Foreign trusts, capital gains, and Australian beneficiaries – ATO finalises view

The Australian Taxation Office (ATO) finalised Tax Determinations TD 2017/23 and TD 2017/24 on 13 December 2017. Released in draft in November 2016, the Determinations consider certain aspects of the interaction of the capital gains provisions and the trust assessing provisions in Division 6 as those provisions apply to foreign trusts. In particular, where a foreign trust makes a capital gain on assets that are not taxable Australian property (TAP) and distributes that gain to Australian beneficiaries.

The view expressed in TD 2017/23 and TD 2017/24 is that where a foreign trust makes a capital gain on the disposal of an asset that is not TAP, and the foreign trust distributes the capital gain to an Australian resident, the Australian resident will not benefit from the CGT discount or capital losses. While this view accords with a technical interpretation of the legislative provisions it may be an unintended policy outcome of the relevant provisions.

TD 2017/23

Section 95 provides that the net income of a trust is calculated on the assumption that the trustee is an Australian resident taxpayer. The trustee then includes income from all sources, whether in or out of Australia, in net income.

Section 855-10 – the ‘statutory source rule’ for capital gains and losses – provides that a foreign resident, or the trustee of a foreign trust for CGT purposes, disregards a capital gain or loss from a CGT event on assets that are not TAP.  The ATO view in TD 2017/23 is that section 855-10, in effect, takes precedence to the assumption under section 95. The effect of the ATO view (that the trustee of a foreign trust disregards a non-TAP capital gain or loss when calculating net income under section 95) is that the capital gain is not assessed to Australian resident beneficiaries under either section 97 (present entitlement) or section 102-5 (specific entitlement).   

The following example included in TD 2017/23 illustrates the application of the ATO view.

The Kiwi Trust was established in New Zealand. The trust is a foreign trust for CGT purposes as the trustee company is incorporated in New Zealand and the trust is centrally managed and controlled there. The trustee can appoint income and capital of the trust to a range of beneficiaries, some of whom are resident in Australia.

The trustee invests in shares in Australian companies that are not 'taxable Australian property'. The trustee sells some of those shares.

As the trust is a foreign trust for CGT purposes and the shares are not 'taxable Australian property', no capital gains or losses from the sale will be reflected in the net income of the trust under section 95. Accordingly, Subdivision 115-C will not treat the trust's beneficiaries (or the trustee) as having capital gains in respect of the sale.

The trustee distributes an amount attributable to the gain to a beneficiary resident in Australia. Section 99B may then apply to include an amount in the beneficiary's assessable income

TD 2017/24

The ATO follows TD 2017/23 with TD 2017/24 which considers the application of section 99B. Section 99B is a ‘provision of last resort’ in Division 6 that taxes beneficiaries of trusts on distributions to the extent those distributions are not corpus or have been taxed under certain other provisions of the Tax Acts. The ATO view in TD 2017/24 is that the distribution of an amount that had its origins in a capital gain from non-TAP of a foreign trust is assessed under section 99B and is not eligible for the CGT discount or offset by capital losses (or carry forward capital losses).

The following example, based on the one in TD 2017/24, illustrates the application of the ATO view.

The Kiwi Trust sells shares in an Australian public company that it had owned for five years. The shares are not taxable Australian property.

The trustee makes $50,000 capital gains from the share sale but these are not relevant in calculating the trust's net income.

The trustee distributes an amount attributable to the capital gains to Erin, a resident of Australia. Erin has a $40,000 net capital loss that she has carried forward.

Erin must include the entire $50,000 in her assessable income under section 99B. She cannot reduce the amount by her net capital loss or by the CGT discount.

Differences to the Drafts

As noted above, TD 2017/23 and TD 2017/24 were released in Draft in November 2016. While the finalised Determinations are materially the same as the Drafts, there are some important differences that have the effect of (somewhat) limiting the view expressed in the Drafts:

  • TD 2017/23: the ATO removes the view that the approach could mean that foreign beneficiaries of a non-fixed trust would be assessable in Australia on their share of gains from non-TAP.
  • TD 2017/24: the ATO adds that section 99B will not bring to tax amounts attributable to capital gains that would be disregarded by any resident taxpayer.

What does it mean?

The ATO view may apply to all foreign trusts (including, for example, foreign listed trusts) and also investments in foreign trusts by Australian trusts. The view will also mean that the tax outcomes for Australian beneficiaries of foreign trusts will be different depending on whether the asset is TAP (CGT discount and capital loss offset) or non-TAP (no CGT discount or capital loss offset). The outcomes will also be different depending on whether an Australian trust or foreign trust makes the distribution.  Taxpayers may ask why?

The Determinations illustrate the complexity of the interaction of Division 6, the CGT provisions, and Division 855. Around the time of the release of the Drafts, the ATO indicated that further guidance on these interactions would be forthcoming. For example, on the distribution of non-TAP capital gains by an Australian trust to foreign beneficiaries. To date, no public guidance appears to have been released (although the ATO indicated in the Compendium for TD 2017/23 that it is developing a Determination on source, Division 6, and Subdivision 115-C).

Division 6 that had its origins in 1915, the CGT provisions from 1985, Division 855 from 2007, and the post-Bamford rewrite of Subdivision 115-C from 2011 are not comfortable bedfellows. Legislative reform appears the only way to resolve the interactions between those provisions – while that would be welcomed – it appears unlikely in the short term.  After all, the changes in 2011 to Subdivision 115-C were labelled the “interim changes to improve the taxation of trust income”.

To discuss this further or for more information please contact:

Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia

Millie Mavrodis
Sladen Legal
T +61 3 9611 0130
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia