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  • Discussion paper: Capital gains and non-resident trust beneficiaries

    The purpose of this discussion paper is to facilitate consultation between the Australian Taxation Office (ATO) and the community on capital gains tax (CGT) and non-resident trust beneficiaries.

    This paper is prepared solely for the purpose of obtaining comments from interested parties. All views are preliminary in nature, and should not be taken as representing either an ATO view or that we will take a particular view.

    This paper is not a publication that has been approved to allow you to rely on it for any purpose. It is not intended to provide you with advice or guidance. Nor does it set out the ATO’s general administrative practice. Therefore, this paper does not provide protection from primary tax, penalties or interest for any taxpayer that purports to rely on any views expressed in it.

    Purpose

    We have previously consulted with stakeholders, including members of the former Trust Consultation Sub-group and the Public Advice and Guidance Panel, to scope the following issues:

    1. Does the residency assumption in subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936) apply for the purpose of section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997), which disregards certain capital gains of a trust which is a foreign trust for CGT purposes?
    2. Where an amount included in a beneficiary's assessable income under subsection 99B(1) of the Income Tax Assessment Act 1936 (ITAA 1936) had its origins in a capital gain from non-taxable Australian property of a foreign trust, can the beneficiary offset capital losses or a carry-forward net capital loss (capital loss offset) or access the CGT discount in relation to the amount?
    3. Does Subdivision 855-A (or subsection 768-915(1)) of the Income Tax Assessment Act 1997 (ITAA 1997) disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3)?
    4. Is the source concept in Division 6 of Part III of the Income Tax Assessment Act 1936 (Division 6) relevant in determining whether a non-resident beneficiary of a resident trust (or trustee for them) is assessed on an amount of trust capital gain arising under Subdivision 115-C of the Income Tax Assessment Act 1997?

    We published draft Taxation Determinations TD 2016/D4 (regarding Issue 1) and TD 2016/D5 (Issue 2). If you have comments about those draft TDs, please send them to the contact officer by 1 March 2017.

    The purpose of this discussion paper is to facilitate further targeted consultation on issues 3 and 4. This is to ensure that in forming a view we have identified related matters of concern and considered all alternative views. Consultation will take place in January/early February 2017. Please contact Lyn Freshwater on 07 3213 5554 or lyn.freshwater@ato.gov.au if you would like to participate. This discussion paper is not seeking suggestions for legislative change.

    Effect of subdivision 855-A (or subsection 768-915(1)) of the ITAA 1997

    Question

    Does Subdivision 855-A (or subsection 768-915(1)) of the ITAA 1997Footnote1 disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3)?

    1. It seems to us that the answer to this question is no. Firstly, section 855-40 only disregards a capital gain that a foreign resident beneficiary makes because of subsection 115-215(3) if the trust is a fixed trust. Further, it seems to us that section 855-10 (or subsection 768-915(1)) does not disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3).

    Discussion

    Extra capital gains: section 115-215

    1. If a trust’s net incomeFootnote2 includes a net capital gain, subsection 115-215(3) may treat a relevant beneficiary as having extra capital gains (that is, in addition to those that the beneficiary has made directly) which are included in the calculation of their net capital gain under the method statement in subsection 102-5(1).
    2. Subsection 115-215(4A) seems to make it clear that the beneficiary is taken to have made these capital gains even though no CGT event has happened directly to the beneficiary.

    Foreign resident beneficiary exemption where there is a fixed trust: section 855-40

    1. Section 855-40 disregards a capital gain that a foreign resident beneficiary of a fixed trust is taken to have made as a result of a CGT event happening to a non-TAP asset of that trust. The purpose of the provision is to provide comparable treatment to that which would have been available had the beneficiary directly owned the trust asset.Footnote3 The terms of the enactment suggest strongly that comparable treatment was not thought to be warranted in the case of a non-fixed trust.
    2. There is also, it seems to us, quite clear policy justification for limiting relief to capital gains of beneficiaries with interests in fixed trusts. Prior to the changes made as part of the New International Tax Arrangements in 2004, our understanding of the law is that foreign beneficiaries of resident trust estates received no relief in relation to trust capital gains attributed to themFootnote4, even though some gains would not have been subject to CGT if they had held the assets directly. This was so, whether the resident trust estate was fixed or not.Footnote5
    3. The rule now reflected in section 855-40 (originally in section 768-605 in Subdivision 768-H) was one of a number of changes aimed at removing tax impediments to foreign residents investing in Australia. In particular, the reform aimed to improve the international competitiveness of Australian managed funds. The Explanatory Memorandum to the New International Tax Arrangements (Managed Funds and Other Measures) Bill 2004 provided:

      1.9 These amendments apply to foreign residents that have interests in managed funds (or other fixed trusts) whose assets are without the necessary connection with Australia.

