On 19 February 2025, the Full Federal Court delivered a significant judgment confirming the Administrative Appeals Tribunal’s decision that a distribution from a trust to a company which remains unpaid (referred to as an ‘Unpaid Present Entitlement’ or ‘UPE’) does not constitute a ‘loan’ under Division 7A of the Income Tax Assessment Act. This landmark decision has far-reaching implications for private companies and trusts.
Understanding Division 7A
Division 7A of the Income Tax Assessment Act 1936 addresses certain loans, payments and forgiveness by private companies to shareholders or associates of shareholders. The intention behind this provision is to prevent profits or assets from being provided to shareholders or their associates tax-free by treating those loans and payments as dividends unless they are either repaid in full or placed under the terms of a complying loan arrangement.
The Commissioner’s view since 2010
Since the 2010 financial year, the Commissioner of Taxation has taken the stance that a UPE from a trust to a company qualifies as a ‘loan’ for Division 7A purposes. Consequently, to avoid it being treated as a deemed dividend by the company back to the trust, the UPE needed to be either:
- Paid in full by the trust to the company within particular timeframes,
- Put on ordinary complying Division 7A loan terms (i.e. paid back over a particular timeframe with principal and interest repayments), or
- For certain years and types of arrangements, put under a ‘sub-trust’ arrangement, which may’ve had more favourable repayment terms than an ordinary Division 7A loan.
Before the 2010 financial year, such a UPE could remain unpaid from the trust to the company indefinitely and Division 7A would essentially only apply to such an arrangement if the trust made a loan to a shareholder or associate of a shareholder of the company rather than, for example, the trust retaining the funds to use in its business or investment activities.
The judgment’s impact
The Court’s judgment, which notably lacked any legislative history commentary, focused on the words in the tax law defining ‘loan’ for Division 7A purposes. Unless the Commissioner successfully appeals this decision, or there is legislative reform, this interpretation restores the position on UPEs to that which existed before the 2010 financial year.
Practical considerations
This decision brings up several practical questions, including:
- Will the Commissioner seek leave to appeal the Full Court’s decision to the High Court and if granted, will they be successful?
- How should UPEs already placed under arrangements to comply with the now-invalidated Commissioner’s view be handled?
- For June 2023 UPEs, which would have required placement under an arrangement by the lodgement day of 2024 tax returns, what actions should be taken if those returns have not yet been lodged?
- What should taxpayers do with their tax planning for the year ending 30 June 2025, or indeed lodging tax returns for the year ending 30 June 2024?
While the Court decision was unanimous and a major win for taxpayers, it is not the end of this issue. It is crucial for affected taxpayers to seek expert advice on how the decision impacts their current structure and what future opportunities may be available. While the implications of this decision are potentially substantial for a broad group of people, maintaining an ongoing understanding of the issue is essential for effective tax planning and compliance.
If you’d like practical advice on how this might affect you, contact your local William Buck Tax Advisor.
