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Taxation of Australian trusts may soon be turned on its head

by Ross Forrester

For over a decade, taxation of Australian trusts has been governed by an administrative position taken by the Australian Taxation Office (ATO) . 

If effect, the ATO rules have been as follows:

Where a trust allocates profits to a company, and the company: (i) knows that it can demand payment of the profits; (ii) the company does not demand profits; and (iii) the persons controlling the company and trust are associates of each other, then the unpaid profits to the trust fall under the extended definition of “loan”, and if the loan is not repaid it becomes a dividend.

The ATO has a complicated set of rules indicating when the unpaid profits will not become a loan. Managing these rules requires a high degree of care.

The ATO position has required trusts to pay their profits (typically by cash) into the company to enjoy the company tax rate. This has reduced the effectiveness of many Australian trusts.

The Bendell case

In the Bendell case, the trust allocated profits to a company from 2013 to 2017. The profits were shown as an “unpaid present entitlement” in the accounts. The ATO administrative approach was not followed.

The ATO presented that the unpaid profits from the trust to the company fell under the definition of a loan, and so, the unpaid trust profits would have become an unfranked dividend.

The decision

The tribunal held 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”.

This case represented a significant change in direction. In essence, the decision potentially gave grounds for somebody to argue that the administrative position endorsed by the ATO was not law and should not be followed.

The ATO response

The ATO has indicated that they will appeal the decision in Bendell case. Pending the appeal the ATO will continue to manage its compliance approach according to its existing tax rulings. The ATO has also indicated that other areas of law might apply to a taxpayer even if the ATO loses this case, so it is likely to continue with its administrative position.

A single judge of the federal court typically supports the decision of a tribunal, so a ratification of the law endorsed by the ATO will likely only happen if the matter goes to the full federal court. This is yet to be seen. 

The impact of Bendell could have a wide-reaching impact. The current administrative practice might be challenged and make trusts a much more attractive tax structuring and estate planning vehicle. In the meantime, tax advisors are left with the difficult choice of conservatively following the ATO approach or taking a risk by referring to the tribunal and being open to amended assessments. 

Ross Forrester is the director of Westcourt, an Australian accounting and tax structuring firm. He is the Asia-Pacific Regional Chair of the GGI ITPG, and State Chair for The Taxation Institute of Australia. 

19 April 2024

Ross Forrester

Westcourt Family Business Accountants, Director

Westcourt Family Business Accountants