      1.12 These amendments are not confined to foreign residents with interests in widely held unit trusts. The amendments will apply to interests in closely held trusts and trusts that are not unit trusts. This is to ensure the benefits of the measures apply as widely as possible, irrespective of the trust arrangements through which the foreign resident invests. However, the trust in which the foreign resident has invested and all relevant trusts in the chain must meet the definition of ‘fixed trust’ in the ITAA 1997. This is important to the integrity of the amendments
    4. Section 855-40 also applies to disregard capital gains ultimately taken to be made by a foreign beneficiary through a chain of fixed trusts where the CGT event happens to a CGT asset of the first-tier fixed trust. What is significant is that the capital gain of the beneficiary is not disregarded if any of the trusts in the chain are not fixed trusts. It would seem to us particularly odd if this outcome were to be reversed by the application of section 855-10 (see below).

    General foreign resident exemption: section 855-10

    1. Subsection 855-10(1) provides that a foreign resident can disregard a capital gain from a CGT event if the event happens in relation to a CGT asset that is not taxable Australian property.
    2. It has been suggested that this ‘general’ exemption provision disregards a capital gain which a foreign beneficiary of a non-fixed trust is taken to have made as a result of a CGT event happening to non-TAP assets of the trust.
    3. However, a capital gain that a foreign beneficiary makes because of the operation of subsection 115-215(3) is not a capital gain from a CGT event that happens to the beneficiary; rather, such an event happens to the trustee. While subsection 855-10(1) does not expressly provide that the relevant CGT event must happen ‘to’ the foreign resident, this is an inference reasonably drawn from the statutory context.
    4. In particular, the presence of a specific rule in section 855-40 enabling beneficiaries of fixed trusts to disregard certain trust capital gains seems to us to be a strong indicator that beneficiaries of non-fixed trusts are not catered for by section 855-10.
    5. If subsection 855-10(1) could disregard trust capital gains attributed to foreign beneficiaries, it presumably could do so without regard to whether or not the trust was a fixed trust , rendering that aspect of section 855-40 redundant. The statutory context strongly suggests to us that the intention is to disregard capital gains for foreign beneficiaries of fixed trusts, but not foreign beneficiaries of non-fixed trusts. Such an intention is consistent with the policy considerations set out above.

    General temporary resident exemption: section 768-915

    1. Section 768-915 operates to disregard a capital gain made by a temporary resident if that gain would have been disregarded under Division 855 if the temporary resident was a non-resident. In that case, Subdivision 115-C would similarly treat the temporary resident as having extra capital gains. These cannot be disregarded whether the trust is a fixed or non-fixed trust (that is, there is no counterpart for temporary residents of section 855-40). We do not know whether this was a deliberate outcome or an oversight.

    Alternative views

    1. An alternative view is that subsection 855-10(1) can disregard a capital gain that a foreign beneficiary makes from a non-TAP asset of a non-fixed trust as a result of the application of subsection 115-215(3).
    2. It is argued in support of this view that the first view requires words to be read into section 855-10. That is, it requires the words ‘that happens to you’ to be read into the chapeau to subsection (1) after ‘CGT event’.
    3. Alternatively, it is argued that the first view unduly relies on the maxim expression unius exclusio alterius in the inference drawn from the presence of section 855-40.
    4. Another basis for the view is that with the introduction of Division 855, it was contemplated that non-residents would only ever be subject to tax on capital gains that came from non-TAP, without qualification as to whether the gains were made directly, or through trusts. This is said to be so despite the re-enactment in Division 855 of specific provisions relating to fixed trusts from Subdivision 786-H.
    5. As noted above, it seems to us that when the provisions are read as a whole, in context, and having regard to the way the provisions have developed over time; the better view of the law is that section 855-10 cannot be interpreted to apply to objects of non-fixed trusts. If section 855-10 were interpreted to disregard capital gains for any foreign residents, including foreign beneficiaries of non-fixed trusts, it would render section 855-40 redundant. This may be considered a more strained interpretation.

    Example 1: Resident discretionary trust

    During the 2016 income year, the trustee of a resident discretionary trust derived income from a business.

