Login
iscover
A taxpayer has succeeded in the long-awaited Commissioner of Taxation v Bendel decision by the Full Federal Court.
Newsletter
Doing the right thing: Division 7A and UPEs
21 February 2025
•
11 minute read
On 19 February 2025, the Full Court of the Federal Court, comprising Logan, Hespe, and Neskovcin JJ, handed down its much anticipated decision in Commissioner of Taxation v Bendel [2025] FCAFC 15 (Bendel Decision).
You’re out of free articles for this month
To continue reading the rest of this article, please log in.
Create free account to get unlimited news articles and more!
This was an appeal by the Commissioner against a decision of the AAT concerning an issue that lies at the heart of private group arrangements where trust income is distributed to a corporate beneficiary. The Full Court unanimously dismissed the Commissioner’s appeal, holding that a “loan”, as defined in s 109D(3) for the purposes of Division 7A of the Income Tax Assessment Act 1936 (Cth) (1936 Act), requires a transaction which creates, or in substance effects, an obligation to repay an amount. The creation of an obligation to pay an amount was not sufficient. Accordingly, it held that an unpaid present entitlement (UPE) owed by a trustee to a corporate beneficiary could not amount to a “loan”, nor a deemed dividend, under Division 7A.
Background
Since 2010, following the release of Taxation Ruling TR 2010/3, the Commissioner has applied Division 7A on the basis that a UPE owing to a corporate beneficiary, if left unpaid, could amount to “financial accommodation” or a “transaction (whatever its terms or form) which in substance effects a loan”, and was therefore a “loan” as defined in s 109D(3). That is, until now.
The Bendel Decision focuses on arrangements that will be familiar to many advisors and private groups across Australia. The taxpayers were an individual and a private company. Both taxpayers were beneficiaries of a discretionary trust. The individual was the director of both the trustee and the corporate beneficiary. From time to time, the trustee resolved to distribute income to the corporate beneficiary. The corporate beneficiary did not call for payment of those entitlements.
The Commissioner applied his long-held view, finding that the UPE owed to the corporate beneficiary was a “loan”, and therefore a deemed dividend, for the purposes of Division 7A. The Commissioner decided that the deemed dividend was included in the trustee’s net income and assessed the taxpayers on their respective shares of that deemed dividend. As the Full Court observed (at [88]), a consequence of the Commissioner’s construction of Division 7A is that a share of net income to which a corporate beneficiary has been made presently entitled and on which the corporate beneficiary has been taxed in one year is again included net income of that same trust in the following year, which had “the potential result of an overall tax impost that is higher than if the corporate beneficiary was never made presently entitled at all”.
The taxpayers objected to the Commissioner’s assessments, those objections were disallowed, and the taxpayers appealed to the Administrative Appeals Tribunal (AAT). The AAT found for the taxpayers and rejected the Commissioner’s position. The stage was set for the Commissioner’s appeal to the Full Court of the Federal Court.
The arguments
On appeal, the Commissioner contended that the AAT had:
-
Failed to address the correct statutory question by asking itself whether a UPE to income (or capital) of a trust is a “loan”.
-
Failed to give effect to the ordinary and plain meaning of the definition of “loan” in s 109D(3) of the 1936 Act, arguing that its terms should be construed broadly.
-
Failed to give effect to the legislative purpose of Division 7A.
Naturally, the taxpayers argued that the AAT’s interpretation of s 109D was correct. The taxpayers argued that the terms of s 109D(3) required some positive act, and to make a “loan” as defined, a private company “must do a thing” rather than simply not call for payment of a UPE. Further, a transaction which “in substance effects a loan” required both an entitlement to be paid and repaid.
More broadly, the taxpayers contended that their interpretation was consistent with the balance of Division 7A. To construe s 109D as deeming a dividend to the trust would undermine the clear intention of Subdivision EA of the 1936 Act (the provisions dealing specifically with UPEs), with the consequence that two taxpayers could be assessed in respect of the same UPE.
