Our international tax series discusses Commonwealth tax issues relating to non-resident beneficiaries or non-resident trustees of a trust.
This second article of the series focuses on the income tax consequences for non-resident beneficiaries (including trustee beneficiaries) of an Australian trust. We consider the capital gains consequences in a later article.
Foreign beneficiaries – the basic position
A non-resident is assessable on ordinary and statutory income from all Australian sources or on income on some basis other than having an Australian source (see our first article here).
If a beneficiary of an Australian trust is a non-resident for tax purposes for the full income year, then the beneficiary’s assessable income only includes its share of the net income of the trust attributable to Australian sources.
In contrast, where a beneficiary is an Australian tax resident for part of a year and non-resident for the rest of the year, the assessable income of the beneficiary will include:
the beneficiary’s share of the net income of the trust attributable to when the beneficiary was an Australian resident; and
the beneficiary’s share of the net income of the trust attributable to when:
the beneficiary was a foreign resident; and
to an Australian source.
To help the assessment and collection of taxes in respect of foreign beneficiaries, the trustee of a trust of which a non-resident beneficiary is entitled to a share of the net income of the trust, must lodge a tax return with the Australian Taxation Office (ATO) and pay tax on that share.
The trustee pays tax at the top individual marginal tax rate (excluding Medicare) if the foreign beneficiary is an individual or trust with a 27.5% or 30% rate if the foreign beneficiary is a company depending on whether the company beneficiary is eligible for the lower corporate tax rate or not.
Tax paid by the Australian trustee on behalf of the non-resident beneficiary is not a final tax and is, in effect, a non-final withholding tax. The non-resident beneficiary must file an Australian tax return that includes the income from the Australian trust (together with any other income taxable in Australia). Depending on the taxable income of the non-resident beneficiary, the beneficiary may receive a refund of part (or all) of the tax paid by the trustee.
There are exceptions to this basic position.
Interest, unfranked dividends, and royalties
Withholding tax rules apply to the share of the income of a trust being Australian sourced interest, unfranked dividends, and royalties to which a foreign beneficiary is entitled.
Withholding tax is a final tax. That is, in the absence of other Australian income the beneficiary does not need to lodge an Australian income tax return, nor can the beneficiary receive a refund of all or part of the withheld amount (unless withheld in error).
The trustee must pay the withheld amount to the ATO 21 days after the end of the month in which the derivation of the interest, unfranked dividends, or royalties occurs. Generally, this is when the non-resident beneficiary becomes presently entitled to that income. For example, if the distribution resolution occurs on 30 June, the trustee must pay the amount to the ATO by 21 July.
Withholding tax rates are 30% for unfranked dividends and royalties and 10% for interest.
Australia’s double tax treaties, for countries where Australia has such an agreement, lower these rates if the beneficiary is a resident of a ‘treaty country’.
The withholding rules apply to amounts paid to a foreign resident, be it an individual, company, or trust, by an Australian payer irrespective of whether the payer is a trustee. For example, an Australian bank pays interest to an Australian trust which then withholds 10% when it makes a non-resident beneficiary presently entitled to that interest.
The proportionate approach
A beneficiary is generally liable for tax on the “share” of the net income of the trust. The High Court held in Bamford the meaning of the phrase equates to the proportion of the trust income in respect of which present entitlement exists.
The decision of the Full Federal Court in Greenhatch, and as interpreted by the ATO in its decision impact statement, is that in the absence of specific streaming rules, “the proportionate share of the net income of the trust that is included in assessable income … has no character beyond that inherent in the share of the net income as being a proportionate share of all net income” (emphasis added)
That is, except for franked dividends and capital gains (see below) for which there are specific streaming rules, the taxation rules discussed apply a proportionate approach to all the net income of the trust irrespective of whether the distributions of trust income were of a particular character. An example best illustrates this point.
For example, an Australian trust derives $100 of interest and $150 rent and the trustee decides to distribute the $150 rent to the non-resident beneficiary and $100 interest to the resident beneficiary. If this occurs, the non-resident beneficiary is presently entitled to 60% of the net income of the trust and the resident beneficiary is presently entitled to 40%.
Despite the non-resident individual beneficiary receiving the distribution of rent, that beneficiary is assessed on 60% of both the interest and the rent. This means that $60 (60% * $100) of interest will be subject to withholding taxes and $90 (60% * $150 rent) of the rent will be assessed to the trustee. The trustee will pay tax on the $90 at the highest marginal tax rate.
Streaming – franked dividends and capital gains
Streaming of income is the allocation of specific types of income to specific beneficiaries. For Australian tax purposes, a trust can only stream franked dividends and capital gains effectively. All other amounts, including franked dividends and capital gains that do not follow the procedures for streaming set out in the tax Act, are taxed using the proportionate basis above.
Franked dividends to which a beneficiary is specifically entitled (streamed) or presently entitled (proportionate approach) are not subject to dividend withholding tax.
Even though no Australian dividend withholding tax may apply to franked dividend, a non-resident beneficiary does not get the benefit in its own jurisdiction of the refundable tax offset that a franking credit usually provides to a resident beneficiary.
An Australian trust can also make a beneficiary “specifically entitled” to, that is “stream”, capital gains to non-resident beneficiaries. The interaction of the streaming rules, the capital gains tax discount, and the “statutory source” rules for foreign residents is complex. We discuss the implications of, and interactions between, these rules in the next article of our series.
Conduit foreign income
Despite its name, conduit foreign income is not foreign income, it is Australian income — an unfranked dividend paid by an Australian company– paid to a non-resident.
Broadly, conduit foreign income is tax-exempt foreign income (for example, non-portfolio dividends) received by an Australian company paid as an unfranked dividend to a foreign resident (and declared to be conduit foreign income). The conduit foreign income is non-assessable in Australia in the hands of the foreign resident and is not subject to dividend withholding tax.
The same treatment applies where a non-resident beneficiary of an Australian trust is presently entitled to the share of the net income of a trust that is reasonably attributable to an unfranked dividend declared to be conduit foreign income. That is, the share to which the non-resident beneficiary is presently entitled is non-assessable in Australia and is not subject to dividend withholding tax.
Because conduit foreign income is an unfranked dividend, a trust cannot effectively stream for tax purposes conduit foreign income, with the proportionate approach applying.
As discussed in our last article, the concept of foreign persons, companies, or trusts for State or Territory taxes differs from the federal income tax concepts (above) and between each state and territory. Foreign persons and entities can be liable for surcharges on land transfer duty and land tax and the land tax (absentee owner) surcharge.
Sladen Legal’s State taxes team has written about the State and Territory tests here.
This is the second article of our international tax series. In our next article, we discuss the capital gains tax issues for a non-resident beneficiary and trustees.
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