House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Taxation of Non-Resident Trusts

Overview

This chapter describes the changes in the taxation of Australian beneficiaries of non-resident trust estates.

Introduction

Prior to the commencement of the foreign source income (FSI) measures, which had effect, generally, from the 1990-91 income year, the taxation of the income of a non-resident trust estate was broadly the same as for a resident trust estate. Formerly, where a resident beneficiary who was not under a legal disability was presently entitled to any income of a non-resident trust estate, that income was included in the beneficiary's assessable income (section 97). If the resident beneficiary was under a legal disability, the trust income to which the beneficiary was presently entitled was assessed to the trustee on the beneficiary's behalf (section 98).

Where the non-resident trust estate derived income to which no beneficiary was presently entitled (broadly, accumulating income), only so much of that income that had an Australian source was taxed to the non-resident trustee (sections 99 and 99A). Accumulated foreign source income of the non-resident trust estate was subject to tax in the hands of the resident beneficiary only if and when it was paid to or applied for the benefit of that beneficiary (section 99B).

The FSI measures changed substantially the taxation of the income of non-resident trusts. These measures apply to certain types of trusts to which Australian residents have transferred assets (transferor trusts) and operate to attribute for tax purposes the income accumulated in such trusts to those transferors.

However, avenues still remain even after the implementation of the FSI measures for the deferral of Australian tax on trust income from foreign sources until that income is paid to an Australian resident. If the resident does receive the trust income, an interest charge is applied to compensate the revenue for that deferral. In some cases, it is clear that the trust income is accumulating for the benefit of residents and it is these cases that will be addressed by the FIF measures.

The amendments described in this chapter supplement the objective of the FSI measures in preventing the deferral of Australian tax. The amendments will:

i)

nsure that an amount is not included in the assessable income of:

n Australian beneficiary under section 97; or

trustee, under subsection 98(1) or (2), on behalf of an Australian beneficiary under a legal disability;

in relation to the income of a non-resident trust estate where the FIF measures apply to the beneficiary's interest in that trust estate;

ii)

xclude from the calculation of a beneficiary's share of the net income of a public unit trust the effect of the FIF measures on the trust's net income where all the interests of the beneficiary and associates of the beneficiary in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000;

iii)

et out the way in which the income of non-resident trust estates is to be calculated and attributed to their Australian beneficiaries;

iv)

xempt a taxpayer from an interest charge on an amount received, or applied for the taxpayer's benefit, that is attributable to the income or profits of an estate of a deceased person where that amount was paid to, or applied for the benefit of, the taxpayer within three years after the death of that person;

v)

xempt a taxpayer from an interest charge on an amount received, or applied for the taxpayer's benefit, that is attributable to the income or profits of a trust estate which at all times during the year was a public unit trust for the purposes of Division 6AAA and was not a controlled foreign trust within the meaning of Part X; and

vi)

equire taxpayers to show that an amount, being property of a trust estate, that was paid to, or applied for the benefit of the taxpayer, was paid out of accumulated profits which are referable to income other than:

n the case of a listed country trust estate, eligible designated concession income; or

n the case of an unlisted country trust estate, income that has not been subject to tax in any listed country,

before that amount will be exempt from the interest charge on distribution.

These amendments will have effect from the 1992-93 year of income.

Explanation

Excluded taxpayers

Section 97 includes in the assessable income of an Australian beneficiary, who is not under a legal disability, so much of the share of the net income of a trust estate to which the beneficiary is presently entitled as is attributable to a period when the beneficiary was a resident of Australia.

Subsections 98(1) and (2) include in the assessable income of a trustee so much of the share of the net income of a trust estate as is referable to a period when:

beneficiary under a legal disability was a resident of Australia; or

s referable to a period when a beneficiary, who is deemed to be presently entitled to a share of the income of the trust estate under subsection 95A(2) because the beneficiary has a vested and indefeasible interest in the income of the trust estate, was a resident of Australia.

The proposed amendments will ensure that an amount is not included in the assessable income of an Australian beneficiary under section 97 where the FIF measures apply to the beneficiary's interest in a non-resident trust estate and section 529 applies to include an amount in the assessable income of the beneficiary. [Subsection 96A(1)]

A trustee will also not be assessed under subsection 98(1) or (2) on behalf of an Australian beneficiary of a non-resident trust estate where the beneficiary is under a legal disability. [Subsection 96B(2)]

The only instances where the FIF measures will not apply to an Australian beneficiary's interest in a non-resident trust estate are those specifically set out under the FIF measures. For instance, where:

a)

he taxpayer is an attributable taxpayer of the trust under the transferor trust measures (that is, Division 6AAA) [Paragraph 493(a)] ;

b)

he taxpayer is an attributable taxpayer of a controlled foreign trust under the CFC measures (that is, Part X) [Paragraph 493(b)] ;

c)

he total of the values of all interests held by a taxpayer who is a natural person (including interests held by associates) in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000 [Section 515] ;

d)

he taxpayer is a natural person who has an interest in a trust estate which is a foreign employer-sponsored superannuation fund maintained by an employer, or an associate of the employer, for the benefit of the taxpayer as an employee [Section 519] ;

e)

he taxpayer is a beneficiary of a designated publicly listed trust estate which invests in a country for which direct investment on a stock exchange is prohibited [Section 513] ; or

f)

he taxpayer qualifies for the exempt visitor exclusion from the FIF measures. [Section 517]

Taxpayer's with interests of less than $50,000

Certain small investors are excluded from the FIF measures. Consistent with this exclusion, the proposed amendments will exclude foreign investment fund income from the assessable income of a resident public unit trust when calculating a small investor's share of the net income of the trust estate. This exclusion will apply where the sum of the values of all the interests of the small investor and associates (as defined in section 491) in FIFs, FLPs and resident public unit trusts at the end of the year of income do not exceed $50,000 [subsection 96A(2)]. (Refer to the notes on the exemption for interests of less than $50,000 in Chapter 10.) [Section 515]

In calculating the beneficiary's share of the net income of the trust estate in a subsequent year of income, the trust estate's net income is to be calculated ignoring attribution credits which arose during the years of income when the beneficiary was exempt because of subsection 96A(2). This will mean that the beneficiary will not benefit from the exemption which applies for previously attributed amounts (section 23AK) or for a reduction in the disposal consideration of the FIF interest because of an unused FIF attribution account surplus (section 613) where that benefit would otherwise arise because of amounts which were included in the trust estate's attributable income in a year of income when the beneficiary was exempt from attribution because of subsection 96A(2). [Paragraph 96A(2)(d)]

Attribution of trust income

From the 1992-93 year of income, the share of the income of an Australian beneficiary of a non-resident trust, who is not assessed under the FIF measures, will be calculated on a new basis. [Section 96B]

There are two methods by which the beneficiary's share of trust income will be calculated. The first method applies where all of the trust's accounting income, profits and gains are income, profits and gains to which the beneficiary is presently entitled or which are distributed to the beneficiary within two months of the end of the income year.

The terms "income, profits or gains" have their normal meaning and relate to the ordinary accounting and trust law concepts of trust income. For this purpose, an amount that was credited to, or applied for the benefit of a beneficiary of the trust estate is treated as paid to the beneficiary.

Where these conditions are met, the following formula is used to calculate the share of a beneficiary in the net income of the trust estate:

Net income x Attribution percentage


Net income means the net income of the trust estate. The net income of a trust estate is, broadly, the assessable income of the trust estate calculated under the Principal Act as if the trustee were a taxpayer and a resident of Australia and deducting allowable deductions. It would include, for instance, assessable FIF income from interests that the trustee holds in a lower tier FIF. (Subsection 95(1))

Attribution percentage means the percentage of the total income, profits and gains of the trust estate to which the beneficiary is presently entitled or that was paid to or applied for the benefit of the beneficiary in the year of income of that trust or within 2 months after the end of the year of income. [Subsection 96C(1)]

Where the conditions for application of the method are not met, the beneficiary's share of the net income of the trust estate is determined by three steps as follows:

Step 1

Calculate the share of the net income referable to interests held in a trust estate for the whole year.

Calculate the part of the beneficiary's share of the net income of the trust estate that is attributable to any interest the beneficiary had in the trust estate throughout the whole year of income using the following formula.

Net income x Attribution percentage


(These terms are described below.)

Step 2

Calculate the share of the net income referable to interests held in a trust estate for only part of the year.

Calculate the part or parts of the beneficiary's share of the net income of the trust estate that is attributable to any interest the beneficiary had throughout a particular part of the year of income using the following formula;

Net income x Attribution percentage x (Number of days held / Total number of days)


(These terms are described below.).

Step 3

Calculate the total share of the net income referable to interests held in a trust estate.

Total the amounts calculated in steps 1 & 2 to determine the beneficiary's share of the net income of the trust estate. [Subsections 96C(2) to (5)]

Meaning of the terms in the formulas:

Net income means the net income of the trust estate.

Attribution percentage means the greater of:

a)

he percentage of the income of the trust estate to which the beneficiary was entitled, or was entitled to acquire, because of the beneficiary's interest in the trust estate (that is, any interest in the income of the trust estate that the beneficiary had or was entitled to acquire); or

b)

he percentage of the corpus of the trust estate to which the beneficiary was entitled, or was entitled to acquire, because of the beneficiary's interest in the trust estate (that is, any interest in the corpus of trust estate that the beneficiary had or was entitled to acquire).

A beneficiary is entitled to acquire anything that the beneficiary is absolutely or contingently entitled to acquire, whether because of the exercise of any right or option or for any other reason. [Subsection 95C(5)]

The attribution percentage for a taxpayer is to be reduced if the sum of the attribution percentages of all resident taxpayers in the trust estate exceed 100 per cent. In this case, the taxpayer's attribution percentage is to be reduced by the same proportion as the sum of the attribution percentages of all resident taxpayers in the trust estate exceeding 100 per cent. [Subsection 96C(6)]

Number of days held means the number of days in the part of the year of income throughout which the beneficiary had an interest in the trust estate.

