The ability of Australians to invest offshore and for Australia to operate as a regional financial centre may be seriously undermined by two new draft Tax Determinations addressing capital gains.

TD 2016/D4 and TD 2016/D5 which were issued on 30 November address the circumstance of capital gains made by the trustees of foreign trusts in respect of assets that are not taxable Australian property (‘TAP’).

Section 855-10 of the Income Tax Assessment Act 1997 provides that a non-resident, or the trustee of a foreign trust for CGT purposes, must disregard a capital gain or capital loss in respect of an asset that is not TAP. The purpose of this provision is to ensure that Australia does not claim universal jurisdiction over capital gains throughout the world.

The position is more complex where there is an Australian beneficiary of the foreign trust. Normally, the net income of any trust is calculated as if the trustee were an Australian resident individual. In this way, foreign source income is allocated to presently entitled Australian beneficiaries regardless of the location of the trust. However, in TD 2016/D4 the Commissioner concludes that when dealing with the capital gains of a trust, s. 855-10 overrides the general residency assumption.

Accordingly, a non-TAP capital gain of a foreign trust is not allocated to beneficiaries in the usual manner, nor is it taxed to the trustee. Instead, the Commissioner concludes, the physical distribution of the capital gain is statutory income under s. 99B.

The ramifications of the treatment are quite profound, and there is a sting in the tail in TD 2016/D5: not only does the Commissioner conclude the physical distribution of the capital gain is statutory income under s. 99B, he also concludes that no CGT discount is available to reduce the s. 99B assessable amount.

Taken in combination, these two conclusions produce a range of adverse outcomes for any person investing offshore through a trust. For example:

  • whereas direct ownership of foreign assets will attract the CGT discount on capital gains for certain taxpayers, an investment through a foreign trust will not. This includes investments by Australian trusts through foreign sub-trusts;
  • similarly, capital gains on direct investments can be offset against capital losses, but s. 99B income cannot;
  • because the non-TAP capital gain will not be allocated to beneficiaries under the ordinary trust provisions, an Australian beneficiary may be taxed under the transferor trust provisions, including an interest charge on subsequent distributions;