Edited version of private advice

Authorisation Number: 1051896823190

Date of advice: 4 October 2021

Ruling

Subject: Foreign trust distribution

Question 1

Is the distribution from the foreign trust that represents the initial payment for the disposal of the shares assessable to you under the capital gains tax provisions?

Answer

No.

Question 2

Is the distribution from the foreign trust that represents the initial payment for the disposal of the shares assessable to you under subsection 99B(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 3

Will the future distributions to you by the foreign trust that represent the earnout payments from the disposal of the shares be assessable to you under subsection 99B(1) of the ITAA 1936?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You are a citizen of Country X and hold a temporary visa.

Your spouse is an Australian citizen.

You were given the opportunity to acquire shares in a Country X resident company (the Company) you work for.

You were entitled to acquire a number of shares for a total acquisition cost of $X.

As you wanted to the shares to be beneficially held for you in a trust, you arranged with relatives for a discretionary trust they controlled as trustees (the Trust) to acquire the shares.

Your relatives are residents of Country X, the Trust was established in Country X, and the Trust is a Country X resident trust.

You agreed to advance the $X acquisition cost of the shares as a loan to the trustees of the Trust and all parties acknowledged this in writing.

You borrowed the funds to advance to the Trust from a bank. The Trust paid you interest equivalent to the amount of bank interest you incurred on your loan.

The Company subsequently entered into a buyout arrangement with another entity and the shares that were beneficially held for you in the Trust were disposed of to the purchasing entity.

The buyout payment arrangement comprised of an initial payment (the initial payment) and three subsequent annual earnout payments. The exact amount of the future earnout payments is based on certain criteria being met.

The initial payment received by the Trust from the purchasing entity for the shares was $Y.

The Trust made a distribution to you of $Y which comprised of the repayment of the loan of $X and a gain on the sale of the shares of $Z.

There was no tax payable in Country X on the sale of the shares either by you or the Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 99B

Income Tax Assessment Act 1936 Subsection 99B(1)

Income Tax Assessment Act 1936 Subsection 99B(2)

Income Tax Assessment Act 1936 Paragraph 99B(2)(a)

Income Tax Assessment Act 1936 Paragraph 99B(2)(b)

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 Subdivision 855-A

Reasons for decision

Questions 1 and 2

Subdivision 855-A of the ITAA 1997 provides that taxable Australian property broadly includes direct and indirect interests in Australian real property and capital gains tax (CGT) assets used by foreign residents in carrying on business in Australia.

Non-taxable Australian property includes, for example, CGT assets such as foreign real property or shares held in foreign companies.

Taxation Determination TD 2017/24 (TD 2017/24) explains that the trustee of a foreign trust for CGT purposes does not include in the net income of the trust a capital gain from a CGT event happening to a CGT asset which is non-taxable Australian property. Further, the amount is not treated as a capital gain of the trust's beneficiaries and no additional amounts are included in the assessable income of the trustee under Subdivision 115-C of the Income Tax Assessment Act 1997 (ITAA 1997).

An amount attributable to the capital gain may nonetheless be assessable to the beneficiary under section 99B of the ITAA 1936 which deals with the receipt of trust income that has not previously been subject to tax in Australia.

Subject to subsection 99B(2) of the ITAA 1936, subsection 99B(1) requires a beneficiary to include in their assessable income an amount of trust property that is paid to, or applied for their benefit, provided the beneficiary was resident at any time during the income year in which the payment or application was made.

The amount made assessable by subsection 99B(1) of the ITAA 1936 does not have the character of a capital gain for Australian tax purposes, nor is there any linkage between subsection 99B(1) and Subdivision 115-C of the ITAA 1997.

Subsection 99B(2) of the ITAA 1936 excludes certain amounts from the scope of subsection 99B(1). Most relevantly to you:

•         paragraph 99B(2)(a) excludes an amount representing corpus of the trust estate, except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by 'a taxpayer being a resident', would have been included in the assessable income of that taxpayer for a year of income, and

•         paragraph 99B(2)(b) excludes an amount that, if it had been derived by a taxpayer being a resident, would not have been included in the assessable income of that taxpayer of a year of income.

The phrase 'a taxpayer being a resident' refers to a hypothetical taxpayer as explained in TD 2017/24:

13. Paragraphs 99B(2)(a) and 99B(2)(b) posit a 'hypothetical taxpayer' who is a resident, but do not otherwise specify characteristics of that taxpayer. In the Commissioner's view, it cannot be assumed that this hypothetical taxpayer has other characteristics; for example, that it is an entity eligible for the CGT discount.

14. Paragraph 99B(2)(a) refers to an amount derived by 'the trust estate', but then hypothesises a scenario in which that amount was derived by 'a taxpayer being a resident'. It is evident from this language that the hypothetical taxpayer is not the trustee of the trust, but an entirely separate, fictional entity. There is support for this approach in Howard v. Federal Commissioner of Taxation where the Full Federal Court observed that the 'hypothesis posited is that the amount received by the [Esparto] trust estate was derived by a resident taxpayer', which was relevantly different from the actual characteristics of that trust and its trustee.

15. Moreover, paragraph 99B(2)(b) identifies the hypothetical taxpayer without reference to any trustee.

16. Both paragraphs 99B(2)(a) and 99B(2)(b) employ the indefinite article 'a' to identify a non-specific taxpayer deriving the amount in a non-specific year of income. This indicates that the hypothesis in these provisions is concerned with resident taxpayers generally, rather than a particular trustee or beneficiary. Nor do those paragraphs refer to any particular category of taxpayer.

In your case, you received a distribution from a foreign trust that had its origins in a capital gain from the disposal of foreign shares that were non-taxable Australian property.

As capital gains from the disposal of CGT assets such as shares are included in the assessable income of Australian resident taxpayers, paragraph 99B(2)(a) of the ITAA 1936 operates so that the amount of the distribution that is referrable to the foreign capital gain is included in your assessable income under subsection 99B(1) of the ITAA 1936.

As stated above, an amount made assessable by subsection 99B(1) of the ITAA 1936 does not have the character of a capital gain for Australian tax purposes (in the hands of the beneficiary) so the assessable amount of the distribution cannot be reduced by a capital loss or the 50% CGT discount, for example.

Although no amount is assessable to the foreign trust in Australia, the amount assessable to you under subsection 99B(1) of the ITAA 1936 will be equivalent to the amount of the capital gain the foreign trust made as calculated under the Australian capital gains tax provisions. In your case, the assessable amount will be broadly the difference between the full amount of the initial payment distributed to you less the amount of the loan repaid to you by the trustees of the Trust.

Question 3

The creation of the right to receive the future earnout payments is a CGT asset for Australian taxation purposes (subsection 108-5(1) of the ITAA 1997).

CGT event C2 happens when the ownership of an intangible CGT asset, such as a right, ends by the asset being redeemed, cancelled, released, discharged, expiring, or being abandoned, surrendered or forfeited (section 104-25 of the ITAA 1997).

The receipt by the Trust of each future earnout payment will result in a capital gain from a CGT event happening to a CGT asset which is non-taxable Australian property.

Therefore, as explained above, each of these future distributions made to you by the Trust will be included in your assessable income under subsection 99B(1) of the ITAA 1936.