Edited version of private advice

Authorisation Number: 5010069697352

Date of advice: 5 October 2020

Ruling

Subject: Section 99B and foreign income tax offset

Question 1

Does paragraph 99B(2)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the distribution received out of 'pre-CGT reserves' from the Foreign Trust?

Answer

Yes.

Section 99B of the ITAA 1936 deals with receipt of trust income which was not previously subject to taxation.

Subsection 99B(1) of the ITAA 1936 provides that where, during a year of income, a beneficiary of a trust, who was a resident at any time during the year, is paid a distribution from the trust, or has an amount of trust property applied for their benefit, that amount is to be included in the assessable income of the beneficiary.

Subsection 99B(2) of the ITAA 1936 modifies the rule in subsection 99B(1). Paragraph 99B(2)(b) states:

"(2) The amount that, but for this subsection, would be included in the assessable incomeof a beneficiary of a trust estate under subsection (1) by reason that an amount, being property of the trust estate, was paid to, or applied for the benefit of, the beneficiary shall be reduced by so much (if any) of the amount, as represents:

......

(b) an amount that, if it had been derived by ataxpayer being a resident, would not have been included in the assessable income of that taxpayer of a year of income;"

If you receive proceeds from the sale of pre-CGT USC shares, the capital gain will be subject to paragraph 99B(2)(b). As the asset was acquired by the Foreign Trust before 20 September 1985 it is exempt from capital gains tax, therefore, the capital gain will not be included in your assessable income.

Note: The original cost base of the shares is considered to be corpus of the trust and distribution of amounts relating to this is not assessable pursuant to paragraph 99B(2)(a).

Question 2

Is a foreign income tax offset available as a result of sections 770-70 and 770-130 of the Income Tax Assessment Act 1997 (ITAA 1997) for distributions from the Foreign Trust which are assessable under section 99B of the ITAA 1936?

Answer

Yes.

You are entitled to claim a foreign income tax offset for tax paid by the trustee on distributions that are assessed under section 99B of ITAA 1936.

Subsection 770-10(1) of the ITAA 1997 states that "you are entitled to a tax offset for an income year for foreign income tax. An amount of foreign income tax counts towards the tax offset for the year if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year." Foreign income tax offset is a non-refundable tax offset and is limited to the lesser of foreign tax paid or Australian tax payable on the foreign income.

Section 770-130 allows a taxpayer to obtain a tax offset for an income year for foreign income tax paid by another entity.

This ruling applies for the following period:

Year ending 30 June 2021

The scheme commences on:

1 July 2020

Relevant facts and circumstances

You are a resident of Australia and a potential beneficiary of a discretionary trust established in a foreign country.

You became an Australian resident for tax purposes on XX XXXXX 20XX, having previously been resident in the foreign country.

The Trust is a resident of the foreign country for tax purposes and is not an Australian resident for tax purposes.

The Trust has retained earnings and other reserves account for in the equity section of its balance sheet.

Financial statements include a 'pre-CGT reserve' account which represents an amount of capital gain retained by the Trust attributable to the sale of a CGT asset.

The 'pre-CGT reserve' can be traced to the proceeds from sale of foreign shares which occurred in 20XX. The settlor was originally issued B class shares in the foreign company in 19XX and immediately transferred the shares into the Foreign Trust. The original cost base of the foreign shares is believed to be nominal, but in any event would have represented amounts contributed from the original settlor to the Trust. In 19XX those B class shares converted to A class shares in accordance with the original company constitution. The A class shares carried the same rights and had equivalent market value to the B class shares.

The capital gain from the sale of A class shares in the foreign company was taxed in the hands of the trustee at capital gains tax rates in the foreign country. The tax paid has reduced the 'pre-CGT reserve' accordingly.

The balance of the Trust fund represents retained earnings from the subsequent investment of foreign company shares' sale proceeds as well as previous dividends from the foreign company which had been invested on behalf of the Trust.

The Trust is subject to income tax in the foreign country on its worldwide income. The rate of tax payable in the foreign country is generally 20% on dividend and capital gains income. The foreign country also applies a 3.8% Net Investment Income Tax only to passive income.

As a potential beneficiary of the Trust, you may receive future distributions from the current year income of the Trust, the pre-CGT reserve, or the other retained earnings of the Trust. Distributions of income which have been subject to the foreign country's tax within the Trust will not be subject to additional foreign country's tax when made to the beneficiary.

Further, the trustee of the Trust had notified you of its intention to make such a distribution, and you have requested that no such distribution is made until appropriate advice can be obtained regarding the application of Australian tax law to the distribution.

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 770-70

Income Tax Assessment Act 1997 Section 770-130

Income Tax Assessment Act 1997 Subsection 770-10(1)