High Court rejects longstanding ATO views on unpaid present entitlements

Other provisions and proposed reforms could mean the taxpayer's win is fleeting 16 min read

In a highly anticipated decision, the High Court has held that an unpaid present entitlement of a private company beneficiary to trust income is not a 'loan' that can be deemed to be a dividend the company has paid to the trustee. In so doing, it rejected the position set out in public rulings and other practical guidance that the Commissioner of Taxation has applied since 2009.

In this Insight, we consider the implications Federal Commissioner of Taxation v Bendel will have for the past, present and future taxation of ownership structures involving discretionary trusts with private company beneficiaries—including whether proposed tax reform will render the taxpayer's victory temporary.

Who in your organisation needs to know about this?

Heads of Tax; Tax Managers; Family Office Executives

Key takeaways 

• Unpaid present entitlements of private company beneficiaries to trust income, of themselves, do not result in a deemed dividend that is effectively double taxed to the trustee or beneficiaries under Division 7A of the Income Tax Assessment Act 1936 (Cth). As such, there should be no need for such entitlements to be converted to Division 7A compliant loans.
• However, subsequent inaction on, or dealings with, such entitlements by the trustee or beneficiary may still result in adverse taxation outcomes under other provisions (eg subdivision EA, s109F or s100A). While the decision provides private groups with greater flexibility in conferring entitlements to trust income, there are nevertheless still limits on what can be achieved.
• Taxpayers should consider whether to object against prior year assessments giving effect to the position the Commissioner of Taxation (the Commissioner) adopted in public ruling TD 2022/11 and former public ruling TR 2010/3. For many income years, the time period within which to object may have expired already.  

Taxation of the income of discretionary trusts

Common business/investment structure

The facts in Bendel are relatively simple, and involve a common structure for carrying on business or investment activities in Australia: a discretionary trust with a class of objects that includes a corporate beneficiary (sometimes described as a 'bucket' company).¹ Among other considerations, discretionary trusts provide flexibility for trust income to be distributed between the various objects/potential beneficiaries of the trust (generally, individual family members and their related entities). Beneficiaries who are presently entitled to trust income are taxed on a corresponding share of the trust's taxable income at their applicable tax rate.

In a simple scenario that provides some context for the Commissioner's views and approach leading up to this case, the share of taxable income assessable to a corporate beneficiary would be taxed at a lower rate (ie 30%, assuming the standard corporate tax rate) than the rate that would apply to the same share of taxable income being assessed to, say, individual family members who are already taxed at a high marginal rate, including the Medicare levy (eg 39% or 47%), or income accumulated by the trustee, which would be taxed at a flat rate equal to the highest marginal rate (ie, 47%).

The Commissioner has expressed his concern in the past that if the amount to which the corporate beneficiary is presently entitled is not distributed but instead retained by the trustee as a so-called unpaid present entitlement, '[e]conomically, the practice replicates a trustee accumulation and the policy of the law is thereby being compromised'.² He has sought to apply the deemed dividend rules to address this behaviour, as we will explain.

Private company payments, loans and debt forgiveness deemed to be dividends

Eventually, the corporate beneficiary would be expected to pay dividends to its shareholders (generally, one or more individual family members), resulting in those shareholders being taxed on those dividends at their applicable tax rate, generally with a credit for the income tax paid by the company under the dividend imputation system.

To prevent private companies instead engaging in other (non-taxable) transactions for the benefit of their shareholders, Division 7A of the Income Tax Assessment Act 1936 (Cth) generally deems:

1. payments;
2. unrepaid loans; and
3. debt forgiveness,

by a private company to a shareholder (or their associate) to be a dividend paid to that shareholder (or associate), subject to certain exceptions. Each of 'payment', 'loan' and 'debt forgiveness' are defined broadly. Relevantly for the present purposes, s109D(3) defines a 'loan' to include:

(a) an advance of money; and

(b) a provision of credit or any other form of financial accommodation; and

(c) a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and

(d) a transaction (whatever its terms or form) which in substance effects a loan of money.

Commissioner considers unpaid present entitlements to be loans that are deemed dividends

In Bendel, the trustee of the discretionary trust made the relevant corporate beneficiary presently entitled to trust income over a number of years. However, in accordance with the terms of the trust deed, the trustee did not resolve to 'pay' (ie distribute) that trust income to the company; instead, it purported to 'set aside' the trust income amounts, and hold them on a separate fixed trust for the sole and absolute benefit of the company. As the company did not call for the amounts to be paid to it, the trustee had the power under the trust deed to invest those amounts pending payment to the company, which it did by lending most of them to Mr Bendel, who was the sole shareholder and director of both the trustee and company, as well as an object of the discretionary trust.

