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Ruling

Subject: Payments made by a foreign trust

Question 1

Will the amount of money paid to you by the trust, being a repayment of an amount of money you loaned to the trust, be regarded as assessable income?

Answer:

No

Question 2

Will the trustee of the trust be assessed on the distribution of the accumulated income of the trust to the beneficiaries of the trust (for the period that the beneficiaries have been Australian residents) who are under 18 years of age?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

A family trust was established in another country.

The trustees of the trust are individuals, two of which are residents of Australia.

You initially loaned the trust a sum of money. The loan was intended to be repaid at the trustees' discretion.

The accrued interest earned in the trust was for the sole use of the beneficiaries of the trust. The funds were to be held in trust until the beneficiaries (your children) reached X years of age and released at the trustees' discretion.

The children are both under 18 years of age.

You intend to wind up the trust and transfer the funds to Australia to invest in the property market. You intend that the initial loan will be repaid to you and that the income of the trust (accrued interest) will be paid to your children (the beneficiaries of the trust).

You and your family emigrated to Australia from another country. You are now Australian citizens and intend to remain in Australia indefinitely.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(2)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1936 subsection 97(1)

Income Tax Assessment Act 1936 paragraph 97(1)(a)

Income Tax Assessment Act 1936 subsection 98(1)

Australian Treaty Series 1981 No 14 Article 11

Australian Treaty Series 1981 No 14 Article 23

Reasons for decision

Summary

The amount of funds paid to you by the trust will not be considered assessable income in your hands. This is because the funds represent a repayment of an amount of money that you initially loaned to the trust.

As the beneficiaries of the trust are considered to be under a legal disability (under 18 years of age), the trustee of the trust will be assessed on any income earned on so much of the share of the net income of the trust as is attributable to a period when the beneficiaries were residents. Accordingly, the trustee would be required to register the trust in the tax system.

The double tax agreement between Australia and another country does not restrict Australia's right to tax in full the income a beneficiary receives from the trust (or in which the trustee is assessed on behalf of the beneficiary). However, in situations where tax has been paid in that other country in relation to that trust income, a foreign tax credit will be allowed against the Australian tax payable on that income.

Detailed reasoning

Loan repayment

A loan, according to The Macquarie Dictionary (Multimedia) version 5.0.0 -01/10/01, is 'something lent or furnished on condition of being returned, especially a sum of money lent at interest'. Generally, the money must be returned either in one sum at the maturity of the loan or in periodic payments. Thus, a liability arises when the debtor borrows money under a loan contract.

Principal payments on loans are not an expense to the payer or income to the recipient - they are reduction of a liability (an amount payable) and an asset (cash) to the payer and, are an increase in one asset (cash) and a decrease in another asset (an amount receivable) to the recipient.

Accordingly, the repayment to you of the money you originally lent to the trust is not assessable income to you, nor a deductible expense to the trust.

Taxation implications for beneficiaries

Subsection 95(2) of the Income Tax Assessment Act 1936 (ITAA 1936) contains the definition of a resident trust estate, other than a unit trust. This subsection provides that, in relation to a year of income, a trust estate will be a resident of Australia if, at any time during that income year:

· A trustee of the trust estate was a resident, or

· The central management and control of the trust estate was in Australia

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that if you are an Australian resident, your assessable income includes the ordinary income you derive directly or indirectly from all sources, whether in Australia or overseas in the income year.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income may be included in assessable income under another provision as statutory income. Section 10-5 of the ITAA 1997 lists certain statutory income amounts that form part of assessable income, included in this list are sections 97 and 98 of the ITAA 1997 which deals with income received from a trust.

Distributions from a trust are included in your assessable income under subsection 97(1) of the ITAA 1936. Here it states that if you, as a beneficiary of a trust who is not under a legal disability, are presently entitled to a share of income from that trust, your assessable income shall include that portion of the trust's income that your are eligible to receive (paragraph 97(1)(a) of the ITAA 1936).

A beneficiary will be presently entitled to the assets which are held in trust for them if they could take legal action to recover their share of income from the trust at any time. There are a couple of extensions to the rule, such as if the beneficiary is under a legal disability, or they have a vested interest in the trust, they are still deemed to be presently entitled to the asset. These extensions or conditions will be stipulated in the trust deed. In basic terms though, if the beneficiary is able to demand their share of the asset from the trustee, they will be presently entitled to any income derived.

People are considered to be under a legal disability if they cannot give a valid discharge for money paid to them. Beneficiaries are under a legal disability if they are minors (that is, under 18 years old as at 30 June).

Subsection 98(1) of the ITAA 1936 provides that where a beneficiary who is under a legal disability is presently entitled to a share of trust income, the trustee is liable to pay tax on that share. The trustee is taxable on:

· so much of the share of the net income as is attributable to a period when the beneficiary was a resident; and

· so much of the share as is attributable to a period when the beneficiary was not a resident and is also attributable to Australian sources.

As the beneficiary is less than 18 years of age (a minor) and, therefore, under a legal disability at the end of the income year, the trustee is assessable on the beneficiary's share of the net trust income under subsection 98(1) of the ITAA 1936.

Accordingly, any income of the trust distributed to the beneficiaries that has accumulated in the trust since the beneficiary became a resident of Australia, will be assessed to the trustee of the trust.

Effect of double tax agreement

In determining liability to Australian tax on foreign sourced income received by a resident, it is necessary to consider not only the income tax laws but also any applicable double tax agreement.

In this case, the information provided by you indicates that the income distributions that the beneficiaries will receive are sourced from another country.

The Australian Treaty Series is a convention between Australia and another country for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.

Article 11 of the agreement, in relation to interest income provides that:

Interest arising in one of the Contracting States, being interest to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State. 

To give effect to the elimination of double taxation, Article 23 of the agreement states that:

Subject to the provisions of the law of Australia from time to time in force which relate to the allowance of a credit against Australian tax of tax paid in a country outside Australia (which shall not affect the general principle hereof), tax paid in that other country, whether directly or by deduction, in respect of income derived by a person who is a resident of Australia from sources in that other country (not including, in the case of a dividend, tax paid in respect of the profits out of which the dividend is paid) shall be allowed as a credit against Australian tax payable in respect of that income.

The agreement does not restrict Australia's right to tax in full the income a beneficiary receives from the trust. However, in situations where tax has been paid in that other country in relation to that trust income, a foreign tax credit will be allowed against the Australian tax payable on that income.

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