Tag: beneficiaries

IRC 674

Posted on by Peter Harper

After covering Section 675 of the Internal Revenue Code, or IRC, in our previous article, let’s go into the next section that clients want to learn more about: IRC Section 674.

What is a Grantor Trust?

Before we begin, let’s start with a simple understanding of what a grantor trust is before going into how financial processes such as IRC can apply to it. Every grantor trust begins with a grantor, defined as any person who either creates a trust, i.e. the settlor, or directly or indirectly makes an excessive property transfer to a trust. A grantor is, therefore, the person with administrative powers to make a gratuitous transfer of their trust property, whether it is the grantor’s estate, trust assets, items of income, or capital gains from an investment. 

Hence, a grantor trust is a trust where the grantor has control over the trust to the extent that they will be recognized as the owner/taxpayer of all or any part of the trust for possible federal income tax purposes. That way, they are directly taxed on the income and any other tax attributes belonging to the trust as if it did not exist. The IRS disregards the trust for federal income tax purposes and treats the grantor/primary taxpayer as the deemed owner of the trust assets and trust property included. 

What Grantor Trusts Are Used For

Grantor trusts have mainly been used for estate and gift planning purposes to avoid an income tax, gift tax, or estate tax, as well as to best reg trust assets according to the grantor’s wishes. These trusts are sometimes called Intentionally Defective Grantor Trusts (IDGT). 

See below for some of the grantor trust methods used by estate planners to reduce and minimize taxes:

    • In the case of a revocable grantor trust, probate can be avoided;
    • However, an irrevocable trust cannot be changed unless given consent from the beneficiaries involved. The purpose is to reduce or eliminate taxes after the grantor passes, though some, including gift tax if a gift exceeds $15,000;
    • As a “leveraging” tool to grow the impact of giving to designated donees such as using a Grantor Retained Annuity Trust (GRAT);
    • As a protection structure for trust assets, providing adequate security for particular business interests such as possible creditors or claimants (if the circumstances involve business succession planning).
Funding The Grantor Trust – Who is the Grantor? 

Essentially, a trust’s grantor is that trust’s settlor (or ‘notional settlor’). They are defined as any person who either creates a trust, i.e., the settlor, or directly or indirectly will make a gratuitous transfer of a trust property or items of income (grantor’s estate, capital gains, etc.) to a trust and is regarded as the primary funder.

Provisions Triggering Grantor Trust Status

The rules within the Internal Revenue Code’s Subchapter J, Subpart E govern when the trust income is taxable under a grantor trust status to the grantor or another person who is deemed to be the substantial owner of the trust (and, therefore, the primary taxpayer). This rule was designed primarily for federal income tax purposes instead of the trust itself or its beneficiary. Thus, they are granted administrative powers over the trust when the said grantor trust status is recognized and finalized by the IRS.

These provisions for grantor trust status are also contained in IRC 671-679:

  • IRC 671 – Sets forth the overall principle that if the grantor is recognized as the owner of the trust, then they must include the trust’s income when calculating their taxable income and income tax;
  • IRC 672 – Sets forth the definitions and rules when applying the grantor trust provisions to a subordinate party;
  • IRC 673 – 678 sets out the rules to decide when the trust’s existence can be ignored for federal income tax purposes, including if a grantor can reacquire corpus if they substitute the trust corpus with property or asset of similar value, adequate interest, and adequate security;
  • IRC 679 – sets out the rules to determine when a foreign trust will be regarded under grantor trust status with or without income tax applied.

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IRC Section 674 – Power to Control Beneficial Enjoyment

Now that we understand the general provisions for a grantor trust and what may trigger a status, let’s look more closely at what Section 674 can do for you.

IRC Section 674 General Rule

IRC §674(a) puts forward the general rule for power to control beneficial enjoyment that the grantor will be recognized as the owner of any trust portion concerning the corpus or income’s beneficial enjoyment. Therefore, they are liable to a power of disposition used by either the grantor or a nonadverse party (or, in unique cases, both) without any adverse party’s consent or approval.

Exceptions for Certain Powers

This particular section of the Internal Revenue Code allows certain powers not only for the grantor but for a subordinate party and or the items of interest within a trust, such as beneficiaries, the will, income, and corpus:

Power to Apply Income to Support of a Dependent

Any power to distribute trust income to support a beneficiary the grantor has been deemed or deems themselves legally obligated to support does not automatically trigger the trust as a grantor trust unless it is used for other beneficial interest purposes. This exception applies even if the grantor or the grantor’s spouse holds this power. Support for a beneficiary that may not be included includes premiums and gifts over $15,000, which can be subject to a gift tax. However, the grantor may be exempt from income tax under IRC 677(b).