Consistent with the position set out in a current public ruling,³ the Commissioner issued assessments for each year on the basis that the unpaid present entitlements of the company were a 'loan' by the company to the trustee because they were 'a provision … of financial accommodation' under s109D(3)(b) or 'a transaction … which in substance effects a loan of money' under s109D(3)(d) due to the company not calling for payment of its entitlements.

The taxpayer sought review of the assessments in the Administrative Appeals Tribunal, which held that the unpaid present entitlements were not loans as defined, given subdivision EA of Division 7A contained specific provisions that dealt with unpaid present entitlements of private company beneficiaries.⁴ The Commissioner appealed to the Full Federal Court, which held that unpaid present entitlements were not loans as defined, because the definition of 'loan' requires a transaction that creates an obligation to repay an amount or in substance effects an obligation to repay, and not simply the existence of a debtor-creditor relationship, whereas an unpaid present entitlement was simply an obligation to pay an amount with no associated obligation to repay.⁵ The Commissioner sought and was granted special leave to appeal to the High Court.⁶

High Court holds unpaid present entitlements do not result in deemed dividends

Legal effect of trustee resolutions: no debtor-creditor relationship

Despite the parties having agreed before the Federal Court that the trustee resolutions and trust accounts for each year created a debtor-creditor relationship between the trustee and company beneficiary,⁷ a majority of the High Court held that the trustee resolutions and accounts:⁸

• effected a setting aside of the unpaid present entitlements, but not a distribution of those amounts;
• resulted in the entitlements being held on newly created separate fixed trusts for the company; and
• did not give rise to a debtor-creditor relationship between the trustee and company.

The High Court emphasised that the legal effect of a trustee resolution depends upon the terms of the relevant trust deed and the particular language of the resolution, as well as the actions of the trustee and beneficiary.⁹

In this case, the resolutions expressly provided for the trustee to 'set aside' (not 'pay' or 'apply') the net income of the trust for the company beneficiary under the terms of the trust deed, which in turn provided that such amounts ceased to form part of the trust fund, and came to be held on a separate fixed trust for the company, in relation to which the trustee had a power to invest the amounts for the benefit of the company 'pending payment' to it of those amounts. As such, the resolutions did not create an unconditional duty on the trustee to pay (ie distribute) those amounts to the company, because the trust deed contemplated an interim period during which the amounts were still held on trust and invested.¹⁰

Furthermore, the resolutions identified the property of the separate fixed trusts with sufficient certainty by referring to a defined percentage of the net income of the trust set aside for the company beneficiary. This language enabled the separate trust property to be clearly identified or ascertained without any ambiguity or uncertainty: it was a defined percentage or proportion of the overall trust property, being a sum of money in the form of (a proportion of) the receipts of and debts owed to the trustee for each year.¹¹ On this basis, the High Court effectively overturned the Tribunal's finding that no separate trust (at least in a conventional sense) arose because it was not possible to identify any specific asset or property held on such a separate trust.¹²

Finally, the Court held that while a debtor-creditor relationship could arise if either the trustee made a resolution to distribute income to a beneficiary (ie an unconditional undertaking to pay), a beneficiary presently entitled to income called for its payment, or the trustee admitted it owed a debt to the beneficiary, none of that had happened in this case. In particular, there was insufficient evidence to conclude that the trust accounts constituted an admission by the trustee of indebtedness, including because they could be read as merely recognising the separate fixed trusts in respect of the unpaid present entitlements.¹³

Unpaid present entitlements not loans

By the same majority, the High Court also held that the expanded definition of 'loan' in s109D(3) does not encompass circumstances where a beneficiary does not insist on being paid an unpaid present entitlement. More specifically, failure to call for payment of an unpaid present entitlement is not the provision of financial accommodation or a transaction that in substance effects a loan. The provision of financial accommodation or a transaction that in substance effects a loan requires some initial or anterior transfer of value from a private company to a shareholder (or their associate) involving the private company actively doing something to move that value. Mere inactivity by the private company is not the 'provision' of financial accommodation or a 'transaction'. Moreover, doing nothing or acquiescing to the retention of funds is not a 'transaction', which requires some interchange or interaction between entities. As the company beneficiary in this case simply did nothing, it followed that it had not made a 'loan' to the trustee as defined in s109D(3).¹⁴

The High Court held that its conclusion was reinforced by the broader statutory context and legislative history of Division 7A:¹⁵

• Section 109D refers to loans being 'repaid', and the various limbs of s109D(3) expressly or implicitly require some form of an obligation to repay an amount or value supplied (eg by transfer of property or supply of services); on this point, the Court expressly approved most of the Full Federal Court's reasoning.
• One of the definitions of debt forgiveness in s109F(6)—which applies if (objectively) a reasonable person would conclude that a private company will not insist on an entity paying an amount of debt owed to the private company—would be superfluous if a 'loan' included a company (subjectively) failing to call for payment of a debt.
• Parliament intended to deal with unpaid present entitlements of private company beneficiaries specifically in subdivision EA of Division 7A, which, broadly speaking, provides that where the trustee makes a payment or loan to, or forgives a debt of, a shareholder (or their associate) in a presently entitled company beneficiary, the amount is included in the assessable income of the shareholder (or their associate).

