The Australian Taxation Office recently released draft Taxation Determinations TD 2019/D6 and TD 2019/D7. The combined effect of the draft Determinations is that capital gains (whether foreign sourced or not) attributed to a foreign resident beneficiary of an Australian resident trust are assessable to that beneficiary, unless the trust is a fixed trust.
The draft Determinations raise important considerations for international tax planning, and demonstrate how the ownership structure of an Australian investment can significantly impact the tax outcome for foreign resident beneficiaries of Australian trusts.
The draft Determinations must be considered in the context of the following principles in the Income Tax Assessment Acts (ITAA) 1936 and 1997:
• the assessable income of a foreign resident includes income derived from Australian sources only, whereas the assessable income of an Australian resident includes income from all sources (sections 6-5 and 6-10 ITAA 1997);
• an Australian resident beneficiary who is presently entitled to a share of the income of the trust, would include so much of the share of the net income of the trust that is attributable to a period when they were not an Australian resident, which is attributable to sources in Australia (section 97(1)(a)(ii) ITAA 1936). The trustee is then liable to be assessed and to pay tax on the net income of the trust that is attributable to that beneficiary (sections 98(2A) and 98(3) ITAA 1936);
• assessable income includes net capital gains (section 102-5(1) ITAA 1997) and when applying the method statement for calculating such gains, a beneficiary is required to gross up their proportionate share of a capital gain attributed to them, in order to apply capital losses and the appropriate discount percentage to the gains (section 115-215 ITAA 1997);
• a foreign resident who directly holds non-taxable Australian property (TAP) and the trustee of a foreign trust holding non-TAP can both disregard a capital gain or capital loss from a CGT event in relation to the non-TAP (see Subdivision 855-A of the ITAA 1997). TAP generally includes direct and indirect interests in Australian real property, mining, quarrying or prospecting rights, CGT assets used in carrying on a business through a permanent establishment in Australia, or options and rights to such assets; and
• a capital gain that a foreign resident beneficiary of an Australian resident trust makes is disregarded where the trust is a “fixed” trust – i.e. one in which the beneficiaries have fixed entitlements to all of the income and capital of the trust (sections 855-40 and 995-1 ITAA 1997).
The draft Determinations
In TD 2019/D6, the ATO states that Subdivision 855-A of the ITAA 1997 does not disregard a capital gain that a foreign resident beneficiary (or temporary resident beneficiary) of an Australian resident non-fixed trust makes because of the inclusion of the gross up under subsection 115-215(3). Once finalized, the TD is to operate retrospectively.
The ATO distinguishes between fixed trusts and non-fixed trusts, stating that a capital gain attributed to a foreign resident beneficiary under subsection 115-215(3) is disregarded only if the trust is an Australian resident fixed trust – the consequence of which is that the foreign resident beneficiary is assessable on capital gains on non-TAP that is distributed by an Australian-resident non-fixed trust.
In TD 2019/D7, the ATO states that the concept of “source” is not relevant:
1. to determining whether an amount of a trust’s capital gain is assessable to a foreign resident beneficiary or trustee; and
2. in relation to a foreign resident beneficiary’s share of TAP gains of a non-resident trust and a trustee’s share of a capital gain.
This is contentious as it was understood previously that a foreign resident beneficiary of an Australian discretionary trust was only taxable in Australia on Australian-sourced income (see section 97(1)(a)(ii) ITAA 1997). However, in TD 2019/D7 the ATO is suggesting that is not the case, and that section 115-220 ITAA 1997 makes the amount drawn from Subdivision 115-C assessable to the trustee under section 98 ITAA 1936, regardless of source.
TD 2019/D7 is intended to apply to capital gains included in the net income of a trust estate for Australian tax years ending 30 June 2020 and onwards.
What does this mean for Australian / international tax planning?
If the draft Determinations are finalized, capital gains (regardless of source) attributed to a foreign resident beneficiary of an Australian resident trust are assessable to that beneficiary unless the trust is a fixed trust. This creates concerns for international tax planning as:
1. the draft Determinations do not address the application of Australia’s double tax agreements (DTAs), creating uncertainty as to how the ATO’s interpretation of the relevant provisions would affect, and be affected by, Australia’s obligations under the DTAs; and
2. as noted in the table below, the tax treatment of gains derived from the disposal of non-TAP assets will vary for a foreign resident, depending on whether the gain is attributable to them:
a) through direct ownership;
b) as a foreign resident beneficiary of a fixed Australian resident trust;
c) as a foreign resident beneficiary of a non-fixed Australian resident trust; or
d) as a foreign resident trust.
Structure CGT Implications
Direct ownership by foreign resident Disregarded (Subdivision 855-A of the ITAA 1997)
Foreign resident beneficiary of a fixed Australian resident trust Disregarded (section 855-40)
Foreign resident beneficiary of a non-fixed Australian resident trust Assessable
Foreign resident trust Disregarded (Subdivision 855-A of the ITAA 1997)
1. Subject to appropriate advice, Australians should review and consider restructuring indirect holdings of non-TAP before leaving Australia, or alternatively:
a. set up foreign structures for holding such property; or
b. return to Australia before a liquidity event occurs.
2. Direct or fixed trust ownership of non-TAP is now preferable to (discretionary) trust ownership in an international setting. The use of fixed (unit) trusts may become more prevalent as an international tax planning tool over direct ownership as it affords asset protection. The use of discretionary trusts in this context could be problematic if capital gains are inadvertently attributed to a foreign resident beneficiary on the basis of a present entitlement to the income of the trust.
For more information, contact:
Senior Tax Advisor
U.S. Australia Tax Desk