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Division 7A Episode vi – Return of the Jedi (taxpayer)!

A recent tribunal decision could be a game changer for businesses in relation to their tax. Could this mean the return of the Jedi, I mean, taxpayer? Is the tax landscape about to change…again?

Today we bring you the latest episode in the tax saga, or in other words (sci-fi geek jokes aside), we’ve put together this article to explain what happened with Bendel v Commissioner of Taxation and some key takeaways.

 

In the recent case of Bendel v Commissioner of Taxation (Bendal) the Administrative Appeals Tribunal (AAT) throws doubt on the ATO’s long-standing practices around Unpaid Present Entitlements (UPEs) from trust triggering deemed dividends for taxpayers.

 

Background

Division 7A of the Income Tax Assessment Act 1936 is a set of provisions that deem a private company to have paid an unfranked dividend where the company either:

  • makes a payment to;
  • loans funds to; or
  • forgives debt of

a shareholder or their associate.

The concept of a loan extends to the ‘provision of financial accommodation’, and specific issues arise for a company which is the beneficiary of a trust. This can occur where the trust:

  • has income at the end of an income year;
  • distributes the income for tax purposes by making the company beneficiary specifically entitled to all or part of the income; and
  • retains the income instead of physically paying the company beneficiary, creating a UPE.

For at least the last 13 years the ATO has taken the approach that where there is a common controller of the relevant entities, the UPE will constitute the provision of financial accommodation, and therefore risks triggering a deemed dividend under Division 7A.

Complicating matters, there are specific integrity provisions in Division 7A known as ‘Subdivision EA’ which apply to UPEs, and apply where:

  • the company beneficiary has a UPE owing from the trust at the end of the income year; and
  • the trust separately makes a payment to a shareholder of the company or an associate of the shareholder.

Bendel

The relevant facts in Bendel are quite simple:

  • Mr Bendal was a beneficiary of several discretionary trusts as well as the sole director and shareholder of two companies that were also beneficiaries;
  • in the relevant years the trusts made the company beneficiaries presently entitled to income; and
  • the trust did not physically pay the income to the companies, creating UPEs.

The ATO argued that these UPEs were loans under Divisions 7A and therefore trigger unfranked dividends to Mr Bendel.

The AAT disagreed, and said that as a matter of statutory interpretation the UPEs were not a loan. The case did not consider the application of Subdivision EA, however presumably the UPEs would be a loan if the further conditions under Subdivision EA had been met.

Key takeaways

We do not expect to see any immediate change from the ATO to their interpretation of Division 7A and UPEs, especially given this was a Tribunal decision rather than a Court decision.

It is also not yet known whether the ATO will appeal the decision.

However this is a case of ‘watch this space’ – the ATO’s compliance approach to Division 7A and UPEs creates significant practical issues for many small and medium businesses run in a trust structure, reducing the ability to retain income for business operations and expansions. Any changes in this space will have far reaching consequences.

 

If you would like some tax or legal advice for your business, please give us a buzz and our experienced team will be able to assist. Get in touch here or visit us here to learn more about our services and team.

 

This publication is intended for information purposes only and should not be regarded as financial or legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as financial or legal advice.  If there are any issues you would like us to advise you on arising from this publication, please let us know.