Insights | 05 Apr 2024

Bendel v Commissioner of Taxation: Are we about to see a major change to Division 7A?

For roughly 13 years, the Australian Taxation Office (ATO) has acted on the basis that unpaid trust distributions to corporate beneficiaries are considered “financial accommodation” provided to the trust, and therefore are subject to taxation under Division 7A of the Income Tax Assessment Act 1936.  A recent decision in the Administrative Appeals Tribunal (AAT) in Bendel v FCT [2023] AATA 3074 (Bendel) has turned this interpretation on its head.

The potential impacts of this decision are far-reaching.  This decision has implications for every business and investment group in Australia with trusts and companies in their structure chart.

Whilst many Tax practitioners have been getting very excited about the decision in Bendel, the ATO has appealed the decision and is unlikely to back away from this fight any time soon.  Practitioners and their clients would be well advised to follow the progress of the appeal very closely.

Unpaid present entitlements and loans under Division 7A

Broadly, Division 7A was introduced to stop private companies from making tax-free advances to related parties.  The legislation works to treat such advances or loans as unfranked dividends from the company, unless the loans are documented and repaid over set timeframes with appropriate interest charges (currently 8.27%).

In 2009, the ATO released a tax ruling which clearly brought unpaid trust distributions to private companies into the Division 7A net (from 2010 onwards).  The ruling, and its successors, maintained the Commissioner’s view that unpaid trust distributions are “financial accommodation” provided by companies to trusts, and therefore are loans for the purposes of the Division 7A legislation, bringing them into the tax net.

Whilst tax rulings aren’t the law, the Commissioner issues rulings to provide the public with guidance as to how he will apply the legislation and case law.  Taxpayers can elect not to follow such guidance; however, the Commissioner can penalise this behaviour.

Putting an unpaid trust distribution on complying loan terms isn’t a tax-free solution, and broadly has the following implications:

  1. The company pays tax on the original trust distribution;
  2. The shareholder must make minimum interest and principal repayments each year for 7 years. If the loan was used for private purposes, the interest won’t be deductible.  These repayments will have to be funded by after-tax income; and
  3. The company pays tax on the interest income earned on the loan as the term progressed.

As interest rates rise, so too does the Division 7A benchmark interest rate, making Division 7A loan management a more costly tax burden.

So, what did the AAT say?

The Tribunal member in Bendel concluded that an unpaid trust distribution to a company, in and of itself, is not a loan and Division 7A should not apply to such an arrangement.  This reasoning is consistent with what many tax practitioners have been saying for some time, albeit whilst living within the bounds of the tax ruling’s edicts.

What does this mean for private groups?

In short, nothing yet as this case has a lot further to play out. The ATO have appealed the AAT’s decision.  The next stop will be the Federal Court, and if things continue to go against the Commissioner, we wouldn’t be surprised to see him continue to appeal to the High Court.

The ATO’s recent interim Decision Impact Statement makes it clear that they are going to continue to hold onto their interpretation until the appeal has run its course.  As outlined above, this could take some time.

The Commissioner noted in his interim Decision Impact Statement that other sections of the legislation may also apply to unpaid trust distributions, such as section 100A of the Income Tax Assessment Act 1936.

Regardless of the outcomes of Bendel, there is always the possibility that the Government could circumvent the process and amend the legislation to specifically include unpaid present entitlements made by trusts to private companies as loans for Division 7A purposes.  After all, the Treasury won’t appreciate a hit to its cash flow!

In summary, we are watching this space for further updates to continue to provide guidance to clients.

Contact Pilot

If you have any questions regarding your trust and taxation matters, contact Murray Howlett or your Pilot advisor on (07) 3023 1300.

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