Q&A: Trust distribution to a foreign resident



Article from The Taxpayer, published May 2019

 Tax & Super Australia’s tax team discusses a query relating to the distribution of a non-taxable amount to a foreign resident from a unit trust. What are the tax implications for the foreign resident in relation to CGT event E4?

Scenario

An Australian unit trust, with an Australian trustee, is wholly owned by a foreign resident company. The unit trust makes a distribution to the foreign resident unitholder that consists of a payment that is not included in the assessable income of the unit holder. The non-assessable distribution has resulted from the difference between the taxable income of the trust and the distributable income (trust law income) of the trust. The amount paid to the unitholder exceeds the cost base of the units held in the unit trust. The majority of the assets held by the trust are cash deposits.

Question

Will CGT event E4 cause a capital gain to arise for the foreign resident?

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Guidance

CGT event E4 occurs when the trustee of a trust makes a payment to you in respect of your unit or your interest in the trust and some or all of the payment is not included in your assessable income. Please note that this does not apply to CGT events A1, C2, E1, E2, E6 or E7. CGT event E4 also does not operate if the unit or interest in the trust was acquired before 20 September 1985.

It should be noted that there are several types of payments, which are not included in the calculation of the non-assessable part of the payment. These will not be discussed here.

CGT event E4 does not apply to discretionary trusts, in most cases. This is because the beneficiaries of the trust are mere discretionary objects. They do not have an interest in trust property until the trustee has validly appointed income to the beneficiary or exercised a power of appointment with respect to the trust property. This is consistent with the Commissioner’s opinion expressed in TD 2003/28.

As in this Q&A, we are discussing a unit holder that is a foreign resident, it is also worth noting that CGT event E4 does not occur when a payment is made to a foreign resident to the extent that the payment is reasonably attributable to ordinary income or statutory income from sources other than an Australian source. However, in this scenario, we are dealing with an Australian sourced payment.

When CGT event E4 applies, there will be either a reduction of the cost base of the units in the trust or the creation of a capital gain, depending on the facts. If the amount of the non-assessable payment is less than the cost base, the cost base and reduced cost base are reduced by the amount of the non-assessable payment. If the non-assessable payment is greater than the cost base, a capital gain will arise equal to the non-assessable payment less the cost base of the units or the interest in the trust. Further, the cost base of the units or interest in the trust will be reduced to nil.

As the unitholder is a foreign resident, we must also consider the operation of Division 855. Generally, Division 855 enables a foreign resident to disregard a capital gain or loss unless the CGT asset is a direct or indirect interest in Australian real property or relates to a business carried on by the foreign resident through a permanent establishment in Australia.

Under section 855-10 ITAA 1997, a foreign resident disregards a capital gain or capital loss from a CGT event if the CGT event happens in relation to a CGT asset that is not taxable Australian property.

The issue in our scenario is whether the units that the foreign resident holds in the Australian unit trust are taxable Australian property. There are five categories of CGT assets that are taxable Australian property. The one that this scenario raises as an issue is whether the CGT asset is an “indirect Australian real property interest”. This term is defined in section 855-25 ITAA 1997. This section requires, among other things, that the interest held in the Australian unit trust is a “non-portfolio interest”. This term is defined in section 960-195. Broadly, this means a holding of greater than 10% in the trust.

Section 855-25 also requires that the interest passes the “principal asset test” in order to be an indirect Australian real property interest. This term is defined in section 855-30. The principal asset test is passed if the sum of the market values of an entity’s assets that are taxable Australian real property exceeds the sum of the market values of the assets that are not taxable Australian real property.

As the unit trust in our scenario has a majority of assets that are cash on deposit, the principal asset test is failed and the units in the trust will not be taxable Australian property. Accordingly, the foreign resident unitholder can disregard a capital gain that has arisen under CGT event E4.

 
 

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