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Beware the foreign asset in an Australian discretionary trust: These tax determinations emphasise the need for review and legislative change – Property Taxes



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The Commissioner has finalised his Taxation Determinations TD
2022/12 and 2022/13 regarding the taxation of capital gains made by
foreign beneficiaries of Australian resident discretionary trusts
on the sale of non-taxable Australian property. These
determinations follow the current law as confirmed in
Greensill and N&M Martin, and again reinforce
the need for review of the taxation of trusts which, particularly
following the hasty patchwork of Division 6E, is overly complicated
and does not appear to reflect the intention of the legislature or
the existing taxation structures.

Last week the Commissioner of Taxation released Taxation
Determinations 2022/12 and 2022/13, which followed the decisions in
Greensill and N&M Martin [2021]
FCAFC 99 and concluded:

  • the source concept from Division 6 Part III ITAA36 does
    not apply to determine whether a non-resident
    beneficiary (or trustee) is taxed on a capital gain from a resident
    trust, or on taxable Australian property held by a non-resident
    trust under Subdivision 115-C ITAA97; and

  • a capital gain by a non-resident beneficiary of a resident
    discretionary trust on non-taxable Australian property is
    not disregarded under Subdivision 855-A
    ITAA97.

We summarised the basic implications of the decisions in
Greensill and N&M Martin following the
refusal of special leave by the High Court of Australia in February
2022 in our Alert here.

Compliance activity and risk

Taxation Determinations TD 2022/12 and TD 2022/13 will apply
retrospectively. In the Commissioner’s usual course, he has
indicated that he will not devote compliance resources to identify
arrangements prior to the 2019 financial year solely on the basis
of these determinations, but if the issue arises in the course of
other compliance activities the Commissioner will apply the law
accordingly.

There is, of course, always a risk that such a matter will arise
as part of other compliance activity. However, there is an
increased risk of adjustments in response to the decisions in
Greensill and N&M Martin and the two tax
determinations because of the Commissioner’s focus on the
taxation of trusts, and particularly those trusts with
international dealings. The Commissioner’s attention on this
area is evident from his Taxpayer Alerts TA 2021/2 regarding
foreign income disguised as a gift or loan (see our discussion of
the TA here) and TA 2022/1 regarding distributions to
children over 18, as well as the draft TR 2022/D1 and PCG 2022/D1
regarding the application of section 100A ITAA36 (see our
discussion regarding 100A here). It is, perhaps, fortuitous that these
determinations issued within a week of the hearing of the appeal in
Guardian before the Full Court of the Federal Court of
Australia.

It is important that non-resident beneficiaries are aware of the
risk of amended assessments following the release of the
determinations. The Commissioner’s compliance activity and any
adjustments are unlikely to be limited by the legislated amendment
period because the focus area of the compliance activity (from the
2020 financial year to date) will be within the amendment period,
and for prior years non-resident beneficiaries may not have lodged
Australian income tax returns resulting in an effective unlimited
amendment period.

Implications and need for change

In submissions before the Full Federal Court and the High Court
of Australia, senior counsel for the taxpayers in
Greensill and N&M Martin identified that the
application of the law as the Commissioner contented (and was
found) did not appear to achieve the purpose of the legislature,
and it disrupted the basic capital gains tax structure and
reflected a change post the 2011 insertion of Division 6E (see the
High Court transcript here).

Two strange practical consequences of the law include:

  • Capital gains without an Australian source are taxed
    differently for discretionary trusts compared with fixed trusts;
    and

  • Capital gains without an Australian source will be taxed
    differently from ordinary income without an Australian source.

From experience, it is very difficult to explain this to
advisers for inbound investors. Division 855 was introduced to
encourage foreign investment. The level of confusion and
inconsistency achieves the exact opposite.

In his Compendium to the two tax determinations, the
Commissioner has since responded to several arguments regarding the
consistency of the determinations with the purpose of the
legislation and policy objectives by reference to the decision of
the Full Federal Court in Greensill and N&M
Martin
. Critically, although the Full Federal Court
acknowledged that the introduction of Division 6E removed the
taxation of capital gains from Division 6, the Court only observed
that the ‘thesis that Parliament never intended that a
foreign beneficiary be bought to tax on non-Australian
gains
‘ did not result in a different construction of
Division 115-C (at [77]). This is a matter of statutory
interpretation. The Court did not comment on the purpose of the
legislation and whether that purpose was met.

At present, the law on the taxation of trusts with respect to
residency implications and capital gains is nonsensical. This is
not to comment on the decision in Greensill and
N&M Martin, but the legislation as enacted and what
surely must be unanticipated results. Not only may the interplay of
Division 6, Subdivision 855-A, Subdivision 115-C and (the hastily
inserted) Division 6E lead to perverse results per the
circumstances in Greensill and N&M Martin,
but the operation of those provisions as considered in
Greensill and N&M Martin may have more far
reaching implications for the taxation of trusts and the
application of section 99B ITAA36 (for example) and the resident
beneficiaries’ receipts from foreign trusts (see TD 2017/23 and
TD 2017/24).

At the very least, over a decade after the introduction of
Division 6E it is clearly well-past time for a review of these
taxation provisions and the overarching policy on the taxation of
trusts.

We will discuss taxation of trusts, both foreign and resident
trusts with foreign and resident beneficiaries, the decisions in
Greensill and N&M Martin and particularly the
interpretation of section 99B ITAA36 in a further article.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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