Power Affecting Beneficial Enjoyment Only After Occurrence of Event

A grantor won’t be recognized as the owner of any portion of the trust established by a such power to affect the trust’s beneficial enjoyment if that power is not exercisable for an extended period of time. Such a period of time should be long enough that, had the postponed power been a reversionary interest stipulated in IRC 673, it would not have triggered grantor trust status (most common periods used are by taxable year). Therefore, control over beneficial enjoyment will not trigger a grantor trust status if the grantor can’t exert it for a period of time. If the power had become a reversionary interest at any point, the trust should have a value of less than 5%. If this happens and to decide if this criterion was met, it is mandatory to determine the prevailing and adequate interest rate and check the applicable IRS Tables under the treasury regulations for confirmation. However, after the expiration of a stated time has occurred, and the power instantly becomes exercisable, the grantor will be recognized as the owner only if they have not relinquished the power earlier. 

Power Exercisable Only by Will

A grantor shall not be recognized as a trust’s owner based on a power to alter beneficial interest and enjoyment if they possess a power exercisable only by a will. The only exception is for a power of appointment to accumulated income of the trust by the will if the trust allows the grantor or a nonadverse party to provide mandatory or discretionary accumulation of trust income.

Power to Allocate Among Charitable Beneficiaries

A grantor shall not be recognized as the owner of any portion belonging to a trust if they have the power to decide the beneficial enjoyment of the trust income or trust corpus when the income or corpus is irrevocably payable for a philanthropic purpose by one or more charitable beneficiaries as defined in IRC §170(c). 

Power to Distribute Corpus

A grantor shall not be recognized as the owner of a trust based on if they have the power to distribute corpus to beneficiaries of the trust. In contrast, the grantor’s power to dispense the corpus has been subjected to a reasonably definite standard outlined in the trust instrument. 

Powers of Distribution Primarily Affecting Only One Beneficiary

The principal and income must be paid to the said beneficiary (or such beneficiary’s estate and any estate tax attached) or to appointees designated by the beneficiary.

Powers of Distribution Affecting More Than One Beneficiary

The principal and income are distributed to such beneficiaries following their respective shares.

Power to Withhold Income Temporarily

A grantor shall not be recognized as the owner of any portion belonging to a trust if they have the power to distribute or apply the trust income to any present beneficiary or to accumulate the trust income if the accrued income and income tax must be paid eventually to one of the following individuals:

      • The beneficiary whom the income was withheld from;
      • The beneficiary’s estate and any estate tax attached;
      • The beneficiary’s designatees;
      • The present income beneficiaries are within one or multiple shares fixed by the trust instrument. 
Power to Withhold Income During Disability of a Beneficiary

The grantor shall not be recognized as the trust’s owner merely because they (or a nonadverse party) hold power to distribute income and accumulate and reg income before adding it to a principal during a period of time in which the income beneficiary possesses a legal disability. Furthermore, any income withheld during such periods does not need to be ultimately payable to the income beneficiary or to their estate and any estate tax attached. It may be payable to whomever the trust declares as the recipient of the trust principal.

Power to Allocate Between Corpus and Income

IRC §674(c) catalogs powers that shall not trigger a grantor trust status if they are to or are being held by an independent trustee, who may be given relatively broad powers over beneficial interest and enjoyment without triggering the grantor to be treated as owner. 

Some examples are as listed:

      • Power to divide and provide income amongst particular income beneficiaries;
      • Power to build accumulated income without needing to pay the income to a beneficiary whom it was withheld from at any time;
      • Power to invade corpus for particular beneficiaries (including persons who aren’t income beneficiaries).
Exception for Certain Powers of Independent Trustees

An independent trustee can be given broad powers over beneficial enjoyment without triggering owner recognition towards the grantor unless they cannot due to nonfiduciary capacity. Examples are:

    • Power over diving and sharing income amongst particular income beneficiaries;
    • Power to build accumulated income without needing to pay the income to a beneficiary whom it was withheld from at any time;
    • Power to invade corpus for particular beneficiaries (including persons who aren’t income beneficiaries).
Power to Allocate Income If Limited by a Standard

The grantor rules mustn’t be applied to a power solely exercisable (without the consent of any adverse party) by a trustee or trustees who are not the grantor or their spouse (who must still be living with the said grantor. Power to distribute, accumulate, or apportion income for or to one or more beneficiaries, or from, within, or to a class of beneficiaries (even if the conditions of Subsection (b), paragraphs (6) or (7) are satisfied), is restricted by a reasonably definite and external standard that is presented by the trust instrument. However, a power cannot fall within the powers described above if any person uses it to add to two or more beneficiaries or a class of beneficiaries to receive the corpus or income. One exception would be where such an action is to provide for after the adoption or birth of children.

