THE SK NEWSLETTER #2 [SPECIAL EDITION, NOV 2023]

Hot off the Press is our Doyle’s listing, the Bendel decision and meet our Associate Adrian Hanrahan.

We recommend you follow our firm LinkedIn page HERE.

It is with immense pride to share that Smailes Krawitz has been listed as the only firm in the Top Tier of “Leading Tax Law Firms – Western Australia, 2023” in the Doyle's Guide. This listing recognises lawyers practising in taxation advisory and disputes matters in the WA legal market, identified by clients and peers for their expertise.

Furthermore, Smailes Krawitz Directors, Chris Smailes and Alan Krawitz, are the only two persons listed in the Pre-eminent category of Tax Lawyers, ranking them at the highest possible level.

This follows the recent Doyle’s recognition of Smailes Krawitz as a Leading Law Firm in Wills, Estates and Succession Planning [WA 2023]. Director Chris Smailes is listed as a Preeminent Wills, Estates & Succession Planning Lawyer, which is the highest rating and Director Alan Krawitz is recognised as a Leading Wills, Estate & Succession Planning Lawyer.

Chris and Alan would like to thank all those who acknowledged and recommended the work of Smailes Krawitz. A great thanks also to our talented team who work hard to deliver the best outcomes, often working to tight deadlines.

We look forward to another year of success at this important time of the firm's growth as leaders in tax, estate and commercial law.

HOT OFF THE PRESS

The Tax Commissioner’s New Clothes – the Bendel Decision

Adrian Hanrahan – Associate

Earlier this week, the Australian Taxation Office (ATO) published an Interim Decision Impact Statement (DIS) in relation to an Administrative Appeals Tribunal (AAT) decision, herein known as the Bendel decision (Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074). If you listen carefully, you might hear the collective sound of many thousands of practitioner’s highlighters squeaking across papers around Australia.

The Bendel decision held that a private company’s failure to call for income of a trust estate (unpaid present entitlement (UPE)) was not ‘financial accommodation’ and therefore not within the ‘extended definition of a loan’ under s109D(3) of ITAA 1936.

While this AAT decision was not a precedential decision (i.e. this did not create law and is not binding on other taxpayers) it created great uncertainty as it conflicts with the long-standing approach taken by the ATO since 16 December 2009. We also note that AAT matters are not bound to follow earlier AAT decisions, but they generally do so unless the earlier decision is plainly wrong. The ATO has since appealed the AAT decision (see Here).

Many tax advisers had publicly questioned the ATO’s approach since 2009, but the Bendel decision was the first time that a taxpayer was brave enough to say in an AAT setting that the Tax Commissioner ‘had no clothes’ in this legislative context.

The ATO’s evolving view on UPEs

To put the Bendel decision in context requires a brief overview of the history of how UPEs have been treated over the years.

Division 7A of ITAA 1936 was introduced in 1997 and was intended to prevent profits or assets being provided to shareholders or their associates tax free.

A deemed dividend (that is generally unfranked) can arise under Division 7A when there is a payment or other benefit from a private company to a shareholder (or their associate), even where the parties characterise the amount as a loan, advance, gift or writing off a debt. To avoid the application of a deemed dividend, such an amount or benefit must be placed on complying Division 7A loan terms, with minimum yearly repayments, all within the prescribed timeframes.

A Division 7A deemed dividend does not apply where a payment or benefit to a shareholder (or their associate) is assessable under other parts of the tax law (i.e. such as normal dividends or director's fees).

Division 7A was amended in 1998 (via section 109UB) to expand its coverage to trusts in certain circumstances (where a trust made a UPE and then later lent the money to a shareholder or associate). A further amendment occurred in 2002 (via Subdivision EA) to fix shortcomings in relation to section 109UB at the time (so that a deemed dividend would arise whether the loan or distribution occurred first).

However, the view adopted by both taxpayers and the ATO was that a trust simply retaining the funds relating to a distribution (i.e. a subsisting UPE) was not captured by Division 7A, specifically in relation to the ‘extended definition of a loan’.

On 16 December 2009 everything changed with the issue of TR 2009/D8 (later finalised as Taxation Ruling TR 2010/3) that stated that the ‘extended definition of a loan’ (specifically, the concept of ‘financial accommodation’) includes the circumstance where funds representing a UPE were retained for use within the trust and the private company acquiesces to that treatment.

To avoid this Division 7A application, taxpayers could follow an administrative concession outlined in PS LA 2010/4 by placing such trust interests on certain subtrust terms.

This subtrust concession was recently withdrawn in 2022 with the issue of Taxation Determination TD 2022/11.

The Bendel decision

This decision involved the private group of Mr Bendel (an accountant), where he had a discretionary trust, a corporate beneficiary of that trust, and several UPEs that weren’t put on Division 7A complying loan terms.

At audit, objection, and then upon review at the AAT, the key issue was whether the corporate beneficiary provided financial accommodation to the trust within the within the ‘extended definition of a loan’. A secondary issue was whether a subtrust (as conventionally understood) existed in respect of the UPE.

The taxpayer contended that the ‘extended definition of loan’ required an interpretation that considered the statutory context of Division 7A and the broader purpose of those provisions (and the history of changes over the years). The taxpayer also argued that in some circumstances, where a UPE remained unpaid and the trust undertook certain transactions to benefit a shareholder or their associates, the perverse situation of double taxation could arise.

The Tribunal underwent a statutory interpretation exercise that considered the text, context, and purpose of the various Division 7A provisions (including considering extrinsic materials and ministerial media releases) and ultimately found in favour of the taxpayer.

On the secondary issue the Tribunal found that it was not possible to identify an asset or property held on a separate trust (subtrust) and what was instead created by the corporate trustee passing the resolutions creating the UPEs was a right or entitlement for the beneficiary, coupled with the corresponding obligation of the trustee.

Practical outcome of the Bendel decision

While this AAT outcome was not a precedential decision, it had the potential to create a situation where a taxpayer adopting this view for their circumstances was at the very least a 'reasonably arguable' position (i.e. it is 'about as likely to be correct as incorrect'). This is an important point when seeking to mitigate tax penalties.

Understandably, this is an undesirable situation for the ATO, and they made the rare step to issue an Interim DIS while the appeal process is completed.

The Interim DIS

In the recently published Interim DIS, it will come as no surprise that the ATO does not intend to revise their current views relating to private company entitlements to trust income, as set out in TD 2022/11.

Whilst the ATO’s approach in the Interim DIS comes as no surprise, it is helpful that they have at least adopted a view (notwithstanding it being their current view).

Summary

The Bendel decision and the subsequent appeal(s) will be closely watched by taxpayers and their professional advisers.

If you have clients with arrangements affected by the Bendel decision, feel free to reach out to us.

Until the appeal process has been completed, the Tax Commissioner appears to be following the approach from the folktale about the emperor continuing the procession showcasing his ‘new clothes’, in the face of serious questions about the potential fictions that it is built upon.

We will keep you informed as developments occur.

Call us on (08) 6373 7756.

FEATURED PRACTITIONER: ADRIAN HANRAHAn

Adrian is an Associate with Smailes Krawitz. He is an experienced tax and commercial lawyer specialising in the tax and legal affairs of high-net-worth individuals, family offices, and private clients. Adrian also enjoys providing his expertise directly to accountants and other solicitors.

Adrian also works as a lecturer at Curtin Law School in both undergraduate (LLB) and postgraduate (MTax) degrees, is a regular presenter at CPD seminars and is a member of the Taxation committee of the Law Society of Western Australia.

Adrian has over 16 years' private practice experience providing advice in tax and private wealth structuring, and additionally, has worked as a Tax Avoidance Taskforce - Tax Specialist, in an Executive Leadership role at the Australian Taxation Office (ATO).

Adrian is instructed by clients who need solutions to complex tax, trusts, asset protection, SMSF, and legal problems for their businesses and investments including reviews, audits and litigation conducted by the ATO. He also advises on the restructure of private groups, trading and investment vehicles to implement succession and estate plans.

Adrian holds the prestigious Chartered Tax Advisor designation. In conjunction with his Master of Applied Finance, legal qualifications and experience, Adrian is well placed to assist Smailes Krawitz clients.

For further information about any of the matters contained in The SK Newsletter or for any assistance with any other tax, trust, estate or commercial law matters, please contact one of our Directors.