Edited version of your written advice

Authorisation Number: 1013069311574

Date of advice: 9 August 2016

Ruling

Subject: Foreign Income Tax Offset (FITO)

Question 1:

Is a distribution in the X income year, of Country Y sourced income ('the distribution') by the trustee of the Z Trust to an individual taxpayer (' the taxpayer'), included in the net income of the taxpayer in respect of the X income year for the purposes of subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes. The distribution of Country Y sourced income is, for the purposes of subsection 6-5(2) of the ITAA 1997, assessable income of the taxpayer in respect of the X income year pursuant to subsection 97(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Question 2:

If the answer to Question 1 is in the affirmative, is the taxpayer entitled to a foreign income tax offset in respect of the X income year, pursuant to section 770-10(1) of the ITAA 1997, for Country Y income tax paid by the Y Trust in each of the earlier income years being, the A, B, C and D income years in respect of the distribution by the Z trust?

Answer:

Yes. The taxpayer is entitled to a foreign income tax offset ('offset') in respect of the X income year, pursuant to subsection 770-10(1) of the ITAA 1997, for Country Y income tax paid by the Y Trust in respect of the earlier income years, being, the A, B, C and D income years which is referable to the amount of income derived by the Y Trust in each of the aforementioned income years and is assessable to the taxpayer in respect of the X income year.

Further, the amount of the offset that can be claimed for each of the years concerned is subject to the limit imposed by section 770-75 of the ITAA 1997.

Relevant facts

The Z Trust

The Z Trust is an Australian discretionary trust.

The Z Trust deed

Beneficiaries

The individual taxpayer, among others, is a beneficiary of the Z Trust

'Legal disability' has the meaning corresponding with that ascribed by the Act and includes the conditions of: infancy, bankruptcy and mental infirmity of which condition the Trustee shall be the sole judge

'Net income' or 'income' is income available for the beneficial enjoyment of the Beneficiaries and is the profit determined according to generally accepted accounting principles, and includes foreign sourced income.

Trust Fund

The said settled sum, paid by the Settlor to the trustee and all moneys, investments and property paid or transferred to and accepted by the trustee as additions to the Trust Fund.

Trustee's Powers

The Z Trust deed sets out the powers and discretions of the trustee which may be exercised by the trustee at any time in the trustee's absolute and uncontrolled discretion. In essence, those powers enable the trustee to pay, at any time, any beneficiary, any part of the Trust Fund, or apply to the benefit of any beneficiary, the moneys of the Trust Fund, as the trustee shall think fit.

Source of Income

The Z Trust does not trade and only receives various forms of investment income.

The Y Trust

The Y Trust is a related discretionary trust of the Z Trust.

The Y Trust is a resident of Country Y for Country Y income tax purposes.

The Y Trust is a non-resident trust estate for Australian income tax purposes.

The Y Trust deed

Beneficiaries

The individual taxpayer, among others, is a beneficiary

Trust Fund

All property which may in the future be received or acquired by the trustee from any source, and the income from such property.

Powers and discretions of Trustee

The trust deed confers upon the trustee, the powers, among others, to deal with the Trust Fund as if the trustee were the absolute owner of and beneficially entitled to the Trust Fund. The Trustee has discretion to make any payment, transfer, application, resettlement or final distribution of all or any part of the Trust Fund to any one or more of the Beneficiaries.

Source of income

The Y Trust carries on leasing operations in Country Y.

A copy of the return of income for the Y Trust in respect of the earlier income years, being, the A, B, C and D income years provide that the trust derived income from leasing and rental, interest income and other income representing recovery of expenses.

The Y Trust derives only Country Y sourced income.

Income derived by the Y Trust over several financial years prior to the X income year was not distributed to its beneficiaries. This has resulted in the Y Trust having substantial retained profits.

Distribution of retained profits

The Trustee for the Y Trust is proposing to make the Z Trust presently entitled to some of its accumulated profits ('the distribution') in the X income year.

The Y Trust has paid trustee tax in Country Y on the distribution made to the Z Trust.

The Trustee for the Z Trust proposes to make the individual taxpayer presently entitled, in respect of the X income year, to the distribution received from the Y Trust.

The taxpayer is an Australian resident.

