A UPE is not a ‘Loan’ for Div 7A Purposes: Bendel and FCT [2023] AATA 3074

Bendel and FCT – the ATO loses with egg on its face

Bendel and FCT [2023] AATA 3074 sheds light on the treatment of Unpaid Present Entitlements (UPEs) under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). At Legal Consolidated, we closely examine this case and its implications for taxpayers and advisers. The court case confirms our view: the position taken by the Australian Taxation Office (ATO) was wrong.

Journal Entries are not Loan Agreements: Chadbourne v FCT.

Background of Bendel and FCT

The case involved Mr B and Gleewin Investments Pty Ltd, members of the Bendel group. Gleewin Investments (as a bucket company) holds a substantial UPE from the 2005 Family Trust for several income years. The Family Trust owes the bucket company about $1.66 million. The ATO took the position that this UPE is a loan to the bucket company. If the ATO is correct (it wasn’t) that makes the loan subject to the Division 7A rules.

The taxpayer, Gleewin Investments Pty Ltd is a ‘bucket company‘. In other words, it is a beneficiary of a Family Trust. The Family Trust ‘distributes’ (but does not actually pay any money) the bucket company a share of the Trust’s income:

  • The ‘distributions’ are recorded in the ‘Current Account’. This is on behalf of the bucket company.
  • And reported in the ‘Liabilities’ side of the Family Trust’s balance sheet as a stand-alone account.

As is often the case, the Family Trust, during the financial year, pays some of the company’s bills. These are also recorded in the current account. They reduce the money the Family Trust ‘owes’ to the bucket company. Conversely, there are some tax refunds for the company. These are kept by the Trustee of the Family Trust. This is because the company does not operate a bank account.

The current account that remains unpaid the ATO assesses as a deemed dividend. This is under section 109D of the Income Tax Assessment Act 1936. These are the  Division 7A rules.

Forgive Family Trust UPEs – Unpaid Present Entitlements

Are UPEs actually loans or separate trusts? Bendel and FCTDeed of Debt Forgivenss

The crux of the matter lies in whether these UPEs are loans. The Taxpayers argue:

  • that the creation of a separate trust upon vesting entitlements to income did not involve a loan; and
  • the entitlement to income comes from a trust relationship. This is not a debtor-creditor arrangement, as argued by the ATO. This is an ingenious argument.

Key Decision Points of Bendel and FCT

The formidable Deputy President O’Loughlin, in his ruling, dismissed the notion of a conventional separate trust being formed that could discharge or replace the obligation to pay income entitlements. Instead, he viewed the beneficiary’s interest in trust income as an equitable obligation upon the trustee, not as property owned or controlled by the trustee.

The Court also highlighted the risk of double taxation if the ATO’s stance was accepted. Division 7A lacked provisions to address such a situation. He emphasised that Subdivision EA offered a specific avenue for handling UPEs in favour of corporate beneficiaries.

The ATO has maintained this perspective since as far back as 2010 when it issued Ruling TR 2010/3 and Practice Statement PS LA 2010/4. However, it’s important to note that these documents have been superseded by Determination TD 2022/11. It’s worth highlighting that while the newer determination is in effect, the previous rulings still hold sway concerning trust entitlements that are conferred before 30 June 2022.

This transition from older rulings to updated determinations reflects the evolving nature of tax law and the ATO’s efforts to adapt to changing circumstances and legal interpretations. Taxpayers and advisers should be aware of these developments and consider their implications, especially when dealing with trust entitlements within this specified timeframe.

Division 7A Loan Deed

Conclusion of Bendel and FCT

In conclusion, the case of Bendel and FCT [2023] AATA 3074 challenges the ATO’s previous statements on UPEs as a form of ‘financial accommodation.’ It raises questions about the treatment of UPEs under Div 7A and their dangerous impact on taxpayers and advisers.

How to Build a Div 7A when the borrower is a Family Trust