Edited version of your private ruling

Authorisation Number: 1012506216440

Ruling

Subject: Distribution from foreign trust

Questions and answers:

1. Is the Trust required to include in its assessable income for any given year its share of the income of the Z Trust as it is earned by the Z Trust?

Yes.

2. Alternatively, is the income of the Z Trust only included in taxable income for the Australian resident beneficiaries if and when it is repatriated to the Australian beneficiaries?

Not applicable.

3. If income is included in taxpayers' hands for any given year as a result of the question 1 above, are they entitled to a foreign income tax offset to the extent to which tax has been paid on their behalf?

Yes.

Relevant facts and circumstances

The taxpayer is an Australian resident discretionary trust.

The taxpayer (X Trust) has a xx% interest in the Z Trust, whilst the other Australian resident discretionary trust holds xx%.

The discretionary trust owners are controlled by Australian residents, with the main controllers of each discretionary trust being brothers that separately control each discretionary trust.

The Z Trust is fiscally transparent as outlined in paragraph 5 of TR 2009/6 Income tax: entitlement to foreign income tax offsets under section 770-10 of the Income Tax Assessment Act 1997 where income is derived from investing in fiscally transparent foreign entities.

The Z Trust is considered to be a tax resident of Country Y and has lodged tax returns in Country Y in respect of the trading profits taxable under the Country Y tax provisions.

Company Z is the corporate trustee of Z Trust.

The directors of Company Z are the same as Company X.

Financial statements of the Z Trust for the year ended 30 June xxxx show that during the year Z Trust conducted the following related party transactions with Company X:

· inter-entity loan

· overseas purchases (from Australia)

· management fees

The Z Trust has paid tax on the taxable income in Country Y rather than distribute the income to the beneficiaries and have it taxed in their hands.

This has occurred from the xxxx to xxxx financial years inclusive.

The Z Trust is a discretionary trust so there are no fixed interests. However, the trust distributions are made each year in line with the fixed ownership interests in other entities so that the effect is an interest in xx% of annual income. There is no legal compulsion to do this; it is by convention.

The Country Y tax laws have applied to tax the Z Trust as though it was a Country Y company.

The Country Y profits have not yet been repatriated (sent) to the Australian owners. Rather they are represented by undistributed earnings in the Z Trust.

The Australian discretionary trust unit holders have not included in their income for any of the xxxx to xxxx financial years any amounts in respect of the Z Trust business profits.

The Settlor of the Z Trust has always been a resident of Country Y.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6B(2A)

Income Tax Assessment Act 1936 Section 36

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 101

Income Tax Assessment Act 1997 Subdivision 770-B

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

Reasons for decision

Assessability of income from a trust

Section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) advises that an Australian resident beneficiary who is presently entitled to a share of the income of a trust estate is assessed on their share of the trust estate's net income.

Where a discretionary trustee exercises its discretion and distributes an amount in favour of a beneficiary, section 101 of the ITAA 1936 deems the discretionary beneficiary to be presently entitled in relation to that amount.

Meaning of presently entitled

There is no definition of the term presently entitled in the either the ITAA 1936 or the ITAA 1997. It is therefore necessary to establish the meaning which has been given to the term by the court.

At the heart of the concept of present entitlement lies the immediate present right of a beneficiary to demand and receive payment of the income of the trust estate or a share of it. The leading High Court decision in Harmer & Ors v FC of T 91 ATC 5000 (Harmer), expressed the tests as follows:

(a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and

(b) the beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent which means that the beneficiary must have the right to demand immediate payment.

Section 101 of the ITAA 1936 provides that where a trustee is given discretion to pay or apply the trust income for the benefit of specified beneficiaries, the beneficiaries are deemed to be presently entitled to the amount when the trustee exercises the discretion in their favour.

A declaration, resolution or other act of a trustee in an effective exercise of its discretion will amount to an application of income of a trust estate for the benefit of a beneficiary where:-

· a specific ascertainable portion of the income of the year in question is thereby immediately and absolutely vested in the beneficiary so that even though it might not be immediately paid to the beneficiary it becomes his absolute property and would form part of his estate in the event of his death;

· the declaration, resolution, etc, is final and irrevocable.

To the extent that a resolution conforms to these requirements it will be accepted that it evidences an application of trust income for the benefit of a beneficiary within the meaning of section 101 of the ITAA 1936.

There has been agreement that the Z Trust has determined the trust distributions each year in line with the fixed ownership interests in other entities so that the effect is a distribution of xx% to the X Trust. These distributions have not been received by the X Trust; rather they are being held as undistributed earnings in the Z Trust.

As a specific ascertainable portion of the income has been determined for each year, the X Trust, as an Australian resident beneficiary, has been presently entitled to its share of the trust income from the outset. It is not relevant that the funds have not yet been repatriated to Australia.

Entitlement to a foreign income tax offset (FITO)

The Z Trust has paid tax on the taxable income in Country Z from the xxxx to the xxxx financial years inclusive rather than distribute the income to the beneficiaries and have it taxed in their hands. The Country Z tax laws have applied tax to the Z Trust as thought it was a Country Z company.

Subsection 770-10(1) of the ITAA 1997 provides that where a taxpayer has paid foreign income tax on an amount that is included in their assessable income, a tax offset will be allowed.

Section 770-15 of the ITAA 1997 defines 'foreign income tax' to include a tax on income that is imposed by a law other than an Australian law. Hence, the income tax paid in Country Z by the Z Trust is foreign income tax for the purposes of section 770-10 of the ITAA 1997.

In this case, the X Trust has not paid foreign income tax directly. However Country Z income tax has been paid by the Z Trust, on the income for which it has been determined the X Trust has been presently entitled to.

Section 770-130 of the ITAA 1997 applies to treat a taxpayer as having paid foreign income tax in circumstances where the tax is actually paid by someone else. It, relevantly, 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.

770-130(2) ...

770-130(3) You are 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 Income Tax Assessment Act 1936 (the 1936 Act ), to be attributable to another amount of income of a particular kind or 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.

As noted above, subsection 6B(2A) of the ITAA 1936 applies to deem the income to be attributable to a Country Z source. Paragraph (a) of subsection 770-130(3) of the ITAA 1997 is therefore satisfied.

Although the tax is paid by the Z Trust, treated as a taxable entity in Country Z, but fiscally transparent in Australia, it is paid in respect of the same income included by Australian law under section 97 of the ITAA 1936, in the X Trust's assessable income. That is, the X Trust has borne the economic burden of the tax. Paragraph (b) of subsection 770-130(3) of the ITAA 1997 is therefore satisfied.

Lastly, the taxed amount is less than it would have been had the Country Z tax not been paid and so paragraph (c) of subsection 770-130(3) of the ITAA 1997 is satisfied.

Accordingly, section 770-130 of the ITAA 1997 will apply to deem the X Trust to have paid the foreign income tax paid by the Z Trust, in respect of the amount included in the X Trust's assessable income that is attributable to the distribution of income by the Z Trust to the Australian discretionary trust.

Consequently the Australian resident X Trust satisfies the requirements of subsection 770-10(1) of the ITAA 1997 and is entitled to a foreign income tax offset in relation to the income which originated from the Z Trust. The amount of the foreign income tax offset is calculated in accordance with Subdivision 770-B of the ITAA 1997.