13 September 2019
About a year ago we bemoaned the morass into which our trust tax regime has fallen, including in the operation of the international tax rules. We foreshadowed further action by the ATO in relation to non-resident beneficiaries following on from consultation that started in late 2016. Now the ATO has released two draft determinations, which as expected sink the law into more confusion as the results do not make policy sense.
TD 2019/D6 concludes that a foreign resident beneficiary presently entitled to a capital gain of an Australian resident non-fixed trust on an asset which is not taxable Australian property (non-TAP) is assessable on the capital gain even though that would not occur if the foreign resident made the same gain directly rather than through the trust. A simple example is a discretionary trust with an Australian resident trustee and foreign resident beneficiary selling a portfolio interest in shares listed on the Australian stock exchange.
The second determination, TD 2019/7, concludes that a foreign resident beneficiary of a resident trust is assessable on non-TAP capital gains whether or not the gain has a source in Australia. So extending the previous example the non-resident beneficiary of the discretionary trust will be taxable even if the trust property has nothing to do with Australia and the gain is not Australian sourced, such as the trustee selling shares in a UK listed company on the London stock exchange through a broker in and under a contract made and executed in the UK.
These counter-intuitive results are said to flow from multiple changes made to Australian tax law over a 33 year period:
- Bringing foreign source income into the trust taxing regime (1979)
- Introducing the CGT with international rules for trusts which drew on Canadian and UK models and did not fit with the basic trust tax regime in Australia (1986).
- Introducing the CGT discount with separate rules for trusts designed to fix a technical glitch in relation to an individual beneficiary using personal capital losses against trust level capital gains, which have created several levels of confusion as shown by subsequent case law (1999).
- Clarifying that conduit treatment applied to capital gains on interests in trusts under the then form of trust CGT international rules with a managed funds focus (2004).
- In the course of reform to international CGT rules, combining the conduit treatment of trust income with the new CGT rules (2006).
- In the course of altering the non-final withholding tax on trust present entitlements of foreign residents further altering the specifics of the CGT conduit treatment in the context of the CGT discount and the CGT conduit rules (2007).
- Finally under the “interim” measures to restore streaming of capital gains and dividends derived through trusts which was perceived to be prevented by a High Court decision, the assessment of capital gains and dividends was moved out of the normal trust income assessment measures into the rules on CGT discount and imputation credits (2011).
Throughout this welter of changes the tax law treatment of trust level capital gains for beneficiaries became more and more complex but the policy intent has consistently been stated as the conduit treatment of trust income, that is, foreign beneficiaries are not taxable on resident trust capital gains that are not both Australian source and TAP. Each of the measures has a specific purpose and the explanatory memorandums focus on the specific purpose and never suggest the results reached in the two determinations. The ATO simply reads the ambiguous language of a small number of provisions to produce a revenue maximising result without regard to underlying policy.
The ATO at least indicates in TD 2019/D6 through highlighting a number of alternative views that there are other readings that many consider would produce results more consistent with policy but justifies its view as reading the provisions “as a whole and in context, and having regard to the way the provisions have developed over time” without any mention of their purpose and underlying policy.
By contrast TD 2019/D7 just highlights how confusing the legislation is without advancing any particular reason for the ATO’s preferred analysis. The result in this case largely flows from the 2011 interim change noted above in relation to which the second reading speech stated, “The government is aware that due to the short timeframe involved in developing these amendments, there may be scope for unintended consequences.” A detailed analysis in 2015 showed why the alternative reading that source and TAP are relevant is preferable.
The ATO claims its reading produces a result “consistent with that which applies in respect of capital gains of non-residents from direct investments.” So many steps in the analysis for this conclusion are missing that it is hard to know what it means, especially as the ATO earlier states that “The capital gains and losses of a resident trust are determined without regard to whether they arise from TAP.” It is also unclear how these statements reconcile with the view that the ATO takes about beneficiary gains in the first determination that TAP is not relevant to the beneficiary for trust level gains because a CGT event does not happen to the beneficiary.
Beyond these specifics, it is incomprehensible why the ATO constantly avoids discussing the stated purpose for the additional inclusion in beneficiary income of trust gains which is the foundation for many odd ATO views in recent times. The 1999 Explanatory Memorandum clearly explains the reason, “This amount is treated as a capital gain of the beneficiary for the purposes of calculating the net capital gain for the year. This gross up factor allows the beneficiary to appropriately apply any capital losses against the trust capital gain before applying the CGT discount that is appropriate for that beneficiary.” The gross up is solving the technical problem that what would otherwise be a net capital gain coming out of the trust could not be offset against gross capital losses of the beneficiary and has nothing to do with the international operation of the CGT in relation to trusts.
It is a mystery why the ATO continues to be unwilling to use the various means at its disposal to reach the sensible interpretive and policy outcomes, but instead creates more and more unintended consequences in relation to trusts and CGT.
 Mark Brabazon SC, “Australian international taxation of attributed trust gains” (2015 Australian Tax Review 141-166.