Total number of days means the number of days in the year of income.[Subsection 95C(5)]

Deceased estates

An interest charge applies to amounts that are included in the assessable income of a beneficiary under section 99B (section 102AAM). In broad terms, section 99B includes in the assessable income of a beneficiary who was a resident at any time in a year of income any property of a trust estate, that is paid to, or applied for the benefit of, that beneficiary in the year of income. However, section 99B does not apply to amounts which have previously been subject to tax in Australia either in the hands of the trustee or of the beneficiary.

The amendments will exempt a beneficiary from the interest charge on amounts received from the estate of a deceased person which would otherwise have been assessable under section 99B where those amounts are paid to, or applied for the benefit of, the beneficiary within three years after the death of that person. [Subsection 102AAM(1B)]

Public unit trusts

The transferor trust measures (Division 6AAA) do not apply to arm's length transfers to non-resident public unit trusts (subparagraph 102AAT(1)(a)(i)(B)). Consistent with this treatment, the amendments will exempt a taxpayer from an interest charge on amounts received, or which have been applied for the taxpayer's benefit, that are attributable to the income or profits of a trust estate which at all times during the year:

as a public unit trust for the purposes of the transferor trust measures (Division 6AAA); and

as not a controlled foreign trust within the meaning of Part X. [Subsection 102AAM(1C)]

Section 102AAF specifies the basic criteria for determining whether a unit trust is to be regarded as a public unit trust for the purposes of the transferor trust measures. Broadly, a unit trust will be a public unit trust if, at any time during the year, any of the units in the unit trust were listed on a stock exchange in Australia or elsewhere or were offered to the public. In addition, a unit trust will be a public unit trust if, at all times during the year, the units in the unit trust were held by 50 or more persons. However, a unit trust will not be treated as a public unit trust where 20 or fewer persons hold 75 per cent or more of the beneficial interests of the income or property of the trust.

The following considerations must be taken into account in determining whether a unit trust is a public unit trust at all times during the year of income:

n entity and its associate or associates (defined in section 102AAB to have the same meaning as described in section 318) are taken to be one person; and

here units in the trust are held by the trustee of another trust estate that is a public unit trust at all times during the year of income, a person who has a beneficial interest in the property of that other trust estate that consists of those units is taken to hold those units. [Subsection 102AAF(3)]

Section 342 specifies the criteria for determining whether a trust estate is a controlled foreign trust within the meaning of Part X. A trust estate will be a controlled foreign trust within the meaning of Part X if there is an eligible transferor in respect of the trust - that is, broadly, if an Australian entity or, a controlled foreign partnership, controlled foreign trust or controlled foreign company, transferred value to the trust estate:

n the case of a discretionary trust estate, at any time (section 347); or

n the case of a non-discretionary trust estate, after 12 April 1989 for non-arm's length consideration (section 348).

A trust estate will also be a controlled foreign trust within the meaning of Part X if there is a group of five or fewer Australian 1 per cent entities (defined in section 317) with associate-inclusive control interests (defined in section 349) in the trust estate totalling 50 per cent or more (section 342).

Interest charge exemption - amounts which have been taxed at comparable rates

Where a non-resident trust estate is a listed country trust estate (defined in section 102AAE) in a year of income, only distributions from certain concessionally taxed income of the trust estate will be subject to the interest charge under section 102AAM. Where a non-resident trust estate is not a listed country trust estate in a year of income, a distribution made from the income and profits of the trust estate of that year of income will be subject to the interest charge to the extent that the amount has not been subject to tax in any listed country in a tax accounting period:

nding before the end of the non-resident trust's year of income; or

ommencing during the non-resident trust's year of income.[Paragraph 102AAM(1)(b)]

Before that amount will be exempt from the section 102AAM interest charge on distribution, a taxpayer will have to show that an amount (being property of a trust estate) that was paid to or applied for the benefit of the taxpayer was paid out of accumulated profits which are referable to:

n the case of a listed country trust estate, income other than eligible designated concession income; or

n the case of an unlisted country trust estate, income that has been subject to tax in any listed country.[Subsection 102AAM(1A)]

Clauses making the amendments

Clause 10: Inserts subsection 95(3) which defines a "non-resident trust estate" for the purposes of Division 6.

Clause 11: Inserts section 96A. Subsection 96A(1) will exclude income referable to an interest held by taxpayer in a non-resident trust estate which has been taxed under the FIF measures from being assessed to the taxpayer again under section 97. Subsection 96A(2) deals with the small investor exclusion from the FIF measures as they relate to resident public unit trusts.

It also inserts sections 96B and 96C which will set out the new method of calculating the shares of the net income of beneficiaries of non-resident trusts.

Clause 12: Amends section 102AAM to exempt taxpayers from the interest charge on certain amounts received under section 99B and to require taxpayers to establish that certain trust distributions are not subject to an interest charge.