ATO loses major court case on unpaid trust distributions to company beneficiaries and Division 7A loans! What could this mean for you?
Written By Ashley Staunton
The Full Federal Court has decided unanimously in favour of the taxpayer in the recent Commissioner of Taxation v Bendel [2025] FCAFC 15 case known as Bendel’s case. This case overrides an ATO interpretation of the Division 7A laws that it has held for the last 15 years in relation to trusts with Unpaid Present Entitlements that result from making distributions to corporate beneficiaries.
What was the issue with trusts and corporate beneficiaries?
Most family trust deeds allow the annual income to be distributed to a wide range of different beneficiaries. These typically include individual family members, other trusts and companies controlled by family members. When distributions are made to a company it is referred to as a corporate beneficiary.
A classic tax minimisation strategy is to have the trust distribute some or all of its income to a corporate beneficiary to ensure that the tax on the trust’s income is capped at company tax rates of no more than 30% rather than individual tax rates of up to 47%.
In many cases the income will be distributed to the corporate beneficiary in the books and tax return of the trust but the money is not actually transferred to a bank account of the corporate beneficiary. Instead, the funds remain inside the trust to either purchase more investments or pay down loans. Doing this creates an unpaid distribution from the trust to the corporate beneficiary known as an Unpaid Present Entitlement (or UPE).
For many years the ATO took no issue with these UPEs to corporate beneficiaries, they could remain unpaid and no interest needed to be charged. However, on 16 December 2009 the ATO released a new ruling where they deemed these UPEs to be Division 7A loans.
This new interpretation of the law by the ATO reduced the effectiveness of using a corporate beneficiary. It essentially meant that distributions to corporate beneficiaries now had to be paid to the corporate beneficiary by lodgement day of the tax returns or put on Division 7A loan terms or a sub-trust loan to be repaid over 7 years with interest via cash transfers or by offsetting dividends from the corporate beneficiary against the loan.
Despite this new interpretation, many trusts have continued to use corporate beneficiaries,however it has forced them to contend with the following key issues among many others:
- Whether to divert funds away from the trust into the corporate beneficiary to pay the UPE and how to invest the funds once inside the corporate beneficiary – noting there is no 50% capital gains discount or franking credit refunds for companies.
- Whether to put the UPE on a Division 7A loan agreement and repay by offsetting against dividends from the corporate beneficiary – noting that this would cause the trust profit to eventually be taxed in the hands of individuals, albeit with the benefit of spreading it over a 7 year period.
- Extra levels of complexity and compliance costs
How does Bendel’s case change the rules?
It has been a long time coming but the successful outcome of Bendel’s case means that we may now be back to the rules as they existed prior to the ATO’s re-interpretation on 16 December 2009.
What this would mean in a practical sense is that we could make trust distributions to a company without also needing to transfer the funds to the company and without it automatically becoming a Division 7A loan.
The opportunity to apply this would be available for any of the following circumstances:
- Any future distributions made to corporate beneficiaries from 2025 onwards
- Any existing UPEs from trusts to corporate beneficiaries that arose in the 2024 financial year where they have not yet been put on Division 7A loan terms or recorded in the financials as such
- Any existing UPEs from trusts to corporate beneficiaries that arose in the 2023 financial year where the 2024 financials and tax returns are yet to be complete and the UPE has not yet been recorded as a Division 7A loan
It may also be possible to lodge objections in relation to any previous UPEs that have already been treated as Division 7A loans or sub-trust loans, particularly those that arose from 2022 and earlier.
However, we believe the ATO will take the view that once you start to treat a UPE as a Division 7A loan or sub-trust loan, including making minimum loan repayments and recording interest between the trust and the company, it loses its character of a UPE – even if this was only done in order to comply with what we now understand was the incorrect interpretation by the ATO at the time.
For this reason we would not recommend changing your approach to these older UPE where you have already begun treating them as Division 7A loans.
Be careful – in some cases UPEs to corporate beneficiaries can still cause Division 7A issues
Despite Bendel’s case, if a trust has made unpaid distributions to a corporate beneficiary and an associated individual has borrowed or drawn money from the trust in excess of any distribution to them, the resulting loan from the trust to the individual could be treated as a Division 7A loan.
The Division 7A loan will be deemed to be income of the individual if not repaid by lodgement date of the tax return or if not put onto a Division 7A loan repayment agreement.
Have we heard the last from the ATO on Bendel’s case?
The short answer is no, we must still tread carefully! The ATO will not walk away from their position easily given the amount of revenue at stake.
They have now sought special leave to appeal the case to the High Court and released an Interim Decision Impact Statement advising that while the appeal is underway their position on the application of the rules has not changed. At this stage it is unknown whether the High Court will grant them leave to appeal or whether an appeal would successful.
Another possibility if the ATO ultimately fails to successfully challenge is that the government may step in and change the legislation to bring UPEs under the Division 7A rules.
This uncertainty created by the ATO’s response leaves taxpayers in limbo as to how to apply the rules in the interim.
What should you do from here?
Unfortunately we cannot sit back and take a ‘wait and see’ approach to any potential High Court or legislative action because tax lodgement and loan repayment deadlines are upon us. A decision must be made now to either continue to follow the ATO’s position until further notice or act to preserve the benefits of the Bendel decision for the maximum number of financial years as possible.
In the event that Bendel’s case is overturned by the High Court, we believe there would be a strong prospect of obtaining ATO Commissioner’s discretion not to apply Division 7A rules to any UPEs where we have applied the new Federal Court interpretation as long as corrective action was taken going forward.
It is for this reason that we encourage our clients to adopt the new interpretation of the law for their trust affairs.
If you have any questions about how these changes may affect you, which approach to takeor how to apply the Bendel ruling to maximum benefit please contact either Ashley Staunton or Tony D’Agostino for a chat on +61 7 3666 0091.
Read more here:
