Bendel’s case – a decision seeking harmony, but the question is whether the ATO will sing along

The Full Federal Court’s unanimous decision about whether an unpaid trust entitlement (UPE) is a loan has now been released.  The facts of the case and the earlier AAT decision are discussed in our previous article (here). The Court held that an obligation to pay is not always an obligation to repay – where a trust makes a distribution then there is an obligation to pay which arises, but that unpaid distribution is not a loan because the obligation to pay the beneficiary which arises is not a repayment. Without there being a repayment, the undrawn distribution is not even a ‘financial accommodation’ type of loan.

The Federal Court took the approach that the usual approach to analysing the law should be followed. By this, the Court meant that it should consider the whole of Division 7A in order to determine whether an unpaid distribution was a loan under section 109D. This approach allows a section to be considered on its own language, but also in the context of the surrounding sections.  Those surrounding sections includes the ones in Subdivision EA. The Court specifically noted that the mischief which Parliament sought to address by introducing Subdivision EA arose in situations ‘… where company profits referable to a UPE make their way to a taxpayer who is subject to tax at personal rates, there is a deemed distribution to that taxpayer and the benefit of the corporate tax rate is lost.’ It went on to say that it did not see ‘… a mischief in respect of UPEs in the way that the Commissioner now perceives.’ That appears to us to be a criticism of the Commissioner where he seeks to extend the tax law via rulings and other statements to cover his own concerns rather than identifying and ensuring that only the Parliament’s concerns are complied with by taxpayers. If the Commissioner believes a change in the law is required to address a concern, then that should be properly put to the Federal Government to decide.

The focus will now inevitably turn to the ATO’s reaction to the decision. It has the normal 28 days to determine whether it will seek leave to appeal to the High Court and lodge that application if it believes it has a worthwhile chance of success. It could also represent to Treasury or the Federal Government for a change in the law, but with the forthcoming Federal election any change may not be swift and may not eventuate at all. Finally, it could accept the decision and adjust its stance. Hopefully we do not see a Decision Impact Statement effectively justifying why the decision will be ignored by the ATO.

If the Commissioner does accept the decision, then there are a number of consequences. Here are some to consider:

• Prior year loans put under complying loan agreements are still loans, and the terms of those loan agreements will need to be complied with.
• Taxpayers who have had deemed dividends arise in recent years from the ATO applying TR 2010/3, PS LA 2010/4, and TD 2022/11 should revisit the basis for those deemed dividends and consider whether an objection has merit.
• The same would apply to penalties imposed. On the decision, the ATO has been incorrect about this law for the past 15 years, so if a tax agent doesn’t fully understand these rules, they are in good company.
• Any accounting staff who has been in the profession for under 14 years won’t know the old rules, so there will be some retraining required. Of course, the same will apply if Parliament changes the law.

It is also worth remembering the ‘mischief’ that the ATO saw in 2010 which started these events. Before 2010, unpaid distributions to companies where the funds remained in the trust were taxed to the recipient company, with any further tax only arising if the funds left the trust or the company. Any loans made by a trust to a beneficiary were taxable under Subdivision EA, so were already taxed at the beneficiary’s marginal tax rate. So, the perceived mischief was that the profit behind a UPE could stay in the trust and be used by that trust to derive further income. In layman’s terms, the difference was that the company paid (probably) 30% tax on the unpaid distribution, whilst the mischief the Commissioner saw was that there might be a higher rate of tax to pay.

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