The ATO’s loss in Bendel could open the door to tax planning opportunities for trusts, but Subdivision EA, section 100A, and other provisions remain lurking risks.
Background
Division 7A remains a key focus area for accountants advising private groups and family businesses. The Australian Taxation Office continues to scrutinise:
- Private company loans
- Unpaid present entitlements (UPEs)
- Related party transactions
The Federal Court’s decision in Bendel went against the Commissioner, but the ATO has confirmed it will continue to administer the law in line with its current views until the appeal process is complete and affected objection decisions will not be finalised in the meantime. For now, taxpayers are left in limbo, with potentially months before the final outcome is known.
What if the Taxpayer Eventually Wins?
If the High Court refuses special leave or rules in favour of the taxpayer, there could be new tax opportunities. However, the Commissioner would still have a number of provisions at his disposal to apply to remove tax deferral.
Subdivision EA
Subdivision EA of Division 7A applies where a trust with an outstanding unpaid present entitlement (UPE) to a private company makes certain payments, loans or debt forgiveness to a shareholder (or associate) of that company. These amounts are included in the shareholder’s assessable income as if they were dividends.
Case Study:
- ABC Pty Ltd is a beneficiary of a discretionary trust, the XYZ Trust.
- At the time of lodging the trust tax return, ABC Pty Ltd has a $25,000 UPE with the trust.
- The XYZ trust lends $25,000 to Bob and $25,000 to Beck, both shareholders in ABC Pty Ltd.
- Neither loan has a written agreement or is repaid before lodgement.
Result: Subdivision EA applies to include $25,000 in the assessable income of both Bob and Beck, a total of $50,000, assuming sufficient distributable surplus, despite only $25,000 having been sheltered from tax at the applicable corporate tax rate by virtue of the UPE to ABC Pty Ltd.
Key Point: Where a UPE exists, the trust is effectively treated as a private company for Division 7A purposes. Personal use of trust profits by individuals will be caught by Subdivision EA.
Reinvestment of Trust Profits
One major tax benefit that may arise from the Commissioner losing Bendel is where the trust reinvests profits or never receives the profits in cash. In this case:
- Neither section 109D nor Subdivision EA would apply.
- No deemed dividend would arise.
- It allows profits to be taxed at the corporate rate, providing 70 cents in the dollar for reinvestment (compared with only 53 cents).
This outcome would put trusts in the same position as companies in terms of reinvestment of profits and would be a major win for taxpayers.
Ongoing Risks: Section 100A
The Commissioner could still challenge arrangements using section 100A, which allows taxation of a person who benefits from a trust distribution made in favour of another person.
In Practical Compliance Guideline (PCG) 2022/2, the ATO states:
- If a corporate beneficiary’s entitlement is retained as a Division 7A-compliant loan for working capital, it is generally low risk (“green zone”).
- If the entitlement is retained without conversion to a loan on at least Division 7A terms, the arrangement is outside the green zone and may be challenged.
Key Takeaways
- Bendel may allow reinvestment of trust profits without triggering Subdivision EA.
- Section 100A remains a risk if entitlements aren’t converted to Division 7A-compliant loans.
- Careful structuring and compliance are essential to minimise ATO challenge.
Conclusion
While Bendel could open the door to favourable reinvestment strategies, taxpayers should remain cautious. Subdivision EA and section 100A continue to present significant risks, and careful structuring is essential to avoid ATO challenge.
For advice on managing trust distributions and Division 7A exposure, contact Vale Legal.
