On 28 April 2020, Thawley J decided, in the Federal Court, that the trustee of a resident discretionary trust was assessable under s 98 of the ITAA 1936 on capital gains made on the sale of shares that were not taxable Australian property which were distributed to a foreign resident. The taxpayer went on to lose its appeal in the Full Federal Court (see related TT article).
See below for a summary of the case.
The facts were these.
- The taxpayer was the trustee of a discretionary family trust.
- In the 2015, 2016 and 2017 income years, the taxpayer sold shares which were not “taxable Australian property”.
- In each income year, the taxpayer resolved to distribute 100% of the capital gains, from the sale of those shares (just over $58m in total), to a foreign resident (Mr G).
- In the 2017 year, the taxpayer also transferred certain shares to Mr G in specie.
The Commissioner assessed the trustee as a taxpayer, under s98 of the 1936 Tax Act, for the 3 income years in question, on the basis that the capital gains distributed to Mr G, were deemed or attributable capital gains of Mr G, under Subdiv 115-C of the ITAA 1997.
The Taxpayer contended, however, that the capital gains distributed to Mr G, should be disregarded by operation of s 855-10(1) of the 1997 Tax Act as they were capital gains “from a CGT event” happening in relation to CGT assets that were not “taxable Australian property”.
The Federal Court disagreed.
- The Court said that s 855-10(1) did not apply to disregard the capital gains, as the Taxpayer was not a foreign resident or the trustee of a foreign trust.
- Further, the amount calculated, under s115-225, that is added (by virtue of s 115-220) to a trustee’s assessment, under s 98 of the ITAA36 is not an amount “from” a CGT event and therefore cannot fall within s 855-10(1).
- Subdivision 115-C applied because the trust had a net capital gain in each of the relevant income years, which was taken into account in working out the trust’s net income.
The Court also found
- that CGT event E5 happened in relation to the shares transferred to Mr G in specie and that the taxpayer, as trustee, made a capital gain under s 104-75(3).
- Section 855-10 did not apply to that capital gain, and the amount by which the taxpayer was liable to be assessed, under s 98, was increased under s115-220.
This result is ‘counter intuitive’ enough to be worth digging in further. After all, had the non-resident: Mr G, owned the shares himself, there would have been no tax on the sale of shares that were not ‘taxable Australian property’ and somehow, inserting a resident trust, changed that to a taxable result.
- Indeed the Taxpayer, started with a premise, that this was the scheme of the Act, and construed provisions in that light.
- But, the Court criticised this, saying that the purpose of the legislation is revealed by its terms, not the other way around. [70]
The Div 6 regime for taxing non-resident beneficiaries
The Court noted that the Div 6 regime for taxing non-residents presently entitled to the net income of a resident trust, was:
- to assess the trustee, under s98(2A) of the 1936 Tax Act, on a share of the tax law ‘net income’ (to which non-resident beneficiary would otherwise be assessed – by virtue of a ‘present entitlement’ to a share of the trust’s trust law