Private ruling: The assessability of foreign trust distribution
Date of advice: 20 July 2016
Published: August 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Is any portion of the funds distributed from the foreign trust assessable income in your hands? | A1: Yes. | Q2: Are you entitled to a foreign income tax offset (FITO) for the tax already paid on the income by the income beneficiaries? | A2: Yes.

Relevant facts and circumstances: The trust was established by way of deed in a foreign country. The deceased was the donor and one of the trustees. There was one other individual trustee together with a third party banking and wealth management services provider. You, together with your sibling were specified as the capital beneficiaries of the trust and it was expected that you would share equally in the capital of the trust. Your sibling is a citizen of the foreign country. You were formerly a citizen of the foreign country and are now a citizen of Australia. You are an Australian resident for income tax purposes. The income beneficiaries of the trust were not specified but could include the capital beneficiaries and their blood relations only. You have never been an income beneficiary of the trust. Since the inception of the trust, all income and capital gains of the trust have been attributed to either the deceased or the other individual trustee for the foreign country's income tax purposes. However, in the accounts of the trust, this income has been capitalised each year. There has not been any resolution confirming the capitalisation of income. You have received advice from your adviser in the foreign country that it is generally accepted and normal business practice that all available income would be capitalised on or in any of the capital investments. You believe that it is normal business practice in the foreign country for the trustees to exercise the discretion given to it as a clause of the Trust Deed which states: The trustees shall be entitled to capitalise any trust income in order to increase the trust capital. Shortly before the deceased's death the trust made two payments, both to your sibling. The trust was prevented by the foreign country bank from making any payment to you until after the deceased's death, due to you not being a resident of the foreign country. Subsequently the trustees made a resolution to make a capital distribution to you. To fund the distribution, the trust had to liquidate approximately 70% of the value of its share portfolios. Due to the foreign country's tax law, the capital gains thus generated were attributed to you. Due to the operation of that same law, your sibling was attributed capital gains which were generated from the sale of investments used to fund a further payment to him/her. Due to your non-resident status for the foreign country's tax purposes, the trust was liable for payment of the capital gains tax liability generated on the amount of capital gains attributed to you. This amount was paid to the relevant foreign country authority. You received an initial amount as capital beneficiary of the trust during the 2014/15 financial year. The amount of this payment was limited due to exchange control limits set by the foreign country bank. The mechanics of that payment were that the trust transferred the amounts to a newly opened bank account in the foreign country in your name, and then transferred to your Australian bank account, leaving an amount in the foreign bank account to cover bank charges and remitted expenses. You have now received the final component of your capital distribution. You will not receive any further amounts from the trust. It is not clear at this time whether the trust will now pay out the other capital beneficiary and be wound up, or whether it will continue as an investment vehicle purely for your sibling's benefit.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 96B | Income Tax Assessment Act 1936 Section 96C | Income Tax Assessment Act 1936 Section 97 | Income Tax Assessment Act 1936 Section 99B | Income Tax Assessment Act 1936 Section 101 | Income Tax Assessment Act 1936 Section 102AAZD | Income Tax Assessment Act 1997 Subsection 6-10(4) | Income Tax Assessment Act 1997 Section 10-5 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Subdivision 115C | Income Tax Assessment Act 1997 Division 770 | Income Tax Assessment Act 1997 Division 802

Reasons for decision: Summary: Subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997) advises that the assessable income of a resident taxpayer includes statutory income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Section 10-5 of the ITAA 1997 lists those provisions about statutory income. Included in this list are: • section 102-5 of the ITAA 1997 which provides that a net capital gain is to be included in assessable income; • section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with present entitlement to the net income of a trust estate; • sections 96B and 96C of the ITAA 1936 which deal with income from non-resident trust estates; and • section 99B of the ITAA 1936 which deals with receipt of trust income not previously subject to tax. Section 96B of the ITAA 1936 applies where a resident taxpayer has an interest in a non-resident trust (including an interest that is to arise at a future time or is contingent to the happening of an event). Where this is the case, the beneficiary is deemed to be presently entitled to, and not under a legal disability, with regard to a share of the income of the trust. The amount is then calculated in accordance with section 96C and assessed under section 97. Section 97 provides for a beneficiary who is presently entitled to a share of the income of a trust estate and not under any legal disability to be taxable in respect of that share. In those circumstances, the beneficiary's share of the trust income is included in their assessable income and the trustee is not required to pay tax on the beneficiary's share. Where a trustee who has a discretion to pay or apply income for the benefit of specified beneficiaries, exercises the discretion in favour of a beneficiary, section 101 of the ITAA 1936 deems the beneficiary to be presently entitled to the amount paid or applied and as such an amount is also assessed to the beneficiary under section 97. Subsection 99B(1) of the ITAA 1936 provides that where, during a year of income, a beneficiary who was a resident at any time during the year is paid a distribution from a 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. The Explanatory Memorandum (EM) for the Taxation Laws Amendment (Foreign Income) Bill 1990 at clause 16 explains that section 99B was introduced to assess an amount paid to an Australian resident beneficiary out of income from foreign sources that had been accumulated in a non-resident trust estate and would not have been taxed while the income accumulated. Subsection 99B(2) reduces an amount that would otherwise be assessable under 99B(1) by so much (if any) of the amount as represents: • a distribution in the form of corpus except if that corpus resulted from the receipt of amounts by the trustee that if received directly by a resident taxpayer would have been assessable income; • an amount that would not have been included in the assessable income of a resident taxpayer if it had been derived by the taxpayer at the time of the derivation by the trustee; • an amount that is non-assessable non-exempt income of the beneficiary because of section 802-7 (relating to conduit foreign income); • an amount that has been previously assessed to the beneficiary under section 97 of the ITAA 1936 or to the trustee under sections 98, 99 or 99A; • an amount that is reasonably attributable to a part of the net income of another trust in respect of which the trustee of the other trust is assessed and liable to pay tax under section 98(4) of the ITAA 1936; and • an amount that has been included in the assessable income of any taxpayer (other than a company) under section 102AAZD (the 'transfer trust' rules). Subdivision 115C of the ITAA 1997 provides rules which ensure that a share of a trust capital gain included in a beneficiary's assessable income under section 97 of the ITAA 1936 is also treated as a capital gain in the hands of the beneficiary. This enables the beneficiary to offset their capital losses and net capital losses against the amount, and to apply the CGT discount (if applicable) to the amount. In Howard v FCT (No 2) (2011) 86 ATR 753 , the taxpayer asserted that an amount distributed to him by a non-resident trust estate was a distribution of the corpus of the trust estate and was therefore a capital receipt. The Commissioner did not take issue with this assertion but said the amount was nevertheless assessable under section 99B to the extent that it was not assessable under section 97. The Court agreed, finding that when the amount that was later distributed to the taxpayer was derived by the trustee, it would have been assessable if it had been derived by an Australian resident. This decision was affirmed on appeal in Howard v FCT (2012) 91 FCA 89 . During the 2014/15 financial year the trustees of the foreign trust made a resolution to make a capital distribution to you. To fund the distribution, the trust had to liquidate approximately 70% of the value of its share portfolios. The sale of the trust assets triggered a capital gains tax (CGT) event which resulted in the Trust having a capital gains tax liability. Due to the foreign country's tax law, the capital gain that resulted from the disposal of the trust's assets was attributed to you and your non-resident sibling and under the same laws the trust was liable for payment of the foreign capital gains tax liability generated on the capital gains attributed to your sibling. This was paid to the relevant foreign authorities. You have received a distribution from the trust being the funds received from the liquidation of shares from the trust estate. Had these funds been derived by a resident taxpayer it would be subject to tax as per section 10-5 of the ITAA 1997. The amounts paid to you represent trust income of a class which is taxable in Australia, but which has not previously been subject to Australian tax in the hands of you or the trustee. None of the exclusions in subsection 99B(2) apply. It is understood that you were entitled to receive your share of the capital of the estate however the funds that were distributed to you were net capital gains and not corpus of the trust. A component of the trust assets that were liquidated were conceivably corpus of the trust, however these were disposed of by the trustees in order to fund the distribution to you. | Detailed Reasoning - Foreign income tax offset: If you have paid foreign tax in another country, you may be entitled to an Australian foreign income tax offset (FITO) which provides relief from double taxation. To qualify for a FITO you must meet all of the following criteria: 1) You must have paid the foreign tax on the foreign income. Subsection 770-130 of the ITAA 1997 explains that you are deemed to have paid foreign income tax in respect of an amount of income where the tax has effectively been paid by someone else on your behalf under an arrangement, or under a foreign tax law. This deeming provision is intended to apply in cases such as where the tax has been paid by, among other things, a trust in which the taxpayer is a beneficiary. 2) The foreign tax must be a tax for which you were personally liable. 3) The income or gain for which the foreign tax was paid must be included in your assessable income for Australian income tax purposes. The FITO is a non-refundable tax offset and is applied to your income tax liability including the Medicare levy and the Medicare levy surcharge where applicable. Any excess is not refunded to you.