Does Bendel’s case highlight broader cracks in the tax system?

The recent decision in Bendel’s Case has caused more than a ripple in income tax circles. A search of the term identifies numerous case summaries and commentary about what the decision might mean for the application of Division 7A. In summary, the decision essentially states that an unpaid present entitlement (UPE) between a trust and a beneficiary company is not caught by Division 7A where the funds are retained by the trust. The decision is important because:

  • it differs from the ATO view as expressed in public and private rulings for the past 13 years that such arrangements are ‘financial accommodation’ from the company to the trust and are therefore, in the ATO’s view, loans to which Division 7A applies; and
  • taxpayers and their advisers are now questioning how they should treat such UPEs.

There is also speculation on whether the ATO will appeal the decision. Some have the view that it will be appealed because the ATO can’t let the decision remain unchallenged, whilst other views are that it will not be appealed because AAT decisions have no precedential value so the ATO can just ignore it, confining the decision to its own facts and saying that it has no wider application.

To put the case in context requires an understanding of how Division 7A has evolved. It was introduced in 1997 with the objective of dealing with shareholders and their associates drawing monies from companies without those monies being treated as assessable dividends. Amounts caught were treated as a deemed unfranked dividend to the recipient. It was amended in 1998 (via section 109UB) to expand its coverage to trusts, but this section only applied where a trust made a distribution and then later lent the money to a shareholder or associate of the company. So, if the money was lent before 30 June and then the UPE arose (as at 30 June) section 109UB raised no deemed dividend.

This was then addressed from 12 December 2002 with the introduction of Subdivision EA as it was drafted widely enough to apply Division 7A regardless of whether the loan or the distribution occurred first. However, under Subdivision EA if a trust retained the funds relating to a distribution made to a company there was no deemed dividend. So, in December 2009, the ATO issued a draft ruling which proposed a view that a UPE was a form of financial accommodation to which Division 7A would apply. Whilst submissions were made to the ATO that this approach had significant issues, the final ruling confirmed the ATO’s changed view. This patchwork approach of changes via law and then by ruling has resulted in calls for Division 7A to be overhauled which has been ignored for years, notwithstanding numerous Board of Taxation reviews and more recent proposed changes by the Morrison government that never eventuated.

In our view this approach is a symptom of a bigger issue in relation to the way tax is being administered. Let’s consider the way successive Federal Parliaments have dealt with difficult tax issues, and the way the ATO has expanded how it administers the tax system.

There was a long period in the 1990s and well into the 2000s where there would be three or four omnibus Tax Law Amendment Bills introduced each year. These bills usually brought in new rules, but also included regular fixes to existing law. It appears there was a system within either or both of Treasury and the ATO to identify issues and put them to the government of the day to decide how to resolve them. The regular amendments to Division 7A referred to above are an example. However, for well over a decade these regular fixes to issues in the tax law have become much rarer.

Arguably, the ATO has sought to keep the tax system running smoothly by issuing public statements about how they interpret the law (e.g., public rulings, law companion guides and general information on the ATO website), and how it will administer the law (e.g., practice statements, practical compliance guidelines and decision impact statements). More often than not, these publications provide useful information to taxpayers and their advisers.

However, in the absence of legislative fixes, to administer the law the ATO has also issued statements designed to address issues which have been based on how it will administer the law and, arguably, are less connected to the law itself. The ATO then often refers to its own pronouncements as if they have the same weight as legislation or case law. It is easy to accept the premise that the ATO has done this for practical reasons and in good faith. But we all know the phrase about where the path paved with good intentions takes you. Bendel’s Case just brings it into clearer focus.

The issue is not limited to Division 7A. In the absence of Federal Parliament paying attention to the technical issues that need addressing in the tax system, the ATO has issued contested opinions and administrative approaches in a number of areas. Some examples of this include:

  • Professional firms are subject to a traffic light system about a perceived risk rather than a set of legislated rules whilst other business types with owner-operators are not;
  • The 45-day holding period rule is still being applied today even though the legislative sections were repealed in 2007; and
  • Business assets which reduce in value over time and eventually expire cannot be depreciated and only result in capital losses for the businesses which own them (e.g., gaming machine entitlements in Sharpcan’s case (see our summary here)).

The flaw in this approach has been exposed in the Bendel decision. Thirteen years of a theory that the equitable obligations which arise from UPEs are somehow converted into loans merely by the passage of time, is bypassed by the AAT just looking at the legislation and identifying that they have been dealt with under Subdivision EA since 2002.

The Bendel decision (subject to any appeal) throws into doubt the ATO’s changed view from 2009 that it then actively imposed on taxpayers, a view that was widely questioned in the tax profession when it first came out. Whilst that raises a question mark about how seriously the submissions provided to the ATO about tax changes are taken, the wider question is whether the ATO is administering other areas of the law incorrectly, and if so at what cost to taxpayers.

As advisers, how should we treat the ATO views as expressed in public statements? They are helpful where they can be relied upon and where it assists our clients, but otherwise we should also look to the law and cases where it doesn’t. That approach could come with a significant cost if the ATO then contests a matter, but there may be significant cost to taxpayers where the ATO’s interpretation is widely disagreed with in the profession.

This year, Federal Parliament sits for about 14 weeks. Whilst there is plenty of other work our Parliamentarians do, our tax system is an important part of the economy, so surely there is some capacity for dealing with long-standing issues like those in Bendel‘s case and the other examples above? Such an approach helps both taxpayers and the ATO.


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This article provides a general summary of the subject covered as at the date it is published. It cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

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