There is documentary evidence of details of the Country Y sourced income derived by the Y Trust for the A, B, C and D income years and trustee tax paid by the Y trust in Country Y in respect of the distribution relating to the abovementioned income years.

Also, there is documentary evidence of details of taxes assessed by the relevant Country Y Revenue Authority in respect of the Y Trust and date/s of payment of those taxes for each of the A, B, C and D income years.

Relevant Legislative Provisions:

Income tax Assessment Act 1936: section 6B

Income tax Assessment Act 1936: paragraph 6B(1A)(b)

Income tax Assessment Act 1936: subparagraph 6B(2A)(a)(ii)

Income tax Assessment Act 1936: subparagraph 6B(2A)(b)

Income tax Assessment Act 1936: section 97

Income tax Assessment Act 1997: subsection 770-10(1)

Income tax Assessment Act 1997: section 770-15

Income tax Assessment Act 1997: section 770-130

Income tax Assessment Act 1997: subsection 770-130(3)

Convention between Australia and Country Y for the avoidance of double taxation with respect to taxes on income and fringe benefits and the prevention of fiscal evasion ('the Country Y Convention').

Country Y Convention: Article enabling relief from double taxation

Reasons for decision

While these reasons are not part of the private ruling, we provide them to understand how we reached our decision.

Question 1

Summary

The Country Y sourced distribution received by the Z Trust is considered to form part of the net income of the trust or the purposes of section 95(1) of the ITAA 1936. If the trustee for the Z Trust exercises its discretion to distribute the amount of the distribution to the taxpayer on or before 30 June of the X income year, the taxpayer would become presently entitled in the X income year, to the amount distributed by virtue of section 101 of the ITAA 1936. As the taxpayer has no legal disability, the distribution is subject to income tax in the hands of the taxpayer pursuant to subsection 97(1) of the ITAA 1936.

Detailed explanation

Beneficiary presently entitled, not under a legal disability

Relevantly, subsection 97(1) provides that the income of a trust estate to which a beneficiary is 'presently entitled' is to be included in the assessable income of the beneficiary.

Subsection 97(1):

(1) Subject to Division 6D of Part III of the ITAA 1936, where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:

(a) the assessable income of the beneficiary shall include:

(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and

...

...

...

Broadly, the main purpose of Division 6D is to ensure that the trustee of a closely held trust with one or more trustee beneficiaries that are presently entitled to a share of the income of the trust, advises the Commissioner soon after the end of the year of income of certain details about those trust beneficiaries.

Key concepts which determine a beneficiary's liability under subsection 97(1)

A beneficiary's liability under subsection 97(1) turns on the following key expressions which are considered in more detail further in this report:

• 'presently entitled' 'to a share of the income'

• 'income of the trust estate'

• 'net income of the trust estate'; and

• 'legal disability'.

Present entitlement

The meaning of the term 'presently entitled' is found in Harmer v Federal Commissioner of Taxation (1991) 173 CLR 264 at 271, where the High Court said:

'a beneficiary is "presently entitled" to a share of the income of a trust estate if, but only if: (a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income'...

The integers of a present entitlement for the purposes of subsection 97(1) are to be determined by, among others, the terms of the particular trust in question: refer Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16, (2011) 192 FCR 298 at [26]-[27], [37]-[38].

A discretionary trust deed may provide a discretion in the trustee to determine, in respect of the income of a particular year, who among a class of beneficiaries is to be entitled. In this regard section 101 of the ITAA 1936 states:

'For the purposes of this Act, where a trustee has a discretion to pay or apply income of a trust estate to or for the benefit of specified beneficiaries, a beneficiary in whose favour the trustee exercises the trustee's discretion shall be deemed to be presently entitled to the amount paid to the beneficiary or applied for the beneficiary's benefit by the trustee in the exercise of that discretion'.

In the case of a discretionary trust, none of the discretionary beneficiaries are presently entitled to any of the income of the trust until the trustee makes a determination that an amount or proportion of the trust income will be distributed to them.

In East Finchley Pty Ltd v Federal Commissioner of Taxation (1989) 90 ALR 457 at 477, Hill J said:

'If that determination were made prior to 30 June in a year of income and was irrevocable the consequence would be under section 98 that there would be as at the end of the year of income (that being the relevant time to determine the issue) present entitlement under subsection 97'.

In effect, the question of whether a beneficiary is presently entitled to income of the trust must be answered during the income year in question. There can be no present entitlement during an income year where a determination to distribute income to a beneficiary is made by the trustee after the end of the income year (see Colonial First State Investments Ltd v FC of T at para 32).

Income/net income of the trust estate

The term net income of the trust' used in subsection 97(1)(a) is defined in subsection 95(1) of the ITAA to mean:

'net income', in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a tax payer in respect of that income and were a resident, less all allowable deductions, except...

The High Court, in Bamford v. Commissioner of Taxation [2010] HCA 10; (2010) 75 ATR 1; 2010 ATC 20-170 (quoting Sundberg J in Zeta Force Pty Ltd v FC of T 98 ATC 4681) said that:

'The words 'income of the trust estate' in the opening part of subsection 97(1) refer to distributable income, that is to say income ascertained by the trustee according to appropriate accounting principles and the trust instrument. That the words have this meaning is confirmed by the use elsewhere in Division 6 of the contrasting expression 'net income of the trust estate'. The beneficiary's 'share' is his share of the distributable income.'

Draft Ruling TR 2012/D1('the draft ruling') is a proposed binding public ruling which sets out the Commissioner's views on the meaning of 'income of the trust estate' in Division 6 of Part III of the ITAA 1936 and related provisions.

The draft ruling provides, at paragraph 96, that the net income of a trust estate referred to as 'distributable income' should properly be taken to be a reference to the income legally available for distribution to beneficiaries.

The ruling considers the types of income that would form part of distributable income. To the extent relevant in the present circumstances, the draft ruling provides at paragraph 116 as follows:

'Where a trustee of a trust (the distributing trust) distributes income to the trustee of another trust (the beneficiary trust), the net income of the beneficiary trust will include its proportionate share of the net income of the distributing trust...'

Legal disability

A beneficiary is only assessable under section 97 where they are not under a legal disability.

The term 'legal disability' in relation to a trust beneficiary is a reference to a beneficiary who is under 18 years of age or mentally incapacitated (Tax Determination TD 92/159).

Application of subsection 97(1) to the taxpayer

Division 6D of the ITAA 1936 which applies to distributions made to presently entitled trust beneficiaries of a closely held trust has no application in the present circumstances as the beneficiary in question is receiving the distribution not as a trustee of a trust estate but in its personal capacity.

Is the taxpayer a beneficiary of the Z Trust and the Y Trust?

The taxpayer is a beneficiary of the Z Trust under the terms of the trust deed.

Similarly the taxpayer is named as one of a number of beneficiaries of the Y Trust.

Is the taxpayer 'presently entitled' to the foreign sourced 'distribution' ('the distribution') by the Z Trust?

The Z Trust is a discretionary trust. The trust deed sets out the powers and discretions of the trustee which may be exercised by the trustee at any time in the trustee's absolute and uncontrolled discretion. In essence, those powers enable the trustee to pay, at any time, any beneficiary, any part of the Trust Fund, or apply to the benefit of any beneficiary, the moneys of the Trust Fund, as the trustee shall think fit.

The trustee for the Z Trust proposes to make the taxpayer presently entitled to the distribution prior to 30 June of the X income year. Provided that the trustee exercises this discretion and makes a determination on or before 30 June of the X income year, in the taxpayer's favour, section 101 would deem the taxpayer to be 'presently entitled' to the distribution in that income year.

Is the 'distribution' distributable income that forms part of the net income of the Z Trust in respect of the X income year?

The Z Trust deed defines net income or income available for the beneficial enjoyment of the beneficiaries as the profit determined according to generally accepted accounting principles and, deems 'net income' to include, among others, any foreign sourced income.

Accordingly, under the Z Trust deed, the Country Y sourced income derived by the Z Trust as a distribution from the Y Trust is net income of the Z Trust that is available for the beneficial enjoyment of its beneficiaries. For the purposes of the discussion on 'distributable income' in Draft Ruling 2012/D1, included elsewhere in this report, the Country Y sourced income is distributable income of the RIG Trust (the beneficiary trust).

