Division 7A & UPEs | Federal Court rejects ATO view
21/02/2025
The Full Federal Court decision in the Bendel appeal1 has significant implications for Division 7A, overturning the Commissioner’s long-standing position that treats unpaid present entitlements as loans.
Background
The Full Federal Court has unanimously dismissed the Commissioner’s appeal from the AAT decision in the Bendel case in its judgement handed down on 19 February 2025.
Full details of the original AAT decision and relevant background can be found in our previous alert here.
The facts involved the Commissioner applying his long-standing view that an unpaid present entitlement (UPE) owed to a private company would fall within the definition of a ‘loan’ for Division 7A purposes. In the Commissioner’s view (as first published in Taxation Ruling TR 2010/3 and Law Administration Practice Statement PS LA 2010/4 as subsequently refined in Taxation Determination TD 2022/11), a UPE owed to a private company will be a loan for Division 7A purposes in the year following that in which the distribution is made.
The term ‘loan’ has an extended statutory definition for Division 7A purposes and includes ‘the provision of credit or any other form of financial accommodation’ and ‘a transaction (whatever its terms or form) which in substance effects a loan of money’. Prior to the Federal Court decision in Bendel, the Commissioner’s view has essentially been that a UPE that remains outstanding once the company has knowledge of the UPE would be a loan within the meaning of one or both of these elements of the extended definition.
The decision
The basis of the Full Federal Court in Bendel is disarmingly straightforward. The Court placed particular importance on various statutory provisions in Division 7A that referred to the ‘repayment’ of a loan and noted the distinction between a transaction or arrangement that creates an obligation to repay an amount and a transaction or arrangement that creates an obligation to pay an amount. Having regard to the language used in the relevant provisions of Division 7A, the Court concluded that to fall within the definition of ‘loan’ for Division 7A purposes the arrangement must be one that gives rise to an obligation to repay. A UPE is lacking this fundamental feature because the trustee of the relevant trust has an obligation to pay or discharge a UPE but does not constitute an obligation to repay the relevant amount. The Court’s view is succinctly stated in paragraph 93 of the judgement as follows:
‘…..s 109D(3) requires more than the existence of a debtor-creditor relationship. It requires an obligation to repay and not merely an obligation to pay.’
Whilst the Full Federal Court decision confirms the correctness of the AAT decision, the reasoning of the Full Federal Court was different. The AAT decision focussed less on interpretation of the relevant statutory provisions and more on the history of the relevant provisions and extraneous material. The appeal judgement is much more conventional and based on the interpretation of the provisions of Division 7A itself.
What does the decision mean?
This judicial decision is a major blow to the Commissioner and will potentially have widespread ramifications for private groups where the use of company beneficiaries is commonplace. The emphatic Full Federal Court decision means that, as the law stands, a UPE is not a loan for Division 7A purposes.
Unless the Commissioner seeks and is granted special leave for a High Court appeal which then overturns the Full Federal Court decision, this decision will stand. This would mean that the Commissioner would need to resile from his position that a UPE owed to a private company represents a loan made by the private company to the distributing trust.
A number of public rulings, practice statements and determinations are based on the premise that has been unanimously rejected by the Full Federal Court, including but not limited to those pronouncements referred to above. The decision will have potential implications not only for UPEs owing directly between a trust and a private company beneficiary, but also the Division 7A rules relating to transactions undertaken by trusts where there is a UPE owing to a company beneficiary (Subdivision EA of Division 7A).
The original AAT Bendel decision was widely regarded as interesting but, being a decision of the AAT, was one that was viewed with some caution. The unanimous Full Federal Court decision is clearly quite a different proposition.
Practical issues – what to do with UPEs?
Until the matter of any further appeal process is determined, the practical question that requires consideration is how to deal with any UPEs affected by the decision in the meantime. This may affect UPEs that came into existence in the 2023 year that, in the Commissioner’s view prior to the latest Bendel decision, were regarded as loans in the 2024 year. It will also impact 2024 and subsequent years’ UPEs until the final outcome is known with certainty. In addition, this important decision will clearly impact on some existing ATO reviews and disputes on foot relating to private groups.
It is unlikely that a decision with respect to the Commissioner’s special leave application (if made) would be known prior to lodgement date of the 2024 tax returns. It is possible that the ATO may approach the Federal Government for a legislative amendment in response to this decision. However, given that an election is only months away, it is unlikely that any legislative change will happen in the near term.
We would expect the Commissioner would issue a Decision Impact Statement and/or a Practical Compliance Guideline on the current decision in the event that an appeal is sought. Taxpayers and ATO officers will need guidance as to how to practically deal with UPEs owing to private companies in the event that the Commissioner seeks to (and is granted leave to) appeal the decision.
A further word of caution.
A further word of caution should also be noted. As resounding a victory as this decision is for the taxpayer, assuming that the decision stands, it does not mean that UPEs owing to companies can be left on foot indefinitely without fear of challenge by the Commissioner. The Commissioner has other ‘weapons in his armoury’ that could be deployed to challenge long-standing UPEs owing to corporate (or, indeed, other) beneficiaries of a trust, including section 100A. The Commissioner’s views on the potential application of section 100A to trust distributions to beneficiaries. that remain unpaid also need to be borne in mind when considering trust distribution matters. The Commissioner’s views on section 100A are themselves the subject of some controversy and will presumably subject to judicial review at some future date, but for the present these views remain on foot.
Furthermore, as noted above, if UPEs owing to companies are left on foot, Trusts will need to be cautious about lending to other associated entities due to the application of Subdivision EA.
How SW can help
SW will continue to monitor and keep you informed on a timely basis of any further developments in this space. It will be important to closely monitor the ATO’s response to this decision and any appeal process that might be instigated by the ATO.
In the meantime, discuss the Bendel decision and its impact on your own group’s UPEs with your SW contact or the contacts listed for this article.
Contributors
[1] Commissioner of Taxation v Bendel [2025] FCAFC 15.
