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Section 99B – TD 2024/D2 – you can’t always get what you need

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The Rolling Stones sang:

You can’t always get what you want

But if you try sometimes you just might find

You get what you need

For some time commentators, including ourselves, have been saying what we want with section 99B of the Income Tax Assessment Act 1936 is legislative reform.

Section 99B was introduced in response to Union Fidelity Trustee Co of Australia Ltd v FCT [1969] HCA 36 which held that the trust taxation rules in Division 6 did not capture foreign source income.

As the explanatory memorandum to the Bill which introduced section 99B said, section 99B “will usually apply where accumulated foreign income of a non-resident trust estate is distributed to a resident beneficiary”.

This leads to the main myth about section 99B, that is, it applies only to foreign trusts. Wrong, there is nothing in the words of section 99B to limit its operation to foreign trusts, as recognised in the consultation paper Modernising the taxation of trust income – options for reform in 2011:

“One of the most significant concerns is about the extent to which it [s 99B] can apply to distributions from resident trusts.”

The potential breadth of the provision, and how it interacts with other provisions of the Income Tax Assessment Acts introduced after section 99B - particularly the capital gains tax (CGT) rules – is uncertain and, arguably, section 99B is not fit for purpose without legislative amendment.

Given there seems little impetus for legislative change, what advisors have been saying they need is Australian Taxation Office (ATO) guidance on its interpretation of section 99B and how the ATO will apply its compliance resources to the provision. Advisors also called for the ATO to ensure it interpreted section 99B in a manner that ensures harmonious operation of the Income Tax Assessment Acts as a whole.

On 31 July 2024, the ATO stepped up and released Draft Taxation Determination TD 2024/D2 (Draft TD) and Draft Practical Compliance Guideline PCG 2024/D1 (Draft PCG). Has the ATO given advisors what they need?

While the ATO has ensured a harmonious operation of the Acts in some respects, in other respects, the ATO’s interpretation may have unintended consequences, particularly in relation to factual situations not dealt with in the Draft TD.

This article will discuss the Draft TD while a forthcoming article will discuss the Draft PCG. But first, a refresher on section 99B.

What does section 99B catch?

In short, any amount, being property of a trust estate, which is paid to (or applied for the benefit of) a beneficiary, who is an Australian resident at any time during the income year, is included in assessable income pursuant to subsection 99B(1). However, section 99B will not apply where one of the following carve-outs under subsection 99B(2) applies:

  1. an amount represents corpus of the trust, except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by “a taxpayer being a resident”, would have been included in the assessable income of that taxpayer (paragraph 99B(2)(a));

  2. an amount that, if it had been derived by “a taxpayer being a resident”, would not have been included in the assessable income of that taxpayer (paragraph 99B(2)(b));

  3. an amount included in the assessable income of the beneficiary under section 97;

  4. an amount is in respect of which a trustee is assessed and liable to pay tax under sections 98, 99 or 99A;

  5. an amount that is non-assessable non-exempt income of the beneficiary under section 802-17 (conduit foreign income); or

  6. an amount included in the assessable income of a taxpayer under section 102AAZD (transferor trust rules).

The difficulty that this creates for taxpayers and their advisers is, once the elements of subsection 99B(1) are established, the taxpayer has the onus of establishing that one of the carve-outs in subsection 99B(2) applies in order to reduce (or eliminate) the amount included in assessable income under subsection 99B(1).

A sting in the tail is that the Australian beneficiary may also be liable to pay an interest charge on the amount assessable under section 99B(1) back to the time when the income representing the amount was derived by the trustee.  

What does the Draft TD say?

Paragraphs 99B(2)(a) and 99B(2)(b) exclude certain amounts of trust property paid to, or applied for the benefit of, resident beneficiaries from being assessed under subsection 99B(1) and depend upon specific tests, that the ATO refers to in the Draft TD as the “hypothetical resident taxpayer tests”.

The ATO views in the Draft TD on applying the hypothetical resident taxpayer tests are:

  1. the only characteristic of the hypothetical taxpayer is that they are an Australian resident;

  2. to determine whether an amount would be assessed in the hands of the hypothetical taxpayer, it is necessary to consider the circumstances that gave rise to the relevant amount in the hands of the trustee; and

  3. the ultimate source of the amount paid or applied to the beneficiary is also taken into account in determining whether it is 'attributable to' amounts which would be assessed in the hands of a hypothetical resident taxpayer for the purposes of paragraph 99B(2)(a) or whether an amount 'represents' an amount that would not have been assessable if derived by the hypothetical resident taxpayer for the purposes of paragraph 99B(2)(b).

