Receiving a Distribution from a Foreign Trust
Late last year the ATO finalised its position concluding that capital gains made by a foreign trustee in respect of non-taxable Australian property (“TAP”) which is distributed to Australian beneficiaries will be taxed in the hands of the beneficiary.
The above conclusion is not a surprise, however, the sting in the tail comes by way the beneficiary is taxed. The ATO’s position is that the beneficiary is taxed as ordinary income and not a capital gain.
The ATO's view, can have significant consequences for Australian residents who are beneficiaries of foreign trusts as such beneficiaries are in a worse position because of investing indirectly in foreign assets via a foreign trust than if they had invested directly (or via an Australian trust).
Generally, where an Australian resident disposes of any asset and makes a capital gain, then they will be entitled to reduce the amount of the gain by any available capital losses and/or the 50% CGT discount. This position is maintained even where the gain is made in an Australian trust and distributed to the Australian beneficiary through a process of gross ups and deeming provisions.
Elsewhere in the legislation are certain provisions that enable non-residents including foreign trustees to disregard capital gains in relation to assets that are not TAP. Traditionally, the view adopted was that foreign trusts may distribute capital gains from non-TAP assets to resident beneficiaries in the same way that resident trusts can (ie by maintaining its character), however, such an approach is no longer consistent with the current ATO view.
The impact is best illustrated in terms of an example which has been extracted from one of the ATO determinations. The example is as follows:
The Kiwi Trust was established in New Zealand and is a foreign trust for CGT purposes. The trustee invests in shares in Australian companies that are not TAP.
On selling the shares, as the trust is a foreign trust for CGT purposes no capital gains or losses from the sale will be reflected in the net income of the trust. Accordingly, the gross up and deeming provisions will not treat the trust's beneficiaries (or the trustee) as having capital gains in respect of the sale.
The subsequent distribution of an amount attributable to the gain to a beneficiary resident in Australia results in the beneficiary being assessed as ordinary income. As such, consideration should be given as to whether distributing to Australian resident individual beneficiaries is the most effective option.
If you are a beneficiary of an overseas trust or may be considering investing in an overseas trust, you should contact your ESV Partner to discuss the potential impact and repatriation strategies.