The Full Federal Court’s decision in Commissioner of Taxation v Bendel provides long-awaited clarity on the treatment of unpaid present entitlements (UPEs) under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). The case centred on whether a corporate beneficiary’s entitlement to trust income, left unpaid within the trust, constituted a “loan” for Division 7A purposes, thereby triggering deemed dividend tax consequences.

In a significant outcome for taxpayers, the Court upheld the Administrative Appeals Tribunal’s decision that such entitlements do not constitute a loan under section 109D(3), absent an obligation to repay. The ruling narrows the scope of Division 7A and confirms that Subdivision EA, not section 109D, is the relevant provision for dealing with corporate UPEs in trust structures.

This case has substantial implications for private groups using discretionary trusts and corporate beneficiaries, especially in light of the ATO’s previously stated position in TD 2022/11 and PCG 2022/2. While the Commissioner has sought special leave to appeal to the High Court, the Bendel decision currently stands as the leading judicial authority on this issue.

Facts

Gleewin Pty Ltd acted as the trustee for the Steven Bendel 2005 Discretionary Trust (2005 Trust), with Gleewin Investments Pty Ltd (a corporate beneficiary) and Mr. Steven Bendel as discretionary beneficiaries. Mr. Bendel was the sole director and shareholder of both entities, effectively controlling them.

For the income years 2013–2017, the trustee resolved to distribute portions of trust income to Gleewin Investments, creating UPEs for the corporate beneficiary. However, these entitlements were not immediately paid out but remained within the trust structure. The Australian Taxation Office (ATO) assessed that these unpaid entitlements actually constituted loans under section 109D of the Income Tax ITAA 1936, triggering deemed dividends under Division 7A.

The Administrative Appeals Tribunal (AAT) ruled in favour of the taxpayer, holding that a UPE does not constitute a loan under section 109D. The Commissioner appealed to the Full Federal Court, arguing that the Tribunal had misapplied Division 7A and that the UPEs should be considered financial accommodation. The Full Federal Court upheld the AAT decision.

Applicable Law

• Division 7A of the ITAA 1936 – Designed to prevent disguised distributions of private company profits by treating certain transactions as deemed dividends.
  
• Section 109D(3) ITAA 1936 – Defines “loan” broadly, including advances, financial accommodation, payments requiring repayment, and transactions that in substance effect a loan.
  
• Subdivision EA of Division 7A – Applies when a trust with a corporate beneficiary makes a loan to a shareholder or associate, treating it as a deemed dividend.
  
• Section 6-25 of the Income Tax Assessment Act 1997 (Cth) – Prevents double taxation of the same income.

Arguments for the Taxpayer

1. No Loan Was Made –The existence of a UPE does not create a “loan” under section 109D(3) because there was no obligation to repay, only an obligation to pay.
   
2. Subdivision EA is the Correct Provision –The Commissioner was applying the wrong section. Subdivision EA specifically deals with corporate UPEs, and it requires an additional step (a trustee loan to a shareholder) to trigger Division 7A.
   
3. Statutory Construction – The wording of section 109D requires an affirmative act by the private company to “make a loan,” which did not occur here. A passive UPE does not meet this requirement.
   
4. Avoidance of Double Taxation – The Commissioner’s interpretation would mean both the trust and the beneficiary could be taxed on the same income, leading to an unintended and unfair tax outcome.
   
5. Precedents and Legal Principles – Prior cases interpreting financial accommodation confirm that a UPE alone does not create an enforceable obligation to repay and does not meet the requirements of section 109D.

Arguments for the Commissioner

1. Financial Accommodation Exists – By leaving the UPEs unpaid, the corporate beneficiary (Gleewin Investments) effectively allowed the trustee to retain and use those funds, which the Commissioner argued constitutes financial accommodation.
   
2. Broad Definition of Loan – Section 109D(3) should be read expansively to capture situations where a corporate beneficiary refrains from demanding payment of its entitlements, thereby providing financial accommodation.
   
3. Consistency with Division 7A’s Purpose – The purpose of Division 7A is to prevent the tax-free use of corporate profits. The Commissioner’s view was that if unpaid UPEs are not treated as loans, taxpayers could easily sidestep the Division 7A provisions.
   
4. Potential for Tax Avoidance – Allowing UPEs to remain untaxed would create a loophole where trust income could be indefinitely retained at the corporate tax rate without being distributed or taxed appropriately.

Lower Court Decision (Administrative Appeals Tribunal)

• The Tribunal ruled that a UPE is not a loan under section 109D(3) because it lacks a repayment obligation, i.e. a necessary element for a transaction to be classified as a “loan”.
  
• It found that Subdivision EA was the relevant provision in cases involving UPEs, and that Division 7A should only apply when a trustee makes a separate loan to a shareholder.
  
• The Tribunal rejected the Commissioner’s argument that section 109D should apply merely because the corporate beneficiary allowed the entitlement to remain unpaid.
  
• The Tribunal expressed concerns about double taxation if the Commissioner’s approach were accepted, as both the trustee and beneficiary could be taxed on the same income.

Full Federal Court Decision

• Appeal Dismissed: The Full Federal Court upheld the Tribunal’s decision.
  
• Clarification of Section 109D(3) – A loan for Division 7A purposes must involve an obligation to repay, not merely an obligation to pay.
  
• Legislative Context Considered – The Court found that Subdivision EA explicitly governs UPEs and that applying section 109D in this context would lead to double taxation.
  
• Commissioner’s Interpretation Rejected – The Court found that UPEs alone do not constitute “financial accommodation” or “loans” within the meaning of section 109D(3).
  
• Emphasis on Statutory Text – The Court reaffirmed that statutory construction must prioritize the text, context, and purpose of the provisions, rejecting an overly broad interpretation of “loan”.

Practical Implications

1. Clarification for Corporate Beneficiaries – Corporate beneficiaries with UPEs are not automatically subject to Division 7A unless further transactions occur (e.g., a trustee loaning funds to a shareholder).
   
2. Impact on Tax Planning –Trustees and corporate beneficiaries should carefully consider the timing of trust distributions and payments to avoid potential Division 7A implications.
   
3. ATO Enforcement Limitations – The ruling restricts the Commissioner’s ability to apply section 109D broadly, requiring clear evidence of a loan or financial accommodation arrangement.
   
4. Subdivision EA Remains Key – The ATO will likely focus more on Subdivision EA compliance when examining trust and corporate beneficiary arrangements.
   
5. Avoidance of Double Taxation – The decision prevents situations where both a trust and a corporate beneficiary could be taxed on the same income, reinforcing legislative intent.

ATO view of this decision

The Australian Taxation Office (ATO) has filed a special leave application with the High Court regarding the Full Federal Court’s decision. Until the High Court appeal process is finalised, the ATO has reaffirmed it will maintain its current views on private company entitlements to trust income as outlined in Taxation Determination TD 2022/11.

The ATO highlights that private company beneficiaries’ handling of unpaid entitlements to trust income may have implications under other tax laws, such as section 100A. An exception to section 100A is when the arrangement is part of ordinary commercial dealings. The ATO’s Practical Compliance Guideline PCG 2022/2 explains that if a corporate beneficiary is entitled to income from a related trust and the trustee retains those funds as a loan on commercial terms, the ATO will not typically apply compliance resources to section 100A.

However, if the trustee retains funds without converting the entitlement to a loan on commercial terms, the arrangement falls outside the green zone described in PCG 2022/2, and the ATO may engage with the taxpayer to understand the arrangement better.

Pending the appeal’s outcome, the ATO will administer the law according to the published views in TD 2022/11. Decisions on issuing amending assessments, private ruling applications, or objections to past-year assessments will not be finalised until the appeal process is complete, unless a decision is required due to the taxpayer’s period of review elapsing or a taxpayer’s notice requiring the Commissioner to make an objection decision. In such cases, decisions will be based on the existing ATO view of the law.

Andersen Comment

While the ATO has sought leave to the High Court appeal the decision, the Full Federal Court’s decision in Commissioner of Taxation v Bendel provides significant clarity on the application of Division 7A to unpaid present entitlements. The ruling confirms that a UPE is not a loan unless there is a clear obligation to repay, limiting the Commissioner’s ability to apply section 109D in such cases.

Going forward, taxpayers must still be mindful of Subdivision EA, which remains the primary provision for addressing tax consequences when trust entitlements remain unpaid and the trustee makes loans to related parties. This case represents a significant taxpayer victory and underscores the importance of clear statutory interpretation in tax law. Time will tell as to the outcome of the High Court appeal and whether any change is Law is considered by the Government pending that outcome.

Andersen will continue to monitor developments in Bendel as they come to hand.