On Wed 1.11.17, the ATO issued an Addendum to Determination TD 2017/22. The Determination provides that a trust for the purpose of the foreign equity distribution rules in Subdiv 768-A of the ITAA 1997. Accordingly, the ATO accepts that a corporate beneficiary can have a participation interest in the foreign company for the purpose of satisfying the 10% participation test. This is subject to the proviso that a beneficiary of a discretionary trust would not have an entitlement at the test time if the foreign equity distribution is made before year end.
However, when TD 2017/22 was issued as a draft (TD 2016/D7), the Draft specifically stated that a corporate beneficiary of a discretionary trust can have a participation interest in a foreign company. The Addendum clarifies that, to the extent that the finalised Determination provides a less favourable outcome than the view expressed in the Draft, taxpayers can rely on the view in Draft TD 2016/D7 for foreign equity distributions made up until 18 October 2017 (when TD 2017/22 was released).
DATE OF EFFECT: The Addendum applies from 18 October 2017.
‘Explanation’ provided in TD 2017/22 for the determination
|49. Subdivision 768-A provides that in certain circumstances an equity distribution made by a foreign company to an Australian resident corporate tax entity is not assessable and not exempt income (NANE income).
50. A foreign equity distribution can be NANE income where the Australian corporate tax entity receives the distribution ‘directly or indirectly through one or more interposed trusts or partnerships’.3
51. For the distribution to be NANE income the Australian corporate tax entity must satisfy the participation test in relation to the foreign company at the time the distribution is made.4
52. The Australian corporate tax entity will satisfy the participation test if the sum of its direct and indirect participation interests in the foreign company (disregarding certain rights on winding up) is at least 10%.5
53. Where the Australian corporate tax entity holds its interest in the foreign company indirectly, section 960-185 states that its indirect participation interest is worked out by multiplying its direct participation interest in the intermediate entity by the intermediate entity’s direct participation interest in the foreign company.
54. Where the Australian corporate tax entity holds its interest in the foreign company indirectly through a trust, the intermediate entity for the purposes of section 960-185 will be the trust.6 A trust is recognised as an entity.7
55. The trust’s direct participation interest is worked out by reference to the trustee’s direct control interest in the foreign company under section 350 of the Income Tax Assessment Act 1936 (ITAA 1936).8
56. The direct control interest the trustee holds in the foreign company ‘at a particular time’ is equal to the percentage of share capital, rights to distributions or rights to vote that the trustee holds in the foreign company at that time.9
57. The ‘particular time’ when applying section 350 of the ITAA 1936 for the purpose of paragraph 768-5(2)(d) will be the time the foreign equity distribution is made (the test time).10
58. It is then necessary to work out the direct participation interest that the Australian corporate tax entity (beneficiary) holds in the trust. This is worked out by determining its direct control interest in the trust under item 2 of subsection 960-190(1) and section 351 of the ITAA 1936.
59. The direct control interest the beneficiary holds in the trust ‘at a particular time’ is equal to the percentage share of income or corpus to which the beneficiary is entitled or entitled to acquire at that time.11 Again, the ‘particular time’ for the purpose of paragraph 768-5(2)(d) will be the time the foreign equity distribution is made (the test time).
60. Although subsection 351(1) of the ITAA 1936 requires the beneficiary’s interest at the test time to be measured as a percentage of total income or corpus entitlements, it may be that its entitlement cannot be expressed as a percentage until the end of the year when the accounts of the trust are taken and the total trust income for the year is known. In such cases, subsection 351(2) of the ITAA 1936 enables the beneficiary’s interest to be expressed as a percentage. It provides that the percentage concerned is to be ascertained at the end of the income year instead of the test time, on the assumption however, that the relevant share to which the beneficiary is entitled (or entitled to acquire) at the test time was the same at all other times during the year of income.
62. A beneficiary’s direct control interest in a discretionary trust is similarly equal to the percentage share of the income or corpus to which it is entitled or entitled to acquire at the test time. However the trustee will usually only exercise its discretion concerning the income and corpus of the trust at the end of the income year, and therefore the discretionary beneficiary would not have an entitlement at the test time (assuming the foreign equity distribution is made before the end of the income year). At the test time the beneficiary is merely a potential object of the trustee’s discretionary power.
63. Examples 2 to 4 illustrate how the participation test applies where a beneficiary’s fixed entitlement to trust income changes during the income year and Example 5 illustrates how the participation test applies to a discretionary trust.