The decision
The Full Court approached the essential issue on appeal, the interpretation of s 109D(3), according to well established principles of statutory construction: by ascertaining the meaning of a statutory provision by reference to its text, context and purpose (at [55]). In this case, it searched for the meaning of the phrases “a provision of credit or any other form of financial accommodation” and a “transaction (whatever its terms or form) which in substance effects a loan of money” as they appeared in s 109D(3).
Notwithstanding that those phrases were capable of bearing a broad meaning, as a matter of statutory construction, their scope depended on the statutory context (at [68]).
The Full Court found that each type of “loan” defined in s 109D(3) encapsulated a concept of repayment, and a transaction was one which “in substance effects a loan of money” where it in substance effects a repayment obligation (at [70]). Moreover, by reading the phrase “any other form of financial accommodation” as importing an obligation to repay, it could be read harmoniously with the balance of s 109D (at [74]).
The context supported the Full Court’s reading of the text. The Full Court noted that the three kinds of amounts that are identified in the simplified outline to Division 7A as being treated as dividends paid by a private company (amounts paid, lent and of debts owed) were not consistent with ascribing a meaning to “a provision of credit or any other form of financial accommodation” that was as broad as that in the Corporations Act 2001 (Cth) (at [75] and [76]). Further, it was apparent that the concept of a “loan” was narrower than that of a “debt” within Division 7A (at [77] and [78]).
Reading the text, in context, the reference to “a provision of credit or any other form of financial accommodation” imported an obligation to repay an identifiable principal sum, rather than simply an obligation to pay (at [79]). That is, the creation of an obligation to pay an amount to a private company, without more was not a “loan” as defined in s 109D(3).
This view gave a harmonious operation to Division 7A, including Subdivision EA (which can deem a dividend where a trustee makes a loan or payment while it owes a UPE to a private company), and the Full Court observed that its interpretation would not give rise to an or irrational absurd outcome.
The Commissioner argued that Subdivision EA and s 109D were directed to different transactions – the former, a transaction between a shareholder or shareholder’s associate and a trustee, and the latter, a transaction between a private company and a trustee.
The Commissioner’s submission was rejected, and the Full Court found that the legislature did not perceive the mischief that lay at the heart of that submission - the creation of a UPE that remains in the trust and is taxed at the corporate tax rate (at [89]). Instead, the relevant mischief was a circumstance where company profits referable to a UPE, and taxed at the corporate rate, made their way to a taxpayer subject to tax at personal rates. That mischief was dealt with by Subdivision EA.
Though the Full Court was satisfied the AAT did not complete the statutory task, it rejected the Commissioner’s interpretation of “loan” as defined in s 109D(3) (at [90]).
Implications
The Commissioner has applied Division 7A on the basis that a UPE owing to a corporate beneficiary, if left unpaid, could amount to a “loan”, and potentially a deemed dividend, since publishing TR 2010/3. Not only has the Commissioner maintained that view, but it was tightened with the publication of TD 2022/11 in 2022. The Bendel Decision effectively makes these views untenable.
In the coming weeks the Commissioner may choose to seek special leave to appeal the Bendel Decision to the High Court. It is notoriously difficult to predict the outcome of special leave applications. However, with a strong, unanimous full court decision, applying orthodox principles of statutory construction, he may face an uphill battle. Another possibility for the Commissioner is to not seek to disturb the Bendel Decision and approach Treasury to amend the legislation. The final possibility is for the Commissioner to do nothing, gracefully accept the wisdom of the Full Court, move on and when reviewing other cases consider, where appropriate, the suite of integrity measures already at his disposal. Whichever option the Commissioner chooses, he can console himself with the knowledge that for a long period before 2010 he was doing the right thing.
By Paul Sokolowski, partner, and Timothy Graham, lawyer, Arnold Bloch Leibler*
* The authors were the instructing solicitors for the taxpayers in the appeal to the Full Court of the Federal Court.
You need to be a member to post comments. Become a member for free today!