Implications of High Court decision for ATO and taxpayers

ATO's current (and former) guidance products incorrect

The reasoning of the Tribunal, Full Federal Court and High Court means that the Commissioner's public ruling on this issue is incorrect to the extent that it states a private company beneficiary provides financial accommodation to a trustee if it does not demand immediate payment from the trustee of an unpaid present entitlement.¹⁶ Absent any urgent legislative amendment to Division 7A, this should mean that the public ruling is either amended or withdrawn.

The public ruling also states that a private company beneficiary provides financial accommodation to a shareholder (or their associate) where its present entitlement to income is satisfied by being held on a sub-trust for the company's exclusive benefit, but the company consents to the sub-trust funds being used by or for the benefit of one of its shareholders (or their associate).¹⁷ Interestingly, the correctness of that position was not argued before the High Court, even though that is exactly what happened in Bendel (ie the company's unpaid present entitlements were mostly loaned to Mr Bendel).

The Australian Taxation Office (the ATO) website contains a statement that it is considering the implications of the High Court's decision, and will update the views set out in its interim decision impact statement on the Full Federal Court decision as soon as possible, to provide practical guidance to impacted taxpayers.¹⁸ While the website statement does not mention whether other guidance products, including the public ruling, will also be updated accordingly, the interim decision statement itself stated that the ATO did not intend to revise the public ruling '[u]ntil the appeal process is finalised'.¹⁹ That finalisation has now occurred.

What may be particularly galling for taxpayers is that they may now be out of time to seek amendments to assessments for prior years, given that the Commissioner's incorrect views on the application of Division 7A to unpaid present entitlements of private company beneficiaries were first applied from 16 December 2009.²⁰ Alternatively, taxpayers may have taken irreversible steps to comply with the Commissioner's incorrect views (eg converting unpaid present entitlements to a loan as defined, which remains subject to deemed dividend treatment under Division 7A).

Importantly, the result in Bendel does not mean that the Commissioner is unable to tax unpaid present entitlements of private company beneficiaries. To the contrary, each of the decisions in Bendel expressly endorse the potential for other provisions to apply instead of s109D.

Potential application of subdivision EA to shareholders (or their associates) in private company beneficiaries with unpaid present entitlements

Before the Tribunal in Bendel, the Commissioner adopted the position that Mr Bendel could not be assessed under subdivision EA on the loans made to him by the trustee from the unpaid present entitlements of the company beneficiary because those entitlements had been satisfied or paid by the creation of the separate trust for the benefit of the company. The Tribunal rejected that position and held that subdivision EA could apply to such arrangements.²¹ The Full Federal Court did not address this position directly, but noted that subdivision EA applies such that company profits referrable to an unpaid present entitlement that make their way to an individual taxpayer are a deemed distribution.²²

The High Court noted that the Commissioner did not rely upon subdivision EA 'even though it expressly addresses cases of unpaid present entitlements of a private company beneficiary.' After reiterating that much of the unpaid present entitlements of the company beneficiary had been loaned by the trustee to Mr Bendel, the High Court held '[t]hus, the facts here broadly correspond with the circumstances to which Subdiv EA is addressed.'²³ Subsequently, the Court also approved of the Tribunal's conclusion that the Commissioner had sought to tax the wrong taxpayer (including the Tribunal's remittal of the matter to the Commissioner to consider the application of subdivision EA to Mr Bendel).²⁴

In other words, the High Court agreed with the Tribunal that the Commissioner could and should have assessed Mr Bendel on the loans he received from the trustee under subdivision EA, rather than trying to assess the unpaid present entitlements as loans to the trustee. Given that express authorisation, the Commissioner might be expected to apply subdivision EA in the future in circumstances similar to those in Bendel. The potential to advance such arguments may also be an incentive for the Commissioner to amend or withdraw the public ruling, given that it currently effectively provides that subdivision EA cannot apply to a sub-trust for the exclusive benefit of a private company beneficiary.²⁵

Potential debt forgiveness deemed a dividend under s109F(6) if a private company beneficiary does not insist on payment of entitlements that are debts

In the course of its reasoning, the High Court noted that under s109F(6), debt forgiveness by a private company deemed to be a dividend includes a case 'in which a private company is owed a debt and is able to, but does not, insist on the payment of that amount'.²⁶ The Full Federal Court also emphasised the difference between a 'loan' to which s109D applies and a 'debt' to which s109F applies.²⁷

This means that for any unpaid present entitlements to trust income that do give rise to a debt (eg because the trust deed or resolution provides for a distribution or payment, the beneficiary had previously called for payment, or the trustee admitted the debt), it would be open to the Commissioner to instead treat the unpaid present entitlement as a debt forgiveness deemed dividend if the objective criteria of s109F(6) are satisfied.

