Recent case law on UPEs and Div 7A – what should you tell clients?

The recent Administrative Appeals Tribunal (Tribunal) decision of Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 (Bendel) has challenged the ATO’s long held view that an unpaid present entitlement (UPE) to a company that is not called upon will amount to a loan under s 109D of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). References to legislation are references to the ITAA 1936 unless stated otherwise.

The ATO’s views on this issue can be traced back to the earlier TR 2010/3 and PSLA 2010/4, now both withdrawn, and more recently restated in TD 2022/11.

From 16 December 2009 to 30 June 2022, TR 2010/3W considered a UPE would, in many instances, constitute a loan as outlined in the following extract:

10. The agreement between the private company beneficiary and the trustee may be an implied agreement. For example, if the private company has knowledge that the trustee has treated its UPE as having been satisfied and a corresponding amount borrowed back (as evidenced, for example, by crediting a loan account in the name of the private company beneficiary) and the private company acquiesces to that treatment, it will be inferred that it has consented to that loan being made.

Many taxpayers have likely been following the ATO’s view provided in TD 2022/11 that has effect from 1 July 2022 and reflects an expansive view on Div 7A’s application to UPEs which provides:

6. The phrase ‘financial accommodation’ in paragraph 109D(3)(b) has a wide meaning. It extends to cases where an entity with a trust entitlement has knowledge of an amount that it can demand and does not call for payment.

Facts

The relevant Bendel entities were Mr Bendel, Gleewin Investments Pty Ltd (Gleewin Investments) and Gleewin Pty Ltd ATF The Steven Bendel 2005 Discretionary Trust (Trust).

The facts, simplified for this article, were as follows:

• Mr Bendel controlled both the Trust and Gleewin Investments.
• In the 2013 to 2017 Years, in varying proportions or amounts Mr Bendel and Gleewin Investments were the only beneficiaries that became entitled to the Trust’s income.
• The Trust recorded the amounts held for the beneficiaries in its accounts. Other amounts, added to and reduced the balance owing in respect of each Mr Bendel and Gleewin Investments.
• The Trust deed provided that UPEs were held separately for each beneficiary on a ‘sub-trust’ arrangement (common in trust deeds).

After audit, amended assessments were issued based on the following: [53]

• Gleewin Investments’ UPEs to prior year trust income comprised loans within the meaning of s 109D(3) made by Gleewin Investments in the current year to the Trust;
• those loans were taken to be dividends paid within the meaning of s 109D(1);
• those dividends were taken to be paid out of Gleewin Investments’ profits by operation of s 109Z;
• the dividends taken to be paid out of profits were assessable income by operation of s 44(1) and included in the Trust’s s 95 net income; and
• the beneficiaries who were entitled to the Trust’s income were liable to be assessed under s 97 for a proportion of each such dividend determined by reference to their proportionate shares of the Trust’s income.

Decision

The AAT held that [101]:

a loan within the meaning of s 109D(3) does not reach so far as to embrace the rights in equity created when entitlements to trust income (or capital) 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.

This finding involved a detailed analysis of the history and context of the Div 7A provisions and a careful analysis of statutory construction by the Tribunal.

What should you tell clients?

This decision is good news for taxpayers. However, the ATO may seek to appeal and thus, it might be some time before a final resolution is reached. It is also possible that a legislative change could be made in response to this case.

Advisers should make relevant clients aware that there is a possible change to the application of Div 7A to UPEs owed by trusts to companies. However, until all appeal rights are finalised and a formal view is issued by the ATO, it would be prudent for taxpayers to follow the ATO’s published position on this issue and monitor developments. Clients should be warned that deviating from the ATO’s published view carries risks.

Sub-trusts

Both parties contended that a separate trust was either created or arose upon vesting entitlements to income, or distributing the Trust’s income each year, that is, under the Trust deed’s ‘sub-trust’ mechanisms.

Interestingly, the Tribunal did not accept contentions from both parties that a separate trust in fact arose in any conventional sense that had the effect of discharging or replacing the obligation to pay entitlements to income to the beneficiaries.

Conclusions

The Bendel decision is sure to be contentious given the ATO’s approach to UPEs under Div 7A from 16 December 2009. While UPEs that arose before 16 December 2009 are generally ‘grandfathered’, ongoing careful management is still needed so these amounts do not fall within Div 7A.

There are also still various proposed changes to the Div 7A rules resulting from a Treasury consultation which are yet to be progressed.

Advisers should carefully monitor developments with the Bendel case and other changes to ensure that they can provide up to date and appropriate advice to their clients.

Related articles:

• ATO checklist for trust distributions
• Is your discretionary trust still discretionary? Case law developments on trustee duties
• Discretionary trusts – variations and issues
• Lost trust deeds: Due search and secondary evidence
• Sutton v NRS(J) Pty Ltd [2020] NSWSC 826: Lessons for managing lost trust deeds

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

Note: DBA Lawyers presents monthly SMSF training online. Bryce Figot is presenting a webinar on 7 July 2023 and a recording is available shortly afterwards. For more details or to register, visit https://register.gotowebinar.com/register/610544945094534742.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

By Shaun Backhaus ([email protected]), Senior Associate, and Daniel Butler ([email protected]), Director, DBA Lawyers

DBA LAWYERS

10 October 2023