Similar to many jurisdictions, Australia operates a residence-based approach to determine the tax liability of a taxpayer. Tax residency is very important for many reasons. Generally, Australian tax residents are taxed on world-wide income and are eligible for capital gains tax (CGT) discounts, subject to different tax rates, levies, withholding, tax offsets and exemptions. On the other hand, foreign tax residents are generally only taxed on income from Australian sources. Further, Australian tax residents who receive amounts from a foreign trust could find themselves with unexpected tax liabilities.
Tax residency tests for trusts
In Australia, trusts are common and widely used in the running of a business, and in investment and family financial affairs because of the potential tax benefits and flexibility of the structure.
A trust is considered a tax resident of Australia in an income year if either:
- The trust has a resident trustee at any time during the income year, or
- The central management and control (CMC) of the trust is in Australia at any time during the income year.
If there is more than one trustee (individual or corporate), the trust will be deemed an Australian tax resident if one of them is an Australian resident. If the only trustee/s are foreign resident (individual or corporate), the trust will be treated as a tax resident of Australia only if the trustee exercises the CMC of the trust in Australia. Perhaps surprisingly, it need not be a majority of trustees that is Australia-resident – one trustee out of three can cause a trust to be seen as an Australian tax resident.
Trust tax residency rules may need to be considered alongside the Double Tax Agreements (DTAs) and the impact of “tie-breaker” tests in cases for dual tax residencies. However, whether a trust qualifies for the benefits in the DTA depends on whether a trust qualifies as a “person” under the DTA. For instance, under the United States DTA with Australia, a “person” includes an estate of a deceased individual and a trust; however, this may not be the case for DTAs between Australia and other countries.
Foreign tax residents and Capital Gains Tax (CGT)
Section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that foreign residents and the trustee of a foreign trust can disregard a capital gain or capital loss from a CGT event unless the event relates to a CGT asset that is Taxable Australian Property (TAP).
TAP includes the following:
- Australian real property, such as a house, apartment, commercial building or land
- An indirect interest in Australian real estate property
- A mining, quarrying or prospecting right in Australia
- A CGT asset that you have used to carry on a business through a permanent establishment in Australia
- An option or right over one of the above – for example, a contract to purchase property off the plan and/or
- Assets where individuals disregard capital gain upon ceasing residency. For example, if an individual disregards the capital gain or loss on Australian shares he owns when ceasing Australian tax residency, those shares would become TAP.
Payments and assets subject to section 99B
Despite the effect of section 855-10 mentioned above, Australian beneficiaries of a foreign trust can be taxed under section 99B on non-TAP capital gains made by a foreign trust at double the tax rate that would apply if the trust been an Australia-resident one.
It should be noted that section 99B of the Income Tax Assessment Act 1936 (ITAA 1936) not only applies when money or another asset of a foreign trust is paid, it also applies to amounts “applied for the benefit” of an Australian tax-resident beneficiary of the foreign trust. Section 99B has the potential of taxing amounts that might otherwise be considered tax-free. Trust assets can include cash, land, shares and other assets.
The Australian Tax Office (ATO) gives the following examples of where section 99B may apply:
- An Australian beneficiary receives money from a family member who received it from a foreign trust
- An Australian beneficiary receives a capital distribution from a foreign trust out of the trust's accumulated prior year income
- Parents gift an amount of money to their child from their foreign family trust (or through another intermediary) and the child is also a beneficiary of the trust and
- An Australian beneficiary receives a loan from a foreign trust that is sourced from prior year income derived by the trust.
There are some exclusions listed in section 99B(2) as follows:
- Amounts that have already been assessed to the beneficiary (or the trustee) under another provision of the income tax law
- Amounts paid representing an amount of initial corpus of the trust or additional contributions of corpus and
- Amounts which, if derived by a resident, would not have been included as assessable income.
The ATO is often alerted by data matching information from the Australian Transaction Reports and Analysis Centre (AUSTRAC) monitoring of payments to Australian residents from overseas.
The following two examples exhibited in Taxation Determinations TD 2017/23 and TD 2017/24 set out the ATO’s view on section 99B and its consequences for Australian tax residents:
Example in TD 2017/23
The Kiwi Trust was established in New Zealand. The trust is a foreign trust for CGT purposes as the trustee company is incorporated in New Zealand and the trust is centrally managed and controlled there. The trustee can appoint income and capital of the trust to a range of beneficiaries, some of whom are resident in Australia.
The trustee invests in shares in Australian companies that are not “taxable Australian property”. The trustee sells some of those shares.
As the trust is a foreign trust for CGT purposes and the shares are not “taxable Australian property”, no capital gains or losses from the sale will be reflected in the net income of the trust under subsection 95(1) of the ITAA 1936. Accordingly, subdivision 115-C of the ITAA 1997 will not treat the trust's beneficiaries (or the trustee) as having capital gains in respect of the sale.
The trustee distributes an amount attributable to the gain to a beneficiary resident in Australia. Section 99B of the ITAA 1936 may then apply to include an amount in the beneficiary's assessable income.
Example in TD 2017/24
The trustee of a foreign trust for CGT purposes sells shares in an Australian public company that it had owned for five years. The shares are not taxable Australian property.
The trustee makes AUS$50,000 capital gains from the share sale but these are not relevant in calculating the trust's net income.
The trustee distributes an amount attributable to the capital gains to Erin, a resident of Australia. Erin has a AUS$40,000 net capital loss that she has carried forward.
Erin must include the entire AUS$50,000 in her assessable income under section 99B. She cannot reduce the amount by her net capital loss or by the CGT discount.
The above examples are unexpected interpretations from the ATO and create inconsistencies given that trusts are generally considered to be “flow-through” entities for tax purposes. In the ATO’s view, certain capital gains made by foreign trusts that are not taxed in Australia, may be taxed in the hands of Australian beneficiaries as assessable income. Further, in the ATO’s view, if section 99B applies, the CGT general discount would not be available (meaning that the tax rate on capital gains is effectively doubled) and a recipient would not be able to reduce the taxable amount by applying any capital losses they might have.
The easing of border restrictions, followed by an increase in international movements of people and capital, mean that we, as advisers, need to be alert to the tax implications for Australian tax residents and trusts which might change their tax residency, especially if funds are to be accessed from a trust. In this globalised world, and particularly with Australia being a popular migrant choice, clients of high net worth are likely to have extended families and accumulated wealth overseas. When money or assets of a foreign trust are paid to, or applied for, the benefit of an Australian beneficiary, the potential application of this obscure section 99B should not be overlooked.
