AAT decision overturns ATO ruling on trusts and Div 7A
Thousands of trusts have fallen into line with the Tax Office’s position that an unpaid present entitlement to a company constitutes a loan.
The AAT has overturned more than a decade of ATO edicts about the tax implications of unpaid entitlements to companies and what comprises a Div 7A loan in a decision that could affect thousands of trusts.
Tax specialist Mark Molesworth of BDO said the case, Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074, was the first setback to the ATO’s position that an unpaid present entitlement (UPE) to a corporate trust beneficiary constituted a Div 7A loan.
He said the challenge by Stephen Bendel, who the AAT said ran “a busy suburban accounting and registered tax agent practice” via trusts, threatened to generate thousands of objections to rulings and penalties made on the basis of the ATO view.
“The tax office’s position since 2009 is that the unpaid present entitlement itself is a loan for Div 7A purposes,” he said. “The tribunal has effectively said that the tax office didn’t get that right.”
He said the ATO’s position would have informed a huge number of tax arrangements since the “vast majority” of the 971,000 trusts were family trusts, and most of those had a corporate beneficiary.
The vast majority would have fallen into line with the ATO’s guidance and paid interest to prevent paying tax.
“Most taxpayers will have set themselves up so they didn’t end up with a tax liability,” he said. “That’s what most taxpayers in my experience were wanting to do, and were advised to do, because taxpayers generally want the quiet life and will generally seek to abide by ATO guidance.”
“It would be the minority of those 971,000-odd trusts that will actually have been taxed and penalised because of the tax office’s 2009 position. Any taxpayers who have been subjected to tax and penalties … should be looking to their objection rights.”
Mr Molesworth said in the short term, most taxpayers would have to wait and see how the ATO responded to the ruling.
“I'd be shocked if they didn't appeal. If they do appeal, then everything probably goes on hold until that appeal is heard and a judgement delivered.”
“But at some point the tax office will probably issue what they call a decision impact statement about this case, whether now or after the appeals are heard.”
“Once we get to that decision impact statement, I think a lot more thought will go into is there any way as a result of this to simplify Division 7A and the application of Div 7A? Because simplification would be very welcome.”
An ATO spokesperson said: “The ATO is considering the decision of the tribunal including whether any appeal may be appropriate. The ATO does not otherwise comment on matters that are still within an appeal period.”
Mr Molesworth said the AAT ruling hinged on a point of law in connection with subdivision EA, an anti-avoidance provision introduced in the early 2000s.
An explanatory ATO webpage explained subdivision EA had the effect of treating as dividends “any payments, loans, repayments or debts forgiven by the trust to a shareholder of the private company” with a UPE.
Mr Molesworth said the AAT’s decision went to the legal principle of statutory interpretation.
“That says we assume parliament means to do something when they enact a section, a part of a law. The courts and tribunals will prefer to read legislation in a way that gives its actual practical effect to each of its sections.”
“And so if an interpretation tends to mean that there's a part of the law that doesn't have any practical effect, the presumptions or the starting point will be, well, that's not what parliament intended. It intended to actually be trying to do things with its legislation. And that's the principle statutory interpretation that was applied here.”
“What the tribunal has said is the tax office’s position that the unpaid present entitlement itself is a loan is not consistent with the existence of subdivision EA.
“And so therefore, parliament must not have intended to capture the unpaid present entitlements as loans.”
He said with most Div 7A loan payments not due until June 2024, most trusts could afford to bide their time.
“So we've got nine months or so to see what happens in this space,” he said. “Trying to do anything on the fly now probably risks making the situation even more complex than it already is.”
Mr Molesworth, who was a member of a Board of Taxation working group that reviewed Div 7A, said its recommendations centred on simplification of the law and there had been no legislative amendments as a result of that report.
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