With the recent Pandora Papers throwing the spotlight on distributions from foreign entities, it is worth refreshing some specific tax provisions that may capture distributions from foreign trusts and other hybrid type structures.
The key tax provision is Section 99B of the ITAA 1936.
Put simply, all distributions from a trust (whether resident or non-resident) are caught by Section 99B, unless they are specifically excluded:
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, the 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) and has the effect that the amount to be included in assessable income under subsection (1) is not to include any amount that represents either:
- the corpus of the trust (paragraph 99B(2)(a) of the ITAA 1936)
- amounts that would not have been included in the assessable income of a resident taxpayer (paragraph 99B(2)(b) of the ITAA 1936), and
- amounts previously included in the beneficiaries income under section 97 of the ITAA 1936 (paragraph 99B(2)(c) of the ITAA1936).
Paragraph 99B(2)(a) of the ITAA 1936 requires regard to be had to whether or not the amount derived by a trust estate was of a kind that would have been assessable if derived by a resident taxpayer. Thus, for example, if, in accordance with the terms of the trust, income were accumulated and added to corpus and the capitalised amount is subsequently paid or applied for the benefit of a beneficiary, the beneficiary would be assessable on the amount provided (subject to other paragraphs of subsection 99B(2) of the ITAA 1936).
Consider this example:
Mary is a non-resident of Australia and currently resides in the UK. Mary is also the beneficiary of a UK resident family trust (‘The Mary Family Trust).
The Mary Family Trust has accumulated income of $1,000,000 (investment income and post-CGT gains). The corpus (initial settled amount) is $100,000.
Mary decides to come back to Australia (she is a citizen of Australia).
Mary needs to buy a home in Australia. The UK independent Trustee resolves to distribute $1,100,000 to Mary.
What is the tax impact on Mary when the trustee distributes to her $1,100,000?
As noted above, 99B will apply unless the amount is excluded. It would appear that the only amount excluded from 99B would be the corpus of $100,000. The balance of accumulated income would be subject to Australian tax (notwithstanding that the entire amount accumulated offshore whilst she was a non-resident).
When a distribution is caught by section 99B(1) of the ITAA 1936, section 102AAM of the ITAA 1936 also needs to be considered. Subsection 102AAM(1) of the ITAA 1936 is designed to identify those distributions from a non-resident trust estate that will attract the interest charge.
Rather than distribute the $1,100,000 can the trustee loan funds to the beneficiary at an arms length interest rate without a tax impost?
Section 99C of the ITAA 1936 provides further detail in determining whether an amount has been applied for the benefit of a beneficiary for the purposes of section 99B.
Subsection 99C(2) of the ITAA 1936 states, in part, that an amount shall be taken, for the purposes of section 99B, to have been applied for the benefit of a beneficiary if:
c) the beneficiary has received or become entitled to receive any benefit (including a loan or a repayment, in whole or in part, of a loan, or any other payment of any kind) provided directly or indirectly out of that amount or out of property or money that was available for the purpose by reason of the derivation of the amount.
Therefore, regardless of an arm’s length rate of interest where the borrowed funds comprise accumulated earnings, this may be caught by Section 99C.
This area is highly complex and the above simplified example does not do justice to the respective tax issues one may encounter when dealing with foreign entities and distributions to Australian tax residents.
If you require specific advice please contact our member Sean Urquhart of Nexia – Sydney Office on 02) 8264-0755
The above is general information only and should not be relied upon as taxation advice. If you need taxation advice please contact the author of this Article.