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Commonly Used Exceptions by Practitioners

The above powers and exemptions are pursuant to understanding the benefits and setbacks IRC 674 can provide for individuals surrounding a trust. However, exceptions can affect how much an individual within a specific role can receive their distribution, whether because of limitations due to income tax purposes, the number of roles involved, or if a role is deemed a nonadverse party possesses nonfiduciary capacity within the trust. 

Hems

The trustee’s power to make distributions are restricted because of an understandable and absolute standard like health, maintenance, support, or education (HEMS) (IRC Section 674(b)(5)(A));  

Single Beneficiary

There is only one current beneficiary belonging to a trust, and the principal and income must be paid to the said beneficiary (or such beneficiary’s estate and any estate tax attached to it) or to any appointees that the beneficiary has decided (IRC Section 674(b)(6)); 

Pro Rata Shares

The trust possesses two or more beneficiaries, but the principal and income have been distributed to those said beneficiaries based on their relevant shares (IRC Section 674(b)(5)(B));

No Real Control

The grantor nor the grantor’s spouse do not serve as the trust trustee, and less than one-half of trustees are subordinate or related to the grantor (IRC Section 674(c));

Identity of Trustees

Careful consideration should be taken by advisors and estate planners when drafting the trust deed for clients when it comes to rules for any portion of the trust. The central point of this article isn’t just an analysis of typical powers around a grantor trust status. Still, it is also a careful exploration of the identity of the trustees. For instance, if the grantor’s spouse has the co-trustee role, the trust will trigger and become a grantor trust unless an adverse party is a co-trustee. While grantor trust status has many taxable advantages and grants the power of appointment, under the latest tax regime, taxpayers may increasingly prefer to have non-grantor trusts. Careful planning is critical in preventing inadvertent and potentially harmful income tax consequences.

Think that IRC 674 may be for you? Speak with one of our consultants to learn how to proceed forward.

Shaun Eastman

Peter Harper

IRC 675

Posted on by Peter Harper

IRC 675

Following our previous articles on grantor trusts, we will cover the first of the three main IRCs: Section 675.

What is an IRC Section 675?

IRC 675 of the Internal Revenue Code, or IRC, involves, under treasury guidelines, the administrative powers of a foreign grantor trust. To be more precise, it states that the grantor of any foreign trust shall be treated as the owner of the foreign trust. This is only true if, under the instruments’ terms of the trust, that specific administrative control can be exercised primarily for the benefit of the grantor instead of the benefit of the beneficiaries. 

Additionally, suppose the owner of the foreign trust has the power to amend the administrative provisions of the trust instrument, which would result in him, her, or they becoming the trust owner. If that were to happen, the grantor would be treated as the owner of the trust. 

Now that we know the basic understanding of what IRC 675 is, let’s explain its various powers, such as what may cause a foreign trust to become a grantor trust, who the owner of a grantor trust is, and how to toggle grantor trust status. 

Sec. 675’s Administrative Powers

The administrative powers under IRC 675 include several different authorities related to administrative duties; notable examples to take note of include voting powers and directing the investment of trust funds, borrowing funds, and the ability to deal with trust income and funds for less than adequate consideration, as well as not having sufficient interest or security. 

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General Powers of Administration

When we refer to a general power of administration, this will commonly include the following: 

  • The power to vote or direct voting of a trust’s stock or other securities, where holdings belonging to the grantor or the trust are significantly essential from the viewpoint of voting control. 
  • The power to control the funds’ investment by directing or vetoing proposed any trust investment or reinvestment. Of course, this is only to the extent that the funds consist of corporation stocks or securities, in which the grantor and trust’s holdings are significant from a voting control viewpoint.
  • The power to reacquire the trust corpus, also known as the sum of money or trust property set aside to produce income of the trust for beneficiaries by substituting other property of an equivalent value. 

To summarize our three points above, the perspective through which we need to assess whether a grantor has these powers has to do with controlling funds and assets within a trust. 

