Following Treasury’s 2011 Consultation Paper which looked into potential reforms towards updating the taxation of trusts under Australian tax law, including changes that would clarify the scope of section 99B of the Income Tax Assessment Act 1936 (Cth) (1936 Act), the Australian Taxation Office (ATO) has released long awaited guidance in the form of:
- Draft Practical Compliance Guide PCG 2024/D1 (PCG 2024/D1); and
- Draft Taxation Determination TD 2024/D2 (TD 2024/D2),
(together, the Draft Guidance), both of which seek to provide further guidance as to the operation of section 99B.
Comments on the Draft Guidance are due on 28 August 2024. Please contact one of the authors or your KWM contact if you would like any further information on the Draft Guidance.
Contents
- Who is this relevant to?
- Key takeaways
- How does section 99B work?
- PCG 2024/D1
- TD 2024/D2
- Implications
Who is this relevant to?
Section 99B was introduced as a means to overcome the High Court’s decision in Union Fidelity Trustee Co of Australia Ltd v FCT (1969) 119 CLR 177, where the Court held that in calculating the taxable income of a trust under Division 6 of the 1936 Act, only Australian sourced income was taken into account.
While there remains significant uncertainty as to the scope of the provision, the Draft Guidance will be particularly relevant for:
- multinational high net worth estates; and
- public funds management entities,
that involve Australian resident beneficiaries receiving payments or other benefits from non-resident trusts.
Key takeaways
- The Draft Guidance should be read together with the ATO’s existing public guidance around payments received by resident beneficiaries, including Taxation Determinations TD 2017/23 and TD 2017/24, as well as ATO ID 2011/93.
- While the Draft Guidance clarifies the operation of section 99B to some extent, there remains significant uncertainty as to the provision’s scope, including, for example:
- whether it may apply to Australian resident trusts (not just foreign trusts), as was flagged by Hill J in Traknew Holdings Pty Ltd v FCT (1991) 21 ATR 1478; and
- the extent to section 99B may apply alongside Part IVA’s general anti-avoidance rules.
- The Draft Guidance applies both retrospectively and prospectively. Thankfully, the ATO has stated TD 2024/D2 should not impact already existing settlements contrary to the determination, but taxpayers should nevertheless consider past distributions and ensure record keeping is consistent with PCG 2024/D1.
- Taxpayers should ensure they maintain contemporaneous records of any distributions, loans or gifts made by a trustee of a foreign trust to a resident beneficiary.
- The potential broad application of section 99B, as well as the proposed record keeping and compliance management suggested by the Draft Guidance, may be particularly difficult to manage for public funds and investors in public funds.
How does section 99B work?
Payments or benefits are included in assessable income
Section 99B operates to include in the assessable income of an Australian resident beneficiary any amount that is:
- property of the trust estate; and
- is paid to or applied for the benefit of that beneficiary.
This includes, in accordance with PCG 2024/D1 (at [9]):
- distributions;
- transfer of assets;
- use of trust property;
- loans; and
- amounts received from a deceased estate.
One of the key uncertainties of section 99B (which the Draft Guidance does not deal with) is the extent to which section 99B may apply to Australian resident trusts. While introduced to deal with foreign source income, the terms of section 99B only requires the payment or benefit be made to an Australian resident beneficiary, and therefore is broad enough to capture distributions by Australian resident trusts as well.
Exceptions reduce the amount included in assessable income
Subsection 99B(2) lists a number of exceptions which “reduce” the amount to be included in a resident beneficiary’s assessable income. These include amounts which:
- represent the corpus of the trust estate (unless it is attributable to amounts which, if they had been derived by a resident taxpayer, would have been included in their assessable income);
- would not have been included in a taxpayer’s assessable income if they had derived it in the income year;
- is non-assessable non-exempt income due to section 802-17 of the Income Tax Assessment Act 1997 (Cth) (i.e., conduit foreign income);
- are already included under section 97, or otherwise subject to trustee taxation under sections 98 to 98A;
- are notional attributable income under section 102AAZD (i.e., the transferor trust rules).
PCG 2024/D1
PCG 2024/D1 seeks to provide clarity around the operation of section 99B in circumstances where payments or benefits to resident beneficiaries from accumulated property by a non-resident trust.
It applies both retrospectively and prospectively.
Common scenarios where section 99B may apply
The ATO provides a number of common scenarios where section 99B may apply:
Description
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INDIVIDUAL
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Example
uses 2
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Change of residency
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A trustee of a non-resident trust distributing trust property to a beneficiary who has migrated to Australia and considered an Australian resident for tax purposes |
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Distribution
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Non-resident trustee appointing accumulated profits to a resident beneficiary |
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Gift
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Resident beneficiary receiving amounts representing a gift from a non-resident trust estate |
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Loan
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A loan from a non-resident trustee to a resident beneficiary |
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Use of trust property
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Borrowing artwork belonging to a non-resident trust by a resident beneficiary |
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Amounts from a deceased estate
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Distributions of cash and listed shares by a non-resident trustee (executor) as permitted by a will of a non-resident deceased estate |
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Loan forgiveness
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Forgiving a loan made by a non-resident trust to a resident beneficiary |
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Where the arrangements are made on commercial terms (for example, a loan is made with interest charged at the benchmark rate prescribed under Division 7A), the ATO has indicated that such arrangements will be considered “low risk”.
The ATO considers that an arrangement will not be considered “low risk” where:
- there are elements of a “contrived nature” seeking to enable a taxpayer to be within the compliance approach; and
- the purpose of an arrangement is to enable a resident beneficiary to provide a benefit to another resident beneficiary of the trust.
Record keeping
Taxpayers have the onus of proving that an exception under section 99B(2) would apply.
Acknowledging it can be challenging to obtain the documents and information from a non-resident trustee, the ATO has also provided the expected evidence required to substantiate that the ‘corpus’ and ‘non-taxable’ exemption in section 99B(2)(a)-(b) applies.
This includes:
Core documents
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Further supporting documents and information
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Example
uses 2
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TD 2024/D2
TD 2024/D2 provides further guidance on the ATO’s view on the operation of the ‘corpus’ and ‘non-taxable’ exemption in sections 99B(2)(a) and (2)(b) of the 1936 Act.
The draft determination provides that the operation of the exemption depends on specific tests, which is referred to as the “hypothetical taxpayer” tests. This test is derived from the dicta of the Full Federal Court in Howard v Commissioner of Taxation [2012] FCAFC 149:
The hypothesis posited is that the amount received by the [relevant trust] estate was derived by a resident taxpayer; the question posed on its assumption is whether that resident taxpayer would have been required to include the amounts it received as assessable income.
The only characteristic of the hypothetical taxpayer appears to be their status as an Australian resident (see TD 2024/D2 at [34]). What this means is that in applying the test, only considerations applicable to all Australian residents are relevant to the analysis. On this basis, the ATO considers that the CGT discount would not be taken into account on the basis that it is only available to specific classes of resident taxpayers (see at [34]).
In considering the characteristics of amounts paid to a resident beneficiary, the ATO flags two relevant factors including:
- the circumstances / factors attributable to the transaction that generated the amount; and
- the source of the distribution.
In PCG 2024/D1 at [35], the ATO indicates that in most instances, capitalised income or gains accumulated by a trust may be taxed under subsection 99B(1) because of the hypothetical resident test. However, this could be unsurprising having regard to the operation of section 99C(2)(a) of the 1936 Act.
Implications
While helpful, the Draft Guidance leaves a number of unanswered questions. This includes, among others:
- the extent to which section 99B may apply to Australian resident trusts;
- the extent to which section 99B may apply over (or with) the general anti-avoidance provisions in Part IVA; and
- the interaction between section 99B and the transferor trust provisions in section 102AAM.
The scope of section 99B’s application, as well as the areas in which the ATO may apply compliance resources, therefore remains an open question.