Our international tax series discusses tax issues relating to non-resident beneficiaries of Australian trusts and resident beneficiaries of foreign trusts.
This is the third article of the series and will discuss the capital gains tax (CGT) consequences of a trust changing tax residency and the taxation of capital gains attributed to non-resident beneficiaries.
All references are to the Income Tax Assessment Act 1997 and Income Tax Assessment Act 1936 as relevant.
When a trust ceases to be a resident
Capital gains consequences may arise where a resident trust becomes a non-resident trust for CGT purposes.
CGT event I2 happens if a trust ceases to be “a resident trust for CGT purposes”. For CGT purposes, the residency definition differs for unit and non-unit trusts (including fixed or discretionary trusts).
A trust is a “resident trust for CGT purposes” for an income year if, at any time during the income year:
for a non-unitised trust, the trustee is an Australian resident, or the central management and control of the trust is in Australia; or
for a unit trust, one of the requirements in column 2 and one of the requirements in column 3 of this table are satisfied.
Requirements for unit trust
One of these requirements is satisfied
And also one of these
Any property of the trust is situated in Australia
The central management and control of the trust is in Australia
The trust carries on a * business in Australia
Australian residents held more than 50% of the beneficial interests in the income or property of the trust
The phrase “at any time” is highlighted above to emphasise that if the trust meets the definition above at any part of the income year, it will be a resident trust for CGT purposes for the whole income year.
The Australian Taxation Office (ATO) in Tax Determination TD 1999/83 states that:
A trust stops being a 'resident trust for CGT purposes' at the time during an income year when the requirements of the definition of that expression are no longer satisfied. For a trust that is not a unit trust, for example, it stops being a 'resident trust for CGT purposes' when the trustee stops being an Australian resident and the central management and control of the trust is not in Australia.
The practical effect of CGT event I2 happening is that the trustee must calculate whether a capital gain or loss is made for each CGT asset that it owns in its capacity as trustee of the trust just before the trust ceased its residency.
The gain (or loss) is the difference between the market value of the asset at the time Australian residency ends and the cost base of that asset. If a trust holds many CGT assets, this will be an extensive exercise.
CGT assets excluded from CGT event I2 include assets bought before 20 September 1985 and certain types of taxable Australian Property (TAP). For the purposes of CGT event I2, excluded TAP is:
· Australian real property;
· a CGT asset used at any time in carrying on a business through an Australia permanent established; or
· an option or right to acquire any of the above.
When an individual or company ceases to be a resident
For completeness, a similar outcome occurs when an individual or company ceases to be an Australian tax resident. That is, CGT event I1 happens when the individual or company ceases to be an Australian resident. Under CGT event I1, the individual or company needs to calculate a capital gain or capital loss for each CGT asset that it owned at the time it ceased to be a tax resident.
The gain (or loss) is the difference between the market value of the asset at the time Australian residency ends and the cost base of that asset.
Assets bought before 20 September 1985 and certain TAP (see above) are excluded from the CGT event I1.
In addition, individuals can choose to disregard the capital gain or loss on ceasing residency with any capital gain or loss occurring when another CGT event happens to the asset.
Unfortunately, trusts (and companies) do not have a similar choice and unlike an individual, trusts and companies cannot choose to disregard a capital gain or loss from the CGT assets covered by CGT event I1.
Taxation of capital gains for non-resident beneficiaries of Australian trusts
Streaming of capital gains
Subdivision 115-C (in conjunction with Division 6E) provides that capital gains can be streamed to beneficiaries including foreign resident beneficiaries on condition that the trust deed allows for the streaming provisions to apply.
Division 6E modifies the calculation of the net income of the trust and the income of the trust to exclude franked dividends and capital gains which are subject to tax under Subdivision 207-B (franked dividends) and 115-C (capital gains).
Where beneficiaries are “specifically entitled” (that is, streamed) to franked dividends or capital gains then the beneficiary is subject to tax on those amounts under Subdivisions 207-B (franked dividends) or 115-C (capital gains).
Where franked dividends or capital gains are not streamed, for example where a beneficiary is presently entitled to those items, Subdivisions 207-B or 115-C apply but the tax outcome for the beneficiary and the trust is the same as if the beneficiary and trustee had been taxed on a proportionate basis under Division 6 instead.
When a trust distribution includes a component for a capital gain, regardless of whether it is streamed or not, are non-resident beneficiaries subject to Australian tax on that amount?
Under Division 855, a non-resident can disregard a capital gain or loss from a CGT event, if the CGT event happens in relation to a CGT asset that is not TAP.
Expressed differently, unless the CGT asset is TAP, a non-resident should not pay any CGT in Australia. Conversely, if the capital gain relates to TAP the non-resident beneficiary will be subject to Australian tax on the net capital gain.
Importantly, the CGT treatment differs between fixed trusts and discretionary trusts. Where the trust is a fixed trust, section 855-40 should apply to disregard the capital gain or loss if the asset is not TAP.
Discretionary trusts have a different treatment. The ATO is of the view that Division 855 does not disregard a capital gain derived from a non-TAP asset by an Australian non-fixed (discretionary) trust.
The ATO view means that capital gains of a discretionary trust, to which a non-resident beneficiary is specifically or presently entitled, whether derived from TAP or non-TAP is subject to tax in Australia.
No CGT discount for non-resident beneficiaries
Non-residents are not entitled to the CGT discount (typically 50%) on Australian assets bought after 8 May 2012. If the capital gain occurred prior to this date, the CGT discount applies. For assets bought prior to 8 May 2012 and where a CGT event happens after 8 May 2012, the discount is apportioned.
Trustees should be aware of their own and their beneficiaries tax obligations. Their tax obligations and the application of the CGT discount differ where a beneficiary is:
non-resident for the whole year;
non-resident at year end but resident for part of the year; or
resident at year-end but non-resident for part of the year.
This is the third article of our international tax series. The next article will consider the tax consequences for non-resident beneficiaries of deceased estates.
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