannuation, and Taxation. Ian is proud to partner with many SME & Family-owned businesses to provide comprehensive and bespoke strategies to help address the challenges and complexities they encounter through day-to-day operations & management.