Tax experts wait for further clarity after major AAT ruling on trust distributions and loans

Small business tax advisors are carefully assessing an Administrative Appeals Tribunal decision that challenges the Australian Taxation Office’s interpretation of specific trust distribution rules, with one leading accountant “playing a straight bat” before a likely appeal from the ATO itself.

On September 28, the AAT sided with accountant Stephen Bendel in his argument against the ATO’s interpretation of Division 7A of the Income Tax Assessment Act, which addresses loans between trusts and companies.

The decision, if it goes unchallenged, could have significant financial ramifications for other trusts and their beneficiaries.

Before Division 7A came into effect, trust beneficiaries could funnel distributions into ‘bucket’ companies under their control.

As company tax rates fall below the highest personal income tax rates, these ‘bucket’ companies could accept the distributions without the beneficiary facing a hefty income tax bill.

To actually obtain the distributions, the company could then ‘loan’ the money to the beneficiary under extremely lenient terms.

Division 7A pins an interest rate on those loans, making the loan scheme less attractive as a wealth transfer vehicle.

The benchmark Division 7A loan interest rate stands at 8.27% as of July this year, adding a further financial complication to trust beneficiaries considering a company loan structure.

Bendel’s AAT case focused specifically on unpaid present entitlements (UPEs) — that is, distributions noted by a trust but not actually paid to a beneficiary, be they an individual or company.

Division 7A rules can apply “if a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company’s shareholder or their associate,” the ATO states.

Over a period of several years, the ATO considered UPEs linked to Bendel as loans under Division 7A.

The AAT sided with Bendel on appeal, finding that: “The balance of an outstanding or unpaid entitlement of a corporate beneficiary of a trust, whether held on a separate trust or otherwise, is not a loan to the trustee of that trust.”

The decision could have major implications for taxpayers whose affairs included UPEs classified as loans by the ATO, and who paid interest because of it.

Even so, accountants are not rushing to change their own approach to Division 7A rules, given the potential of an appeal by the ATO itself.

Lisa Greig, principal at Perigee Advisers, said she is “playing a straight bat” when it comes to Division 7A until there is further clarity, above and beyond the position laid down by the AAT.

As the decision is administrative and not judicial, a court decision which either enforces or overrides the AAT viewpoint would provide more certainty.

In her view, it is “business as usual, until it goes to the next level of appeal”, she told SmartCompany.

Elinor Kasapidis, head of policy and advocacy at CPA Australia, agreed the AAT decision should not cause advisors and business owners to radically reshape their trust structures.

“Practitioners and their clients should be careful not to react too soon to the decision,” Kasapidis said.

“The [Commissioner of Taxation] may reconsider or appeal.”

In case of an ATO challenge, “practitioners should await the outcome of that appeal before deciding whether to act,” she added.

Despite the calls for calm, the case, and its significant implications, has caught the attention of the wider Australian accountancy community.

Beyond the likelihood of an ATO appeal, “the outcome of this case may bring Division 7A reform back on to the table (or alternatively, a legislative quick fix band-aid approach),” said Andrew Henshaw, managing director at Velocity Legal.

“Expect 2024 to be a year of talking about UPEs and Division 7A,” he added.