Borrowing of the Trust Funds

Another power a grantor can possess is the ability to borrow trust funds. For example, we should consider a scenario where the owner can directly or indirectly borrow the corpus or trust’s income and wouldn’t be expected to completely repay any loan, including any interest, before the beginning of the taxable year.

Power to Deal for Less than Adequate and Full Consideration

This particular power is exercisable by the grantor in a nonfiduciary capacity without the approval or consent of another party. It enables the grantor to purchase, exchange, or otherwise deal with or dispose of the corpus or the trust’s income for less than adequate consideration in money or its monetary worth. Specifically, it could allow a grantor to remove assets from the trust for a small amount of deliberation, thus resulting in the grantor being able to terminate that trust completely. 

Power to Borrow Without Adequate Interest or Security

This power enables the grantor to borrow the corpus or income, directly or indirectly, without sufficient interest or adequate interest or security except where a trustee, if under a general lending power, is authorized to create loans for any person without regard to said adequate interest or security.

What Are The Grantor Trust Powers?

To summarize the definitions and examples above, here are the most common and vital powers a grantor can have over a trust and its process:

  • To change or add the beneficiaries of the trust. 
  • To borrow from the trust or a portion of the trust without adequate security. 
  • To use income from the trust in order to pay life insurance premiums.
  • To change the trust’s composition by substituting assets of equal value.

What Causes Grantor Trust Status?

Now that we know several types of powers a grantor can have, let’s look into what causes a trust to be considered a grantor trust. There are various criteria, but among the most relevant are the following:

  • IRC § 673(a): the grantor maintains a reversionary interest, meaning that the grantor holds a ‘reversionary interest’ in a trust greater than 5% of the trust principal or income.
  • IRC § 674: the grantor can control the ‘beneficial enjoyment’ of trust income or assets.
  • IRC § 675: the grantor maintains administrative control over the trust that can be exercised for his benefit rather than for the trust’s beneficiaries.
  • IRC § 676: the trust allows the grantor (or a nonadverse party) to revoke any part belonging to a trust and reclaim or take back the trust’s assets later. 
  • IRC § 677(a): if the trust distributes income to the grantor, the trust may be regarded as a grantor trust.
    • The grantor will also be treated as the trust’s owner if its income is, or in the owner’s direction, distributed to the owner or the grantor’s spouse. It will also accumulate for any future distribution to the grantor or the grantor’s spouse, or to be applied to payment of insurance policies on either the life of the grantor or the grantor’s spouse.

Additionally, it’s crucial to note that a grantor trust is considered a disregarded entity by the IRS for federal income tax purposes. This will mean that the grantor’s income tax return will include any taxable income or deduction earned by that trust. For the taxpayer’s convenience, the IRS will allow a grantor trust to employ the grantor’s Social Security number (SSN) rather than having a separate tax ID number (TIN).

Also, when discussing what causes grantor trust status, a vital topic to always consider is what grantor trusts’ advantages and disadvantages are. The primary benefit of estate planning is the potential to preserve wealth while minimizing taxes for one’s beneficiaries. That way, beneficiaries will have a lowered tax rate and better prioritization of any estate tax inclusion that may be available. However, a major concern is an assumption that the grantor, as a taxpayer, will have the funds to pay income tax obligations on trust assets and possible interest for the income of the trust during their lifetime. These implications for income tax purposes may cause a grantor to toggle grantor trust status so that the trust is no longer treated as a grantor trust (discussed later in this article). Further, the gift tax is also a concern, so the taxpayer must consider gift tax considerations and tax consequences when creating the trust. 

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Who Is Considered the Owner of a Grantor Trust?

The grantor, also known as the owner, settlor, or trustor, is typically the person who creates the trust and contributes property (such as real estate), other funds, or even trust instruments, such as life insurance, to that trust. The trust property and the owner’s funds become part of the trust corpus (in other words, the trust’s assets). 

Personal or familial trusts often have only one grantor, but can, along with business trusts, have two or more. For example, if more than one person had funded a grantor trust, each one will be treated as a grantor in proportion to the cash or property value they transferred to. 

Suppose a resident of a foreign country is treated as the owner of the trust under the grantor trust rules. In contrast, that specific trust has a domestic civilian or resident as a beneficiary. In that case, the beneficiary will be treated as the trust’s grantor to the extent that the beneficiary made gifts (directly or indirectly) to the foreign owner, irrespective of gift tax applying. 