The first point is unsurprising and is unchanged from the ATO view in Taxation Determination TD 2017/24 (TD 2017/24) which, together with its compendium, are useful when read in conjunction with the Draft TD.

The ATO also says, confusingly, that corpus “refers to trust capital or the assets of the trust as distinct from trust income.”

The Draft TD includes six examples to illustrate aspects of its views on the hypothetical resident taxpayer:

  1. Example 1 (CGT asset acquired before 20 September 1985): a capital gain from a pre-CGT asset would not be included in the assessable income of the hypothetical taxpayer meaning that no part of a pre-CGT capital gain would be included in assessable income under subsection 99B(1);

  2. Example 2 (distribution from a non-resident deceased estate): this implies, but is unclear, that the corpus of a deceased estate of a foreign resident is equal to the cost base determined under Division 128 of the assets comprising the deceased estate;

  3. Example 3 (CGT discount not available to hypothetical taxpayer): the CGT discount cannot be taken into account to reduce the amount which may be included in the assessable income of the hypothetical taxpayer (unchanged from the view in TD 2017/24 although that TD also said that capital losses cannot reduce the amount included under section 99B whereas the Draft TD is silent on that point);

  4. Example 4 (circumstances of derivation):  the trustee’s acquisition date, cost base, and capital proceeds are taken into account in determining the amount – the excess of capital proceeds over cost base – included in assessable income under subsection 99B(1);

  5. Example 5 (settled sums and gifted assets): the cost base (under Divisions 110 and 112) of settled sums and gifted assets will be the market value of those assets on the date of acquisition by the trust; and

  6. Example 6 (capital asset acquired using interest income): when capital assets are acquired with accumulated income, in determining whether an amount received by a beneficiary represents, or is attributable to, an amount which would be assessed to a hypothetical taxpayer, the source of the distribution – that is, via tracing – needs to be identified.

When finalised, the ATO propose that the determination apply both before and after its date of issue. Submissions on the Draft TD are due by 28 August 2024.

Does the Draft TD give advisors what they need?

In short, no.

Advisors will welcome Example 1 and the other Examples could, if clarified when the determination is finalised, help in applying the exclusions in paragraphs 99B(2)(a) and 99B(2)(b). The ATO view on corpus adds little.

The Draft TD, and the Draft PCG, do not address many other questions advisors have in applying section 99B, for example:

  1. the application to Australian trusts (other than redomiciled trusts);

  2. amounts distributed from the revaluation of assets;

  3. non-assessable non-exempt amounts other than under section 802-17, for example non-assessable non-exempt amounts under Subdivisions 152-B, 152-C, and 152-D; and

  4. capital gains and CGT discounts, including the small business concessions, not included in assessable income under section 97 due to the operation of Subdivision 6E or otherwise not assessed under sections 97, 98, 99 or 99A.

That said, given the scope of section 99B, it could be a case of “be careful of what you wish for” if the ATO issued a Determination or Ruling on matters such as these. Guidance – such as a practical compliance guideline – on how the ATO might apply its compliance resources would be welcomed. It is what advisor’s need.

The Draft PCG, that we will discuss in a forthcoming article, is the right type of product. Unfortunately, the Draft PCG’s scope does not extend far enough.

Conclusion

While we welcome the ATO guidance on section 99B, it is not what we want – section 99B requires legislative amendment.

Nor is it what we need.  In the absence of legislative amendment, advisors need greater clarity on technical aspects. For example, what is corpus, and how do the other paragraphs in subsection 99B(2) apply given the ATO's interpretation of paragraphs 99B(2)(a) and 99B(2)(b) as set out in the in the Draft TD. And, importantly, how will the ATO apply its compliance resources to resident trusts. 

Neil Brydges
Principal | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au

Kaitilin Lowdon
Principal Lawyer
M +61 402 859 214 | T+61 3 9611 0120
E: klowdon@sladen.com.au

Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327 |  T +61 3 9611 0105
E: dsmedley@sladen.com.au

Edward Hennebry
Senior Associate
T +61 3 9611 0113 | M +61 428 439 730
E ehennebry@sladen.com.au

Neil Brydges