The ATO has recently released two draft tax determinations – TD 2016/D4 and TD 2016/D5. We expect these will underpin further audit activity around capital distributions from foreign trusts.
The ATO says that certain capital gains made by foreign trusts that are not taxed in Australia under the capital gains tax regime may be taxed in the hands of Australian resident beneficiaries as trust income. This draws on their analysis of section 99B.
The ATO view is that, if section 99B applies, the CGT general discount is not available, and that any capital gains will not be able to be offset against capital losses.
How section 99B works
Section 99B was introduced to stop Australian residents accumulating income in foreign trusts and subsequently distributing that income as untaxed capital in future income years.
However, the provision operates more broadly.
The starting position is that all trust distributions – income or capital – to Australian resident beneficiaries are taxed in their hands subject to specific exclusions in section 99B.
Distributions of capital from foreign trusts to Australian resident beneficiaries can produce alarming results. For example, if a child immigrates to Australia, and subsequently receives a capital distribution from their parents’ overseas trust, the starting point is that the capital amount is included in the child’s assessable income.
The question is then whether the amounts can be excluded, based on the specific exclusions in section 99B(2) which include distributions of:
- corpus of the trust but not if the distribution is attributable to amounts that would have been assessable in Australia if they had been derived by a resident of Australia; and
- amounts that are taxed in Australia under another section – such as distributions of trust income that are taxed under Division 6.
If the overseas trust accumulated income for 30 years, a significant amount of the trust’s capital may be attributable to amounts that would have been assessable income if derived by an Australian resident. If that accumulated capital is distributed to Australian resident beneficiaries, it may be caught by section 99B.
According to the ATO, it also doesn’t matter if the child has only just become an Australian tax resident. The capital distribution would still be caught by section 99B even if the capital was accumulated while all of the family were living overseas. Scary but true.
Then there are the deeming provisions…
Section 99B does not only apply to amounts that are actually distributed. It also applies to amounts ‘applied for the benefit of’ a beneficiary.
Section 99C, which is relevant in determining when an amount has been applied for the benefit of a beneficiary, defines this phrase very broadly and will catch circumstances where, in reality, the amount is not ‘applied for the benefit of’ a beneficiary.
We see many instances where clients have inadvertently triggered a section 99B issue. This is not surprising, as it requires an Australian resident beneficiary to be alert to the issue – before a capital distribution is made to them.
The following examples illustrate the potential problems:
- A taxpayer becomes a resident of Australia and then receives a distribution of capital from a foreign trust. If the amount is attributable to accumulated income, there is a risk it is subject to tax in Australia under section 99B.
- A resident of Australia receives a distribution of capital from a foreign trust following the death of a distant relative. In these cases, it is often hard work proving whether (or the extent to which) the amount is attributable to amounts that would have been assessed in Australia if derived by an Australian resident. The taxpayer has the onus of proving that the amount is a corpus distribution that is excluded undersection 99B(2)(a).
Fortunately, there are solutions…
Onerous legislation sometimes provides opportunities for solutions. For example, beneficiaries might be deemed to receive distributions before they become Australian tax residents. New Zealand citizens residing in Australia may be temporary residents and not subject to income from foreign sources.
There are also practical lessons. It would be prudent to maintain records of the different components of trust corpus (e.g. what portion represents accumulated capital gains) if an Australian resident beneficiary expects that they may become entitled to a distribution of capital at some point in the future.