    The trustee also made non-discount capital gains from the sale of 5000 listed shares that it had owned for less than 12 months. The shares were not taxable Australian propertyFootnote6 (TAP).

    The trustee resolved to make a foreign resident beneficiary presently entitled to all of the trust income (in this case, the business income).

    On these facts, as there was no beneficiary specifically entitled to any of the trust gains, all of the gains will be attributable to the non-resident beneficiary.

    Section 115-220 will operate so that the trustee is assessed under subsection 98(3) of the ITAA 1936 on the beneficiary’s attributable capital gain.

    The foreign resident beneficiary is also taken to have made capital gains under subsection 115-215(3). The beneficiary will receive a refundable tax offset under subsection 98A(2) of the ITAA 1936 for tax paid by the trustee.

    As the trust is not a fixed trust, the CGT exemption in section 855-40 in respect of a beneficiary’s gain attributable to non-TAP assets of a foreign trust does not apply. Nor does subsection 855-10(1) apply to disregard the capital gain which the foreign resident beneficiary is taken by Subdivision 115-C to have made.

    End of example

    Effect of the source concept in Division 6 of Part III of the ITAA 1936 when assessing trust capital gain

    Question

    Is the source concept in Division 6 of Part III of the ITAA 1936 (Division 6) relevant in determining whether a non-resident beneficiary of a resident trust (or trustee for them) is assessed on an amount of trust capital gain arising under Subdivision 115-C of the ITAA 1997?

    1. It seems to us that the answer to this question is no. The source concept in Division 6 appears to us not (or no longer since 2011) relevant in determining whether an amount of trust capital gain is assessable to the non-resident beneficiaryFootnote7 or trusteeFootnote8. [The same view would apply in relation to a non-resident beneficiary’s share of TAP gains of a non-resident trust and trustee’s share of capital that are assessed under 115-222.]
    2. In this discussion, the phrase ‘source concept’ refers to the limitation in Division 6 on the assessment of non-residents (or trustees for them) to amounts ‘attributable to sources in Australia’.Footnote9

    Discussion

    A resident trust must include in the calculation of its net capital gain, capital gains and capital losses without regard to whether they have arisen from taxable Australian property in terms of Division 855 irrespective of whether the trust has non-resident beneficiaries. The net capital gain is then included in the trust’s net income calculated in accordance with subsection 95(1) of the ITAA 1936.

    For each capital gain included in the trust’s net capital gain, Subdivision 115-C treats a beneficiary (whether or not the beneficiary is a non-resident) as having an extra capital gain worked out according to section 115-215. That capital gain is taken into account in working out the beneficiary’s net capital gain under the method statement in subsection 102-5(1).

    For the 2011 and later income years, section 115-220 assesses the trustee under section 98 of the ITAA 1936 on a non-resident beneficiary’s shareFootnote10 of the trust capital gains, including a specific entitlement to the gain (without regard to the rules in Division 6 whereby non-residents are assessed only on amounts attributable to sources in Australia).Footnote11 Section 115-220 does not seem to test whether such a share satisfies the conditions in section 98 of the ITAA 1936Footnote12Footnote13; rather, it increases the amount assessable to the trustee under section 98 without regard to those conditions.

    In other words, it seems the effect of section 115-220 is merely to make the amount drawn, without regard to source, from Subdivision 115-C both assessable and taxable to the trustee under section 98 of the ITAA 1936; and this applies even if there were no other amount the trustee is assessed on (subsection 115-220(3)).

    Similarly, subsection 98A(1) of the ITAA 1936 has no application to determine the beneficiary’s capital gains as this is done by section 115-215 and other provisions within Subdivision 115-C.

    Division 6E of Part III of the ITAA 1936Footnote14 prevents double taxation by providing that such directly increased capital gain amounts are disregarded in determining the trust income and net income that may be assessed through the ordinary operation of Division 6.

    Prior to the 2011 income year, trust capital gains were assessed having regard to the combined operation of Subdivision 115-C and the rules in Division 6 applying to the assessability of trust net income, including source. This was the result of section 115-215 considering whether a beneficiary had assessable income under subsection 98A(1) of the ITAA 1936 (which had regard to source) and if so including additional gains in the beneficiary’s net capital gain calculation.

    The position for the 2011 and later years is consistent with that which applies in respect of the capital gains of non-residents that invest directly.

    Whilst paragraph 6-10(5)(a) indicates that non-residents are required to include in their assessable income only that statutory income which has an Australian source, paragraph 6-10(5)(b) includes in assessable income other statutory income which a provision includes in assessable income on some basis other than having an Australian source. The Explanatory MemorandumFootnote15 says in relation to this provision that there are limited cases where an amount is assessed on a specifically expressed basis, and provides the following example:

    ‘…the capital gains and losses provisions bring to account gains and losses on the disposal of a ‘taxable Australian asset’ rather than on Australian-sourced capital gains and losses’.

    Example 2

    The OZ Trust is a resident non-fixed trust estate. The trustee of the trust holds shares in a land rich Australian company (LandCo) and shares in an Australian company that owns no taxable Australian property as defined in section 855-15 (OtherCo).

    The trustee sells all the shares by contract executed in the United Kingdom in the 2014 income year and makes non-discount capital gains totalling $70,000 and $30,000 respectively. Pursuant to the trust deed, the trustee resolves to treat the gains as income of the trust for that year. There is no other trust income.

    The trustee further resolves to make Edward, a non-resident beneficiary who is not under a legal disability, presently entitled to 100% of the trust income.

    Section 115-220 applies to assess the trustee under subsection 98(3) of the ITAA 1936 on the $100,000 in trust capital gains attributable to Edward. The source concept in subsection 98(2A) of the ITAA 1936 has no application in relation to these capital gains, as they are attributed to Edward directly by section 115-215.

    Capital gains totalling $100,000 are attributed to Edward directly by section 115-215 and are included in the calculation of Edward’s net capital gain for the income year under the method statement in subsection 102-5(1). Edward is entitled to a refundable tax offset for the tax the trustee paid on his behalf under subsection 98A(2) of the ITAA 1936.Footnote16 The same outcome would arise if the trustee did not treat the gains as income but Edward was made specifically entitled to the amounts of capital gains.

    End of example
    Footnote 1
    All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated

    Return to footnote 1 referrer

    Footnote 2
    As defined in subsection 95(1) of the ITAA 1936

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    Footnote 3
    See subsection 855-40(1)

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    Footnote 4
    With the exception of gains from assets to which a beneficiary is absolutely entitled as against the trustee (see Subdivision 106-C of the ITAA 1997 and section 160V of former Part IIIA of the ITAA 1936).

    Return to footnote 4 referrer

    Footnote 5
    Under the ITAA 1936, the interaction between section 160L and section 160T left open no argument that non-resident beneficiaries could obtain exemption in relation to capital gains made by trustees of resident trust estates. There is no evidence that any change was intended to have been made in relation to this outcome either by the TLIP legislation in 1998, or by the subsequent enactment of Subdivision 115-C in 1999 which treated beneficiaries as having capital gains. (Prior to 1999, capital gains treatment was afforded to trust capital gains in the hands of beneficiaries by administrative practice: IT 2328 paragraphs 12-16).

    Return to footnote 5 referrer

    Footnote 6
    Taxable Australian property is defined in section 855-15.

    Return to footnote 6 referrer

    Footnote 7
    See section 115-215, and section 115-220 and sections 95AAB, 95AAC, 98A of the ITAA 1936

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    Footnote 8
    See section 115-220 and sections 95AAB, 95AAC and 98 of the ITAA 1936

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    Footnote 9
    See, for example, subsection 98(2A)(d) of the ITAA 1936

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    Footnote 10
    Section 115-227

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    Footnote 11
    The insertion of section 95AAB of the ITAA 1936 means that beneficiaries may still receive a credit for related tax paid by the trustee under the normal operation of Division 6 (subsection 98A(2) or section 98B of the ITAA 1936).

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    Footnote 12
    Including paragraph 98(2A)(d).

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    Footnote 13
    The purpose of the assumption in paragraph 115-220(1)(b) appears to us merely to establish a framework for the operation of the different parts of section 98 that assess in different circumstances (e.g. where beneficiaries have legal disabilities or are non-residents). The words ‘would be liable to be assessed’ refer, consistently with the previous aspects of the assumption, to the possibility of assessment under a provision of section 98 and do not ask one to determine whether the trustee would actually be assessed on something.

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    Footnote 14
    Sections 102UX and 102UY

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    Footnote 15
    Explanatory Memorandum to the Income Tax Assessment Bill 1996, Residency and source, page 39

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    Footnote 16

    see s95AAB and s95AAC

    Return to footnote 16 referrer

    Last modified: 22 Dec 2016QC 50831