Bear in mind that the grantor is the person who retains the power to control or direct the trust’s income or assets, and is allowed full discretionary protection as the grantor. It’s crucial to understand, especially when dealing with a foreign trust and the income tax consequences surrounding this instrument. Moreover, the owner can also be any person who creates a trust directly or indirectly and makes a gratuitous property transfer to a trust.

How Do I Toggle Grantor Trust Status?

One common question received when looking at IRC 675 is how to toggle a grantor trust status so that the trust will no longer be treated as a grantor trust.. 

Why would a grantor want to do this? Given that there are implications for income tax purposes of a foreign grantor trust, the grantor may deem it too burdensome to be liable for tax on the income attributable to the trust, year after year. Other common motives include keeping up with the tax rate that comes with their specific grantor trust, or for their own discretionary reasons. Therefore, to terminate the grantor trust status or toggle it off, the powers we explored above (which are often used to create the grantor trust status) must be released or terminated. 

How is this done? One possibility this can be accomplished is by transferring power to a specific trustee or a third party, such as a trust protector.

Similarly, to turn the grantor trust status back on after it has been released, the powers released previously must be brought back and given to the previous grantor. This can be done by amending the trust instrument. However, it’s important to remember that a grantor or trustee should never approach this toggling of status flippantly and that professional advice and assistance should be engaged when going down this path. 

New Responsibilities With Incorporation

If the grantor trust status terminates during the grantor’s lifetime, and the trust ceases to be a grantor trust, then the grantor is deemed to have transferred the assets to the trust at that time for federal income tax purposes. The question then becomes, does the grantor recognize a taxable transaction or a gain? Assume the trust has non-recourse liabilities to a third party secured by the trust’s assets. If that is true, the grantor will recognize the gain because the grantor will be deemed to have transferred the secured assets to the trust in exchange for a release of liability. In another scenario, the grantor may also recognize capital gain where the trust owes the debt to the grantor because the trust can be received the secured asset from the grantor in exchange for the promissory note to the grantor as of the date that the grantor trust status terminated. However, based on numerous court cases and tax law examples, there appears to be no gain recognized by either the trust or the grantor’s estate at the grantor’s death for income tax purposes. 

We will be discussing more on the responsibilities within incorporation in later articles, such as gift tax implications, estate tax inclusion, and creating an irrevocable trust, and where the trust deed is drafted to trigger a certain status intentionally (such as an IDGT, which is an irrevocable trust set up by the owner for this particular purpose).  

Speak with one of our consultants to see how IRC 675 can help your financial case.

Arin Vahanian

Peter Harper

US-AU DTA: Article 7 – Business Profits

Posted on by Peter Harper

INTRODUCTION

Covid has changed the way business is done globally. Two of the most common changes are 

– Remote working (Employee sitting in Australia could be working for an employer in the US); and

– The increase in e-commerce businesses and being able to grow and expand these businesses globally without actually leaving the house. 

That being said, have you ever as an employer considered what the potential tax implications could be for the company by having employees working remotely?  

And does your e-commerce business create a permanent establishment in another country perhaps? 

Make sure you have taken proper steps to mitigate any unnecessary tax implications due to the ‘new norm’.

Article 7 is one of the more complex and technical articles in the DTA as it has various components to consider. However, I will try and provide a brief summary of its interpretation.

The first overriding principle of double taxation treaties is that a company resident in one country will not be taxed on its business income in the other State unless it carries on that business in the other country through a Permanent Establishment (PE) situated in that country.

The second principle is that the taxation right of the State where the PE is situated does not extend to income that is not attributable to the PE. The interpretation of these principles has differed from country to country. Some countries have pursued a principle of general force of attraction, which means that all income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable in that country if the beneficiary had a PE there, even though such income was clearly not attributable to that PE. 

In this week’s blog we will have a look at Article 7 of the US/AUS DTA and highlight some key aspects. 

INTERPRETING ARTICLE 7 OF THE DTA – BUSINESS PROFITS

Article 7 sets out the limits of the source state’s taxing rights in relation to business profits. If an enterprise resident in a contracting state has a Permanent Establishment (PE) in the other state through which it carries on business it can be taxable in that other state, as well as the state of residence. The tax is limited in the source state to no more than the profits attributable to the PE. 

Article 7(1) states the basic principle which is that the profits of an Australian enterprise may be taxed in the US only if it carries on business in the US through a permanent establishment and vice versa. In the case of an Australian enterprise, the US can only tax the profits of the enterprise to the extent that they are attributable to the permanent establishment.

