A significant decision was handed down in the Federal Court which impacts the Division 7A consequences of unpaid trust distributions to corporate beneficiaries. The Court ruled against the Australian Taxation Office (ATO) in Commissioner of Taxation v Bendel [2025] FCAFC 15 which essentially goes against a ruling the ATO issued in 2010 dealing with the application of Division 7A on unpaid present entitlements (UPEs) owed to corporate beneficiaries.
As the matter was sent directly to the Full Federal Court, any further appeal options of the Commissioner are limited. This ensures that the decision represents a strong precedent on the application of Division 7A to these arrangements.
Background
Historically, Trusts have been used for asset protection and income splitting by various private groups in Australia. Prior to December 2009, a regular wealth accumulation and tax planning strategy involved the use of “bucket companies” where a discretionary trust would distribute part or all of its income to a company but retain the funds (i.e., cash) to use within the Trust for its own purposes e.g., working capital, purchasing assets etc. This ensured the tax rate on income derived by the Trust was capped at 30% (at the time, the 25% corporate tax rate for base rate entities did not exist). Alternatively, if the Trust distributed income to an individual or a group of individuals, the tax payable would be at the individual’s tax rate i.e., potentially at the highest rate of 47%.
Ordinarily Division 7A would not apply to the UPE owing by the Trust to the company unless an individual (or associate) borrowed money from the Trust i.e., in this circumstance there is “mischief” because the individual is accessing funds from the Trust which have been taxed at the lower corporate tax rate.
If Division 7A applies, the Trust must repay the company the amount of the loan before the earlier of the lodgement date or deadline of the company tax return. Alternatively, the Trust could enter into a loan agreement with the company or enter into a sub trust arrangement which requires yearly repayments (either in cash or commonly through dividends) inclusive of interest owing on the loan. Failure to do any of this, may result in a deemed dividend which results in punitive taxes being payable.
ATO guidance issued in 2010
The ATO released a ruling in 2010 which considered their views of the potential application of Division 7A in relation to UPEs. The crux of the ATO’s views is that when a Trust has a UPE owing to a company within a closely held group, the company would be providing the Trust with financial accommodation (i.e., a loan) if it is aware of the distribution and does not call for payment. This essentially meant that Division 7A would automatically apply to any UPEs owed by a Trust to a company and the Trust would then be required to either repay that in full or enter into a loan or sub trust arrangement with the company.
The key difference between the ATO’s view prior and post December 2009 is that previously Division 7A only applied to UPEs prior to December 2009 if an individual accessed the Trust’s funds. However, following the release of this guidance, this requirement was no longer necessary because Division 7A generally applies in the following year in which a distribution is being made. This meant that most UPEs owing to corporates post December 2009 were treated as Division 7A loans and were generally dealt with under complying loan agreements between the Trust and the Company.
Entering a loan spreads the cash flow hit and tax cost over numerous years rather than paying it upfront. However, it is an expensive exercise once you consider the interest costs and the fact that a company will be paying tax on the interest income and the Trust may not be able to claim interest deductions if there is no nexus with income earning activities.
Bendel Decision
The Federal Court considered the Commissioner’s appeal to an AAT decision handed down in 2023. Essentially, the Court ruled against the ATO, meaning the ruling issued in 2010 is not correct and a UPE does not fall within the definition of a “loan” (i.e., financial accommodation). Therefore, Division 7A does not automatically apply even if the company is aware of the entitlement and does not call upon the UPE for repayment.
A fairly complex matter and without getting too caught up in the complexities, it throws a spanner in the works for the ATO and advisors alike. Most clients and advisors accepted the ATO’s position in 2010 and now will have to re-consider their position following this landmark decision.
What are the ATO’s potential options
The ATO can apply for special leave to appeal the decision to the High Court. However, there is no guarantee this special leave would be granted. In the meantime, we expect the ATO will release a decision impact statement highlighting how this judgement is going to impact their views.
The other avenue to “undo” this decision outside the courts is to look for a legislative solution. In the mid-2010’s the Federal Government announced it would make targeted amendments to Division 7A and, besides a couple of consultations, nothing has been done on a legislative front since that announcement. This case could trigger a legislative change to how Division 7A works, but given its an election year, it is uncertain whether the party in power following the election will have the appetite for such reform.
In summary
The popularity of discretionary trusts has reduced due to the ATO’s views on Division 7A and s100A (which is a different issue) but with this decision, we have been transported back to 2009 and the old “rules” impacting trust distributions to corporates. Income retention may be simpler for Trust by using corporate beneficiaries and capping the tax at 25% or 30%, assuming no individuals are borrowing amounts from the Trust (refer to mischief mentioned above).
How taxpayers respond to the Bendel decision will depend on the approach adopted in their historical tax returns, any Decision Impact Statement issued by the ATO, the decision of the High Court in respect of any application made by the Commissioner for Special Leave to appeal the decision and any announcement from the Federal Government in respect of any legislative solution to this issue (noting a Federal Budget is due to be handed down in March that could indicate the current Government’s approach in this regard).
If you would like further information in relation to this, contact your Moore Australia advisor.