It has long been the ATO’s practice to treat a trust’s unpaid present entitlements (“UPE”) to a company as a loan for the purposes of Division 7A ITAA 1936 – that is, deemed to be an unfranked dividend unless a complying loan agreement was put in place to cover the unpaid amount.
The ATO re-affirmed their long-standing treatment of unpaid distributions in a recent tax determination (TD 2022/11).
A recent case (Bendel [2023] AAT 3074) decided in the Administrative Appeals Tribunal (‘AAT”) rejected the ATO’s threshold basis for their current (TD 2022/11) and past taxation rulings (TR 2010/3).
The AAT decided, contrary to the ATO’s ruling, that for the purposes of Division 7A:
- A UPE was not a loan, having regard to the statutory definition;
- If the UPE was put on a sub-trust (pursuant to the terms of the Trust Deed), the UPE, as an equitable obligation, continued to exist; and
- The provisions of subdivision EA continued to be applicable (that is, a loan made by the trustee to a shareholder/associate of the company could be a deemed divided) if there was a continuing UPE owing to a company.
As of yet, the ATO have not announced their response to the AAT’s decision. Note that decisions of the AAT do not constitute a legal precedent which binds the ATO.
However, and to the extent that the AAT’s decision represents a contrary view to that of the ATO, the practical concern at the moment, is what actions should trustees and corporate beneficiaries undertake in relation to the 2023-year trust distributions which have not been paid by the trustee.
These actions could include:
- Until the ATO provides a response (probably the ATO will appeal to the Federal Court), continue to comply with the current tax ruling and put the UPE on a Division 7A loan agreement to avoid the UPE being deemed to be an unfranked dividend; or
- If the trustee determines to ignore the ATO’s ruling (by accepting the AAT’s decision). However, there would be a very real concern that the ATO will apply their recent section 100A ruling (TR 2022/4) to the UPE and assess the trustee at top marginal rates.
The current situation is completely unsatisfactory, so it is to be hoped that the long anticipated legislative change will finally be introduced to provide some taxation certainty in relation to this very common commercial situation.
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If you wish to receive further specific information or advice on the above please contact Daryl Corpe.
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