Latest Tax Update on Division 7A and UPEs

In this blog, we’ll cover the latest tax updates that have been announced in the past few months. Let’s get started:

Division 7A and UPEs

In Bendel and Commissioner of Taxation [2023] AATA 3074, the ATO’s long-held position was successfully challenged by the taxpayer that unpaid distributions owed to a private company can be considered a loan for Division 7A purposes. Although the case was a win for the taxpayer, before the Federal Court’s decision, the ATO is contesting the decision.

Prior to 16 December 2009, the ATO’s position was that unpaid present entitlement (UPE) owed by a trust to a company was not considered a loan for Division 7A purposes. However, this all changed on 16 December 2009 when some draft documents issued by the ATO suggested that its position had changed. The ATO decided that an unpaid trust distribution owed to a private company beneficiary could be considered a loan for Division 7A purposes.

The primary concern of AAT was that if the unpaid trust entitlement was treated as a Division 7A loan, this could result in the situation of two taxpayers being taxed on the same unpaid trust entitlement. The first point of taxation occurs when the trust distribution is initially received, according to the rules outlined in Division 6 ITAA36. The second point of taxation occurs if the unpaid trust entitlement is later regarded as a Division 7A loan, resulting in an assessable deemed dividend through the Division 7A rules.

In addition to this, the AAT considered that considering an unpaid trust entitlement as a Division 7A loan would be inconsistent with the operation of Subdivision EA. This was due to the fact that the AAT considered Subdivision EA to be the lead-specific provision dealing with unpaid trust entitlements and wasn’t likely to create a second deemed dividend.

When Subdivision EA applies the recipient of the benefit from the trust is considered to have received a taxable dividend, which is the lowest of the following figures:

• The UPE balance owed to the company;
• The benefit’s value given to the recipient (e.g., the loan balance); and
• The company’s distributable leftovers at the end of the relevant income year.

This AAT decision challenges the ATO’s position, with the tax outcomes being potentially important for trust clients that currently owe (or may have owed in the past) unpaid trust entitlements to related private companies. But it doesn’t end over here. On 26 October 2023, a notice of appeal was lodged by the Commissioner to the Federal Court. It is important to note that there is no guarantee that the Federal Court will come to the same conclusion as the AAT.