The ATO is alert to a significant flow of funds onshore from foreign trusts, and has an appetite to review these transactions further with a view to filling government coffers. Impacted beneficiaries and their advisors should be alert to the ATO’s renewed focus on their foreign funds and plan accordingly.

The ATO recently published its long-awaited Tax Determination and Practical Compliance Guideline in relation to the tax implications of Australian residents receiving benefits from offshore trusts. We are seeing more regular ATO enquiries of Australian beneficiaries as a result of their advanced data matching systems.

These releases have wide-ranging implications for Australians with interests in foreign trusts. This is relevant not only to those with direct and indirect interests in foreign trusts, but also those with foreign retirement savings accounts, and beneficiaries of foreign deceased estates.

Background

Sections 99B and 99C of the Income Tax Assessment Act 1936 provide the ATO with the power to tax benefits provided by trusts to resident beneficiaries. Broadly speaking, this legislation was introduced (over 40 years ago) to stop foreign trusts from accumulating profits offshore and then providing them in some form to Australian beneficiaries without tax being paid in Australia.

The legislation is very broad in its application and can extend to direct or indirect payments, and the provision of non-commercial loans to Australian residents. The legislation works to tax the portion of the “benefit” that is attributable to the accumulated profits of the trust. However, tax won’t apply to amounts that would not have been taxable to a “hypothetical taxpayer”, nor payments of corpus/capital from the trust.

If the foreign trust rules apply, a further interest charge can apply to effectively penalise the late recognition of income in Australia. The associated interest charge can be calculated back to the date the trust originally earned the profits. In certain cases, the interest charge can be so significant that the combination of it as well as the tax payable under section 99B can wipe out the value of the benefit received from the foreign trust.

Impact of the ATO publications

1. Hypothetical taxpayer

The ATO has made it clear that the only relevant attribute of the “hypothetical taxpayer” is that he or she is a tax resident of Australia. This means that the CGT discount is not accessible on distributions from foreign trusts, regardless of how the trust’s gain/income arose, and who the beneficiary is.

2. Record keeping

The PCG makes it clear that the onus is on the taxpayer to substantiate any reductions in taxable benefits provided from foreign trusts. Where the reductions can’t be proven by the records of the trust and beneficiaries, the entire value of the benefit may be taxed under section 99B.

If the records of the trust and beneficiaries are good enough, they may be able to prove that the benefit provided to beneficiaries would not have been taxable here, and therefore the benefit can fall outside the scope of section 99B. For example, if the parties can prove that a payment to beneficiaries was a consequence of a disposal of a pre-CGT asset, then the receipt of that amount won’t be subject to tax under section 99B. Insufficient historical records could land beneficiaries with significant Australian tax burdens under this legislation.

3. Distributions from foreign deceased estates

The ATO now classifies distributions from certain foreign deceased estates as “low risk” where:

i. The trust property is distributed to the beneficiary within 24 months of the date of death; and
ii. The total value of the property distributed to the beneficiary doesn’t exceed AUD 2 million.

The ATO states that they will not dedicate additional audit/review resources to consider the application of section 99B further for these low-risk arrangements.

Summary

The ATO’s renewed focus on foreign trusts, combined with their data matching systems, should serve as a reminder for beneficiaries and their advisors to consider the application of the foreign trust rules to their situation.

Contact Pilot

If you have any questions regarding your trust and taxation matters, contact Tom Howard, Kylee Smith or your Pilot advisor on (07) 3023 1300.