Legal disability

The conditions ascribed to the term 'legal disability' are not known to exist in the taxpayer's circumstances.

In summary, the Country Y sourced distribution received by the Z Trust is considered to form part of the net income of the trust or the purposes of section 95(1) of the ITAA 1936. If the trustee for the Z Trust exercises its discretion to distribute the amount of the distribution to the taxpayer on or before 30 June of the X income year, the taxpayer would become presently entitled to the amount distributed by virtue of section 101 of the ITAA 1936. As the taxpayer has no legal disability, the distribution is subject to income tax in the hands of the taxpayer pursuant to subsection 97(1) of the ITAA 1936.

Question 2

Summary

The Article providing for double tax relief under the Country Y Convention requires that, subject to Australian law, credit shall be allowed against Australian income tax payable on income in respect of which Country Y taxes were paid under the law of Country Y and which were levied in accordance with the Country Y Convention.

The taxpayer has indirectly paid Country Y income taxes, imposed under the Country Y tax law, in relation to the proposed distribution from the Z Trust in the X income year. Documentary evidence provided supports the payment of Country Y income taxes paid in respect of the distribution that is attributable to income derived by the Y Trust in the A, B, C and D income years. The distribution is assessable income of the taxpayer in respect of the X income year for Australian income tax purposes pursuant to subsection 97(1) of the ITAA 1936.

Accordingly, the taxpayer satisfies the requirements of subsection 770-10(1) of the ITAA 1997 and is entitled to a foreign income tax offset in respect of the X income year for Country Y taxes paid on the portion of the distribution relating to income derived by the Y Trust in the A, B, C, and D income years.

The amount of the foreign income tax offset that the taxpayer is entitled to in respect of each of the A, B, C and D income years is calculated in accordance with, section 770-75 of the ITAA 1997 which imposes a limit on the amount of the foreign income tax offset that can be claimed in each income year under consideration.

Detailed explanation

Foreign income tax offset

'Foreign income tax' is defined to include a tax on income that is imposed by a law other than an Australian law (section 770-15 of the ITAA 1997). It also includes tax that is correctly imposed by a law other than an Australian law that is subject to an agreement having the force of law under the International Tax Agreements Act 1953.

A foreign income tax offset is available to a taxpayer for 'foreign income tax paid' by the taxpayer in respect of an amount that is included in the taxpayer's assessable income for that year (subsection 770-10(1) of the ITAA 1997).

Income subject to foreign income tax

An Australian resident beneficiary of a non-resident trust who receives a distribution from the non-resident trust, through an Australian trust, is required to include that distribution in their assessable income pursuant to section 97 of the ITAA 1936, subject to certain conditions.

Where foreign income tax has been paid by the non-resident trust on the amount of the distribution, section 770-130 of the ITAA 1997 applies to treat the resident beneficiary as having paid the foreign income tax in circumstances where the amount subject to foreign income tax is included in the beneficiary's assessable income. Subsection 770-130(3) typically covers the situation where foreign income tax is paid by a foreign entity that is ultimately assessable to a beneficiary of a resident trust.

Foreign income tax paid by the taxpayer - extended meaning

Subsection 770-130(1) provides:

770-130(1) This Act applies to you as if you had paid an amount of *foreign income tax in respect of an amount (a taxed amount) that is all or part of an amount included in your *ordinary income or *statutory income if you are covered by subsection (2) or (3) for an amount of foreign income tax paid in respect of the taxed amount.

Subsection 770-130(3) of the ITAA 1997 relevantly provides that a taxpayer is covered by this subsection for an amount of foreign income tax paid in respect of the taxed amount to the extent that:

(a) the taxed amount is taken, because of section 6B of the ITAA 1936, to be attributable to another amount of income of a particular kind of source; and

(b) foreign income tax has been paid in respect of the other amount of income; and

(c) the taxed amount is less than it would have been if that tax had not been paid.

The application of subsection 770-130(3) is considered as follows to determine whether in the present circumstances, the taxpayer is entitled to a foreign income tax offset for foreign income taxes paid by the Y Trust in respect of the Country Y sourced distribution.