It should be noted that dual-resident corporations are excluded from the term “enterprise of one of the Contracting States” by reason of the definition of an Australian or a US corporation contained in Article 3(1)(g) and the definition of residence contained in Article 4.  Such dual-resident corporations are treated as a resident of neither country for convention purposes, and therefor denied the benefit of this article and other provisions in the convention. 

The phrase ‘business profits of an enterprise’ is critical to the operation of Article 7.

The term ‘profits’ is not defined in the agreement and the question arises as to whether it includes profits which are ordinarily regarded as capital in nature or which are not derived from the carrying on of a business.

Article 3(2) of the DTA provides that, unless the context otherwise requires, a reference to profits of a business is a reference to the taxable income of the business. As capital gains are included in taxable income, the section arguably supports the view that Article 7 applies to capital gains. 

The 2006 U.S. Model Treaty Technical Explanation attempts to define business profits more generally in Article 7(1), providing that business profits are ‘income derived from any trade or business’.

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Article 7(2), which is subject to Article 7(3), provides that the profits to be attributed to a permanent establishment are those, which it might be expected to make if it were an independent enterprise engaged in similar activities under similar conditions. The profits must reflect arm’s length prices. For example, the profits of a branch must be calculated as if it were a separate entity distinct from its head office and on the basis that the branch was dealing wholly independently with its head office.

The practical application of Article 7(2) is not as straightforward as it seems. Quite often, a functional analysis needs to be done to ensure that arm’s length principles are applied properly. This includes the proper characterization of the transaction and the commercial risks undertaken by the enterprise.

Article 7(3) states that expenses that are reasonably connected with the profits of the permanent establishment and would have been deductible if the permanent establishment were an independent entity are deductible. Further, these expenses are deductible whether incurred in the Contracting State in which the permanent establishment is situated or elsewhere including executive and general administrative expenses.

Article 7(4) states that no profits are to be attributed to a permanent establishment by reason of mere purchase by that permanent establishment of goods or merchandise for that enterprise. 

Article 7(5) states that unless there is a good and sufficient reason to the contrary, the same method of determining the business profits attributable to a permanent establishment shall be used each year.

Article 7(6) states that where business profits include items of income dealt with in other articles of the Convention the provisions of those other articles override the provisions of this Article. 

Categories of income not specifically included in the definition of business profits are subject to the “overlap” rule of Article 7(6), which provides that a treaty article that governs a specific category of income (for example, the article pertaining to interest or dividends) takes precedence over the business profits article. If the item of income is attributable to a permanent establishment, it may ultimately be taxed under the business profits article anyway, because many of the treaty articles addressing specific categories of income (such as dividends and interest) provide that if the income is attributable to a permanent establishment, it is subject to taxation under the business profits article. 

Article 7(7) allows the ATO and IRS to apply any of its domestic laws to determine a person’s tax liability where the information required to make an appropriate attribution of profits to a permanent establishment is inadequate. 

Article 7(8) provides that nothing in Article 7 prevents each country from applying its domestic law to tax insurance business income provided that such law remains the same (or is modified in only minor respects) since the date the Convention was signed. or will tax the net income of a US trade or business. 

Article 7(9) applies where a fiscally transparent entity, such as a trust, has a permanent establishment in a Contracting State and a resident of the other Contracting State is beneficially entitled to a share of the business profits (beneficial owner).

Where the above requirement is satisfied then the beneficial owner is treated as carrying on a business through the permanent establishment in the Contracting State and therefore its share of the business profits of the fiscally transparent entity are taxable due to Article 7(1). 

For example, if a trust with a US beneficiary carries on a business in Australia through its trustee, and that trustee’s actions rise to the level of a permanent establishment then the US beneficiary will be treated as having a permanent establishment in Australia. This has the consequence that the profits of the trust attributable to the US beneficiary will be treated as business profits subject to Australian tax.

Article 7(9) was introduced at the request of Australia because the trustees of a trust, as the legal owner of the trust property, might be regarded as the only person having a permanent establishment.

CONCLUSION 

This article is probably one of the more difficult articles to comprehend in the DTA. For purposes of this blog, it’s important to know that a source country can’t attribute any business profits in terms of Article 7 if there is no permanent establishment in that source country. 

Our diverse team of International Tax specialists at Asena Advisors, will be able to assist you with applying this article correctly and how to accurately attribute profits to a permanent establishment. 

Shaun Eastman

Peter Harper