High Court backs Bendel over ATO in landmark trust tax ruling

The High Court has ruled in favour of Melbourne accountant Steven Bendel in a closely watched tax case, finding unpaid present entitlements owed by trusts to corporate beneficiaries are not automatically loans.

In a 5-2 decision on Wednesday, the court dismissed the Australian Taxation Office commissioner’s appeal, rejecting its long-held position that such entitlements can be treated as loans that trigger deemed dividends and additional tax.

The ruling could have major implications for small businesses and private groups that use trusts with corporate beneficiaries, a common structure across Australia’s private business sector.

Treasury estimates there are more than 840,000 family trusts in Australia, while the ATO puts trust assets at more than $3 trillion.

“This ruling brings long-awaited judicial certainty to an area of trust taxation that has been the subject of significant controversy and compliance activity for more than a decade,” Tax Institute head of tax and legal Julie Abdalla said.

Mr Bendel’s dispute with the tax office began eight years ago, when the accountant was issued amended assessments of about $420,000 over his personal tax affairs and those of his investment company for the 2014 to 2017 financial years.

He challenged the ATO’s position, setting off a long-running legal battle that eventually ended up in the High Court.

The dispute turned on the treatment of $1.4 million in trust income that had been allocated to a corporate beneficiary but not paid out. These amounts are known as unpaid present entitlements, or UPEs.

In Mr Bendel’s case, the corporate beneficiary paid tax on the income at the company rate, while the funds stayed in the trust.

The commissioner argued that arrangement amounted to the company giving financial accommodation to the trust and the unpaid entitlements should be treated as loans under Division 7A — an anti-avoidance rule aimed at stopping private company profits being shifted to shareholders or associates without the proper tax consequences.

The High Court disagreed. It found the relevant amounts had been set aside for the corporate beneficiary on separate trusts, rather than creating an ordinary debtor-creditor relationship between the trustee and the company.

“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,” the court ruled.

“This has the potential result of an overall tax impost that is higher than if the corporate beneficiary was never made presently entitled at all.”

The decision is expected to reduce Division 7A exposure for private company beneficiaries of trusts, meaning unpaid entitlements will no longer automatically give rise to deemed dividends (and more tax) simply because the money remains in the trust.

It may also give trustees greater flexibility to retain funds within a trust, provided they continue to meet their commercial and fiduciary obligations.

For some taxpayers, the ruling could prompt a review of past assessments where additional tax was imposed solely because of the commissioner’s former position on UPEs.

The Tax Institute said the ATO’s guidance on existing tax rulings and administrative practices about UPEs is expected to change.

Even so, Ms Abdalla said the taxpayers should “continue to exercise care”.

“Division 7A will still apply where funds are actually advanced, loaned, or otherwise made available to shareholders or associates,” Ms Abdalla said.

“We’d expect that following this decision, statutory revision of these rules could be included alongside recent trust tax changes announced in the Federal Budget.”

“This is likely not the final word on this part of the tax legislation.”

The Tax Institute said the decision does not affect the operation of other integrity provisions, including those that may apply where arrangements involve the use of trusts to inappropriately access concessionally taxed company profits.