In regards to the operation of subsection 6B in the previously stated paragraph 770-130(3)(a), subsections 6B(1A) and 6B(2) of the ITAA 1936 deems income derived by, among others, a beneficiary of a trust, to be derived from a particular source as follows:

• if the income derived by a beneficiary is attributable to passive income for the purposes of paragraph 6B(1A)(b), the income is deemed to be derived from that source to which the passive income can be directly or indirectly attributed (paragraph 6B(2A)(b);

• if the income derived by a beneficiary is attributable to interest income for the purposes of paragraph 6B(2)(b), the income is deemed to be derived from that source to which the interest income can be directly or indirectly attributed (paragraph 6B(2A)(b).

The trustee of the Z Trust proposes to make the taxpayer presently entitled, in respect of the X income year, to a distribution of Country Y sourced income. A portion of that distribution is attributable to rental income and interest income derived by the Y Trust in the A, B, C and D income years.

Section 6(1) of the ITAA 1936, defines 'passive income' to include income derived by way of rent. Accordingly, the distribution by the Z Trust to the taxpayer that is attributable to the A, B, C, and D income years is essentially made up of passive income and interest for the purposes of, respectively, subsections 6B(1A) and 6B(2) of the ITAA 1936. This amount is assessable income of the taxpayer in respect of the X income year (taxed amount).

The Y Trust paid trustee tax under Country Y income tax law in respect of the taxed amount. According to documentary evidence provided, Country Y taxes were imposed by assessment in each of the A, B, C and D income years.

For the purposes of paragraph 770-130(3)(a), the taxed amount, comprising of passive income and interest, is deemed to be derived by the taxpayer pursuant to subsection 6B(3) of the ITAA 1936, and is attributable to a Country Y source under paragraph 6B(2A)(b) of the ITAA 1936.

If the taxpayer is made presently entitled to a distribution from the Z Trust representing the taxed amount, that amount is assessable to the taxpayer under section 97 of the ITAA 1936 as determined in the response to Question 1 of this ruling.

Country Y income tax paid by the Y Trust is foreign income tax for the purposes of section 770-15 of the ITAA 1997.

Whilst the taxpayer has not directly paid foreign income tax in respect of the taxed amount, Country Y income taxes were actually paid by the Y Trust in respect of the Country Y sourced taxed amount included in the taxpayer's assessable income.

In relation to paragraph 770-130(3)(b), although the Country Y income tax is paid by the Y Trust, it is paid in respect of the same income included in the assessable income of the taxpayer pursuant to section 97 of the ITAA 1936. That is, the taxpayer has borne the economic burden of Country Y income taxes paid.

In relation to paragraph 770-130(3)(c) Country Y income taxes paid by the Y Trust results in the distribution to the taxpayer in respect of each of the A, B, C and D income years being less than it would have been had the Country Y income taxes not been paid.

Subsection 770-130(3) of the ITAA 1997 will therefore apply to deem the taxpayer to have paid the foreign income tax, that is paid in Country Y in respect of the taxed amount included in the assessable income of the taxpayer.

Country Y Convention

In determining liability to Australian tax on Country Y sourced income, it is necessary to have regard to the Convention between Australia and Country Y for the avoidance of double taxation with respect to taxes on income and fringe benefits.

The Country Y Convention does not disturb Australia's right to tax the Country Y sourced income that is derived by an Australian resident taxpayer. Nor does it restrict or alter Country Y's right to tax the Country Y sourced income.

The Article of the Country Y Convention providing relief from double taxation, requires that, subject to Australian law, credit shall be allowed against Australian income tax payable on income in respect of which Country Y taxes were paid under the law of Country Y and which were levied in accordance with the country Y Convention.

The taxpayer will satisfy the requirements of subsection 770-10(1) of the ITAA 1997 in respect of the X income year. The taxpayer is entitled to a foreign income tax offset in that income year for Country Y income taxes paid in respect of the portion of the distribution relating to income derived by the Y Trust in the A, B, C and D income years and assessable to the taxpayer.

The amount of the foreign income tax offset that the taxpayer is entitled to in respect of each of the A, B, C and D income years is calculated in accordance with Subdivision 770-B of the ITAA 1997. In particular, section 770-75 of the ITAA 1997 imposes a limit on the amount of the foreign income tax offset that can be claimed in each income year under consideration.

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