Such a course was not open to the Commissioner in Bendel, given the High Court's conclusion that no debtor-creditor relationship had arisen between the trustee and company beneficiary. This should mean that other cases involving similar circumstances—in particular, similar trust deed and resolution drafting (eg to 'set aside' income), and actions of the trustee and beneficiary (to not admit the debt or call for payment)—cannot result in any debt forgiveness if there is no debt in the first place.

Potential application of tax to the trustee under s100A if the arrangement between the trustee and company beneficiary is a reimbursement agreement

The Full Federal Court noted that:²⁸

The perceived mischief which lies at the heart of the Commissioner's submission is the creation of a present entitlement which is not paid to a corporate beneficiary and remains in the trust but which benefits from taxation at the corporate beneficiary's corporate tax rate. Division 7A does not operate to negate that present entitlement.

However, that is precisely how s100A operates: it negates a present entitlement to trust income that arises out of a reimbursement agreement. In summary, a reimbursement agreement is defined to be an agreement that provides for money, loans, debt forgiveness, property, services or other benefits to be provided to a person(s) other than the presently entitled beneficiary, entered into for a purpose of securing a person paying less income tax, other than an ordinary family or commercial dealing.

While s100A was not expressly mentioned by the High Court, Full Federal Court or Tribunal in Bendel, the ATO's interim decision impact statement notes that it may apply to unpaid present entitlements, unless those entitlements are converted into a loan by the company beneficiary to the trustee on commercial terms consistent with the exception to deemed dividend treatment under Division 7A contained in s109N.²⁹

The Commissioner has a history of mixed success in applying s100A to corporate beneficiaries. In Federal Commissioner of Taxation v Guardian AIT Pty Ltd, the Full Federal Court held that s100A did not apply to a dividend paid by a company out of its unpaid present entitlement because on the facts the relevant reimbursement agreement did not exist prior to the company being made presently entitled to trust income and the company was not a party to the agreement.³⁰

In contrast, in B&F Investments Pty Ltd v Federal Commissioner of Taxation, the Full Federal Court held that s100A applied to a present entitlement of the corporate beneficiary to trust income in circumstances where the company was taxed at the corporate rate on all of the taxable income of the trust, but only received a distribution of a small amount of this income (with the trustee retaining the rest, despite not being taxed on it at the higher trustee rate).³¹

The Commissioner has made a public ruling on s100A accepting that where it applies to negate a present entitlement of a private company beneficiary, Division 7A would not also operate as to that entitlement.³² The Commissioner has also issued a practical compliance guideline setting out the ATO's compliance approach to various different scenarios to which s100A might apply, including for unpaid present entitlements of private company beneficiaries.³³ Importantly, the Commissioner has an unlimited period to amend assessments to give effect to s100A.³⁴

Federal Budget proposed tax reform for discretionary trusts

Even if Division 7A is not amended as a result of the High Court's rejection of the Commissioner's position in Bendel, the proposed tax reforms in the 2026–27 Federal Budget would create a powerful disincentive to conferring entitlements upon company beneficiaries of discretionary trusts, such that the practice could become a thing of the past. The reforms announced in the Budget include a proposed 30% minimum tax on the income of discretionary trusts to be paid by trustees from the income year commencing 1 July 2028.

While individuals and other non-corporate beneficiaries who are presently entitled to trust income (and who are taxed upon the corresponding share of taxable income) would receive a non-refundable credit for the tax paid by the trustee, corporate beneficiaries will not receive such a credit, meaning that making a company beneficiary presently entitled to trust income would result in double taxation of the income in the hands of the trustee and company beneficiary. This is expressly intended to 'discourage' the use of corporate beneficiaries.³⁵

Such an outcome would be ironic in circumstances where both the Tribunal and Federal Court in Bendel rejected the Commissioner's position because it would have resulted in double taxation of the same trust income in the hands of the company first (as trust income), and then subsequently the trustee or beneficiaries (as a deemed dividend).³⁶

Actions you can take now

• Review notices of assessments to confirm limited amendment periods and consider whether to object to any based on the Commissioner's incorrect views.
• Review trust deeds and pro forma trust resolutions, and reevaluate options for current or future unpaid present entitlements of private company beneficiaries.
• Consider the potential for other provisions to tax unpaid present entitlements of private company beneficiaries (eg subdivision EA, debt forgiveness or s100A).
• Follow the passage of any exposure draft legislation to give effect to the proposal in the Federal Budget to impose a 30% minimum tax on discretionary trusts.