In this case, the taxpayer was the sole director and shareholder of his discretionary trust corporate trustee and what could be seen as a bucket company that was a beneficiary of his discretionary trust.

There were a series of unpaid present entitlements (UPEs) made to the company from the discretionary trust which the company disclosed in its balance sheet as a current asset.

Under a part of Division 7A of the ITAA 36 (Div 7A), a loan made by a private company is caught and taken to be a dividend if it is not repaid, and a loan is taken to include a broadly defined set of 4 limbs including the provision of any form of financial accommodation (e.g. a UPE).

The ATO argued that the UPE constituted a loan by the company to the discretionary trust for not among other things calling for payment of the UPE amount to it that it was entitled to.

The Full Federal Court dissected the definition of loan in Div 7A in the context of that specific part of the ITAA 36 and found that a loan requires an obligation to repay, otherwise it could be a debt or financial accommodation in the broader sense but does not elevate it to being a loan.

Consideration of the broad 4 limbs of the definition of loan in Div 7A was then considered by the Court as in context requiring this obligation to repay despite the definition being inclusive and having 4 separate limbs, only one of which expressly contains the word “repay”.

The Court referred to the perceived mischief to be caught by the anti-avoidance nature of Div 7A that a company beneficiary could be fed UPE benefits from a discretionary trust so that the amount avoids the trust’s accumulation tax rate at the highest marginal tax rate in favour of the lower company tax rate.

But this perceived mischief was found to only apply to the facts in this case if the company’s UPE made their way to another company.

Here, there was a resolution making the distribution that was unpaid and it was recorded in the discretionary trust accounts as a UPE and as well in the accounts of the bucket company as a UPE.

But something more to obligate the discretionary trust to repay the amount to the company was required for Div 7A to catch this as a loan in order that the loan would have to be repaid to the company under Div 7A terms or be deemed a dividend from the company to the discretionary trust.

Here the discretionary trust was not a shareholder of the company – the controlling person being the taxpayer was the sole controller.

If we consider that section 140 of the Corporations Act deems the company’s constitution to have effect as a contract including between the company and a shareholder (and that each amendment to the constitution requires all shareholders to agree to be bound by any amendment to the constitution after they initially become a shareholder) and that the third limb of Div 7A section 109D(3)(c) includes any express or implied obligation to repay, then an obligation under the company’s constitution to repay would be enough to give rise to such an obligation to repay and be considered a loan for Div 7A purposes (as long as the required repayments are actually made).

In this case it was the reverse direction being considered as an entitlement from a discretionary trust that was not paid out to be a loan from the beneficiary company, but from which there was no actual advance of funds from the company to the discretionary trust, which we often are concerned regarding funds leaving the company to shareholders without a Div 7A obligation to protect them from being deemed as a dividend taxed in the shareholder’s hands.

The discretionary trust deed itself obligates the trustee to act on behalf of the beneficiaries but doesn’t place reciprocal obligations on the beneficiaries to the trustee and may not be considered as able to give rise to any contractual obligation, express or implied, for the beneficiary to repay their distribution (paid or unpaid) back to the trustee (the reverse direction to that considered in this case).

The resolutions here were distribution resolutions under the trust deed of the discretionary trust which then deemed the trustee to hold the distributed amounts on sub-trust for the recipient beneficiaries and your typical distribution resolutions would not be expected to contain repayment obligations.

The ATO has indicated in an interim decision impact statement that it has sought special leave to appeal this Full Federal Court decision, which due to it being unanimous indicates some difficulty in successfully appealing the decision.

But this application leaves open the possibility of some embellishment to this reasoning to consider later this year.