Ruling Compendium

The tax outcome that an Australian beneficiary receiving a capital gain through a trust cannot benefit from the CGT discount or use capital losses is not consistent with the appropriate policy outcome.

Hill J in Traknew Holdings Pty Ltd v. FCT 91 ATC 4272 noted the purpose and historical context in which section 99B of the Income Tax Assessment Act 1936 (ITAA 1936) is to be understood. That is, income accumulated offshore in a tax-free form was not subject to tax when distributed to a resident beneficiary. Hill J noted that in some cases, the extreme width of the provision might require it to be read down.

The Full Federal Court in Howard re-affirmed the view that section 99B was introduced as a 'catch-all' provision, with residual effect after the primary operation of section 97 of the ITAA 1936. That is, where Australian resident investors are taxed on a present entitlement basis, section 99B has no residual operation.

Section 99B was never enacted to deal with distribution of capital gains, but was enacted to deal with distributions of foreign-sourced income not previously subject to tax in Australia.

Coupled with the principles of statutory construction most recently outlined in Commissioner of Taxation v. Unit Trend Services Pty Ltd (2013) 250 CLR 523, the Commissioner's view cannot be sustained.

Where amounts are not included in the subsection 95(1) net income, for example, by the operation of section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997), the normal assessing provisions of Division 6, including section 97 cannot operate to appropriately tax them. Section 99B will apply to bring these amounts to tax and appropriately operate as a catch all provision. If section 99B did not apply, the amounts could escape taxation altogether.

We consider that the approach in the determination is not inconsistent with the legislative intention behind section 99B. While the section was introduced before the CGT provisions, its focus is on taxing distributions from non-resident trusts that have not been assessed. One reason that amounts may not be assessed is because of the operation of section 855-10 of the ITAA 1997.

In Traknew, Hill J's comments were dicta, and the factual circumstances under consideration were far removed from those to which section 99B were primarily directed. The scenario there was not in relation to foreign income.

The absence of entitlement to CGT discount for section 99B amounts has long been recognised - see paragraph 6.17 of the February 2003 Board of Taxation Report to the Treasurer, International Taxation.

It is not clear from the Example whether the same approach would apply if the amount was distributed in the same year as the shares were sold.

Capital gains derived by foreign trusts in respect of non-taxable Australian property and distributed in the year of derivation to Australian resident beneficiaries should be assessed on a present entitlement basis to such beneficiaries, for example, under section 97 of the ITAA 1936 and the associated provisions of Subdivision 115-C of the ITAA 1997. It therefore follows that the exception in subparagraph 99B(2)(c)(i) of the ITAA 1936 operates to exclude the relevant amount from being assessed under section 99B.

Section 99B was introduced in 1979 as part of the suite of amendments made to Division 6 after the Union Fidelity decision. The Explanatory Memorandum stated that section 99B 'will normally apply where accumulated foreign-source income of a non-resident trust estate (or of a resident trust estate that previously was not able to be taxed in Australia in light of the Union Fidelity decision) is distributed to a resident beneficiary'.

Where the relevant capital gain is distributed in the year of derivation and is not accumulated, the case should not fall within the ambit of section 99B.

As noted above, because capital gains from non-TAP assets are excluded from a foreign trust's net income in the year that they are made, they cannot be assessed to a beneficiary under the general rules in Division 6 in that year. That is so whether or not the gains are distributed currently.

While the EM said that section 99B would generally apply where amounts had been accumulated, it is not limited to that case, though no interest may be payable.

The Commissioner cites the Union Fidelity case as authority for his view that the hypothetical taxpayer posited by paragraphs 99B(2)(a) and 99B(2)(b) of the ITAA 1936 is a non-specific taxpayer. This reliance is misplaced. Barwick CJ said:

'The effect of the definition of net income of the trust estate in s.95 is that the provisions of the Act are to be applied to the actual income of the trust estate as if it were the income of an individual deriving it.' appear to negate the contention that the hypothetical taxpayer has no characteristics other than being a resident.

The Union Fidelity Case contradicts the Commissioner's position and requires that the enquiry under paragraphs 99B(2)(a) and 99B(2)(b) to be made on the basis that the hypothetical taxpayer were an individual.

The words in paragraph 99B(2)(a) are similar to those in subsection 95(1) of the ITAA 1936 which requires trustees to assume that they are a hypothetical resident taxpayer in calculating their net income. If the trust's characteristics as a trust were not imputed to the hypothetical taxpayer in subsection 95(1), the trust could not assert that any capital gain was eligible as a discount capital gain under section 115-10 of the ITAA 1997 as the hypothetical taxpayer would not be an individual, a complying superannuation entity, or a trust.

Alternatively, section 115-10 is the more specific provision with respect to the calculation of net capital gains, thus overriding the lack of characteristics other than residency in the hypothetical taxpayer in calculating subsection 95(1) net income. An analogous interpretive approach to paragraph 99B(2)(a) should be applied in support of Alternative View 1.

It can't be concluded that the CGT provisions would make the capital gain assessable. Rather section 102-5 of the ITAA 1997 includes the taxpayer's net capital gain in assessable income. To calculate a net capital gain a range of other things would need to be known including the taxpayer's losses and how they were applied against gains. As was the case in Union Fidelity, if nothing is known as to these matters, it cannot be the case that the amount will be included in the hypothetical taxpayer's assessable income.

There is a different statutory context to the hypothetical taxpayer test in subsection 95(1). It is clear the subsection 95(1) test is to be applied to the actual trust estate and that the only matters to be assumed are residence and that the trust was a taxpayer. On this basis there is a clear link to section 115-10 which provides a trust with access to the discount. In the case of the section 99B hypothetical taxpayer test, the trust is hypothetical not actual.

It is not a question of more specific, it's a question of whether it can apply at all. Further, it cannot provide characteristics that are otherwise absent in the hypothetical test in section 99B for example, of an actual trust or individual.

To the contrary, all that we know about a hypothetical resident is that their capital gains would be included in their net capital gain which in turn would be assessable to a resident taxpayer. The other matters that is, application of capital losses or CGT discount don't prevent the determination of an assessable amount for a hypothetical resident taxpayer for the purpose of subsection 99B(1).

The ATO 's proposed view in the tax determination is inconsistent with broader policy objectives relating to achieving comparable tax treatment between direct and indirect investment, particularly outbound investment of resident collective investment vehicles (CIVs), including managed investment trusts (MITs) and Australian superannuation funds.

It is recommended the ATO works with industry and Treasury to ensure Australian investors investing via a managed investment trust (MIT) receive the same CGT outcome whether the MIT invests directly in foreign assets or indirectly via a foreign trust.

Until such time as a law fix, the ATO should consider an administrative or compliance approach and/or the possible application of the Commissioner's remedial power.

The matter does not satisfy the Remedial Power criteria. The issue has been drawn to the attention of Treasury.

The hypothesis posited by both paragraphs 99B(2)(a) and 99B(2)(b) of the ITAA 1936 is similar and preserves or retains the character of 'the amount' under consideration - thus, the capital gain derived by the trustee is assumed to have been derived by the hypothetical resident taxpayer - see Howard v. FCT [2012] FCAFC 149 at [48].

It is clear that Subdivision 115-C of the ITAA 1997 can only apply in relation to amounts attributable to capital gains included in the net income of a trust. As outlined in Taxation Determination TD 2016/D4 Income tax: 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?, capital gains from non-TAP assets are not included in the net income of a foreign trust. Further if a payment could be regarded as a capital gain, one would have expected that section 115-215 of the ITAA 1997 (prior to the 2011 amendments) would have referred to section 99B of the ITAA 1936.

The hypothetical taxpayer tests in paragraphs 99B(2)(a) and 99B(2)(b) of the ITAA 1936 should be applied incorporating the characteristics of trustee and beneficiary where appropriate per Alternative View 1 and 2.

Support for this view can be found in paragraph 41 of the decision in Howard v. Federal Commissioner of Taxation, where the successive application of section 99B of the ITAA 1936 through levels of foreign trusts indicates that the characteristic of the Juris Trust estate as trustee, and the Esparto Trust estate as both trustee and beneficiary is imputed into the application of paragraph 99B(2)(a). Absent this inference, it would not be possible to apply section 99B to the distribution received by the Esparto Trust estate (assuming that it was a resident) from the Juris Trust estate, as section 99B only applies to amounts paid by a trust to a beneficiary of the trust.

This view results in appropriate amounts of assessable income in the beneficiary's hands. For example, a resident individual beneficiary receiving a distribution out of trust corpus representing a previously accumulated capital gain should be assessable on the same amount that they would have been assessable on had they made the capital gain personally.

Section 99B of the ITAA 1997 has not been amended in any significant manner since its introduction, despite subsequent dramatic changes to the income tax law, including the introduction of the CGT regime in 1985 and the CGT discount for certain entities in 1999. Section 99B in its current form is not flexible enough to allow for consistent and cohesive interaction with various other provisions of the tax law. If the only impediment to adopting Alternative View 2 is a single limited circumstance in which it gives rise to an inappropriate result, and in lieu of a broader review of Division 6 of the ITAA 1997, this may be a matter to which the Commissioner could seek to apply his statutory remedial power.

Noted. However, the matter does not satisfy the Remedial Power criteria.

Thus the section 99B reasoning is critical. It should be noted that the rulings do not say the amount will be assessed by subsection 99B(1), rather they say that the amount may be included.

While we take the view that subsection 99B(1) is likely to apply in most cases, there may be other exceptions that are relevant to its application or a Double Tax Agreement may give taxing rights to another country.

A decision in relation to a single case is not of itself sufficient to demonstrate that the ATO has facilitated or contributed to the development of particular views by taxpayers generally or an industry practice. We note that there are other edited versions that take different views, consistent with those expressed in the tax determination.

However, recognising the absence of any earlier public advice or guidance that clearly set out the ATO's views on the issue, the Commissioner does not propose to devote compliance resources to apply the view in the tax determination to distributions received or already assessed in income years ending before the issue of the determination (see Appendix 3).

If an Australian resident purchases an apartment in London and then sells it after a few years the capital gains tax discount would be available.

If instead, money to purchase the apartment was lent or gifted and the trusts sells it after a few years and distributes the gain to the Australian resident beneficiary he should still be eligible for the discount.

We also do not agree that the legislation provides tax symmetry for direct holdings of assets by residents, and assets held in foreign trusts where gains are distributed to residents.

The draft determinations do not address the treatment that would apply if the beneficiaries are temporary residents.

Section 768-910 of the ITAA 1997 ensures that a temporary resident is not assessed on ordinary income or statutory income (other than a net capital gain) that is derived directly or indirectly from a foreign source if the taxpayer is a temporary resident when the amount is derived.

Sections 768-960 and 768-970 of the ITAA 1997 deal specifically with the application of the controlled foreign company rules and transferor trust rules, but there does not appear to be a specific provision dealing with the application of section 99B of the ITAA 1936 to temporary residents.

The view in the draft taxation determination is that amounts assessed under section 99B would not be treated as a capital gain. A temporary resident beneficiary of a foreign trust should not be assessed under section 99B if the distribution they receive represents a capital gain that has a foreign source.

The practical application of the draft taxation determination could be improved by additional comments and/or examples which deal specifically with whether section 768-910 can apply to amounts that would otherwise be assessable under section 99B, and explaining the circumstances in which section 768-910 would apply.

This is particularly relevant for beneficiaries who are residents of Australia but are citizens of New Zealand, as it is common for these individuals to continue to be classified as temporary residents for an extended period of time. Interestingly, the example in TD 2016/D4 deals with a NZ resident trust.

If the exemption in section 768-910 can apply, further guidance would also be required in determining whether a capital gain made by a foreign trust has an Australian source or a foreign source. We understand that the ATO is currently drafting a separate Draft Taxation Determination dealing with this issue.

However, where someone is a resident for part of the relevant year and a temporary resident for part of the same year, section 99B may apply. This is consistent with the approach taken where a foreign resident becomes a resident: see ATO ID 2011/93 Income Tax Application of section 99B of the Income Tax Assessment Act 1936 when accumulated foreign source income is paid to an Australian resident beneficiary who was a non-resident when the trustee derived the income.

Presumably it is not the purpose of section 99B to override specific (and subsequent) CGT exemptions (such as that provided for life policies under Item 3 of the Table in subsection 118-300(1) of the ITAA 1997) in respect of life policies held by trustees, and the flow-on exemption for beneficiaries of that trust under subsection 118-300(1A)).

It would be valuable to taxpayers and tax advisors alike, if the 'final' TDs made it clear that CGT exemptions that would apply to resident taxpayers are not disregarded when applying section 99B.

Changes have been made - see paragraph 21.