UPE and Division 7A


A recent ruling has overturned the long held ATO position of distributions from trusts to corporate beneficiaries being treated as Division 7A loans.

The AAT’s recent landmark decision in Bendel and Commissioner of Taxation [2023] AATA 3074 has successfully challenged the ATO’s view on Unpaid Present Entitlements (UPEs) being Div. 7A loans under Subsection 109D(3).

The Tribunal decision held that a UPE owing by a trust to a corporate beneficiary was NOT a loan under Section 109D.

This was primarily based on the Tribunal’s conclusion that Subdivision EA, not Section 109D, is the governing provision for UPEs owed to corporate beneficiaries from a trust.

Division 7A operates to ensure private companies do not make tax-free distributions of profits to shareholders or their associates. Where a “loan” is deemed to have been made and not repaid or a Division 7A loan agreement put in place by the lodgement date, the private company will be deemed to have paid an unfranked dividend to the recipient in that subsequent financial year.

The ATO has issued TR 2010/3 stating their interpretation of the law when a private company with a UPE from an associate trust is considered to have made a “loan” to the trust for Division 7A purposes.

Whilst the ATO’s position in TR 20210/3 is that a UPE is a loan, they have also issued separate guidance on how a UPE should be treated for tax purposes which is different to the tax treatment for a Div 7A loan.  In Practice Statement Law Administration 2010/4 (PSLA 2010/4) the ATO provided options for holding an amount representing a UPE on ‘sub-trust’ in a manner that would not trigger Division 7A despite the UPE not being discharged or placed on Division 7A complying terms.

UPEs placed under sub-trust arrangements, in accordance with PSLA 2010/4, have previously allowed for better cash flow than the principal and interest payments required to satisfy the terms of a complying written loan agreement under Div 7A (i.e UPEs only require an interest payment to be made whereas Div 7A loans require both principal & Interest payments to be made).

Last year the ATO withdrew the Ruling and PSLA from 2009 and 2010 and replaced them with Taxation Determination TD 2022/11. The Ruling and PSLA continue to apply to UPEs before 1 July 2022, but from this date, the ATO now considers that UPE’s are Div 7A loans, unless very specific sub-trust conditions are met (such as funds being held in a separate bank account to the main Trust funds for the 100% benefit of the corporate beneficiary). 

The ATO position as advised in the Ruling, PSLA and 2022 issued Tax Determination had not been challenged in court, until the Bendel case.

The case involved several trust entities which conducted an accounting and registered tax agent practice, controlled by Mr Bendel and participated in property investments.

The key question from this case was whether a corporate beneficiary made a loan within the definition of s109D(3) of ITAA 1936 in Division 7A, to the trustee of a trust?

In September 2023, the AAT handed down their decision.

The Tribunal determined this was not a loan, noting that within the meaning of s 109D(3) the definition of a loan does not reach so far to include rights in equity created when entitlements to trust income are created but not satisfied and remain unpaid. The balance of an outstanding or unpaid entitlement of a corporate beneficiary of a trust, whether held on a separate trust or otherwise, is not a loan to the trustee of that trust.

The Tribunal also noted that UPEs are more specifically dealt with by Subdivision EA of Division 7A, not Subdivision B (s.109D is part of that Subdivision).

Therefore, UPEs owing by a trust to a corporate beneficiary are not Division 7A loans but instead, place the private company with the UPE in the position of the trustee only in the limited circumstances where Subdivision EA would apply. Subdivision EA would only apply where a trustee creates an UPE in a private company and transfers the underlying cash (or property) to a shareholder or an associate of a shareholder. In all other circumstances where funds have not been paid to the shareholder or associate, Subdivision EA will not apply, and the distribution will not be treated as a Division 7A loan.

The Bendel case challenges the ATO’s previously established view and has created uncertainty for 2023 trust distributions, as well as prior and future year distributions.

It is anticipated that the decision will be appealed by the ATO given the magnitude of the impact on previous and future trust distributions treatment.  However the facts of the Bendel case are uncomplicated and unambiguous, which should mean any appeal by the ATO, will be around a very clean, “vanilla” question of law, and therefore, hopefully beneficial to a favourable outcome for the taxpayer.

It is important to note ATO guidance is not law, but how the ATO interprets, applies and administers the law.

We eagerly await this matter continuing to play out in court under the appeals process, to bring greater clarity and certainly to ongoing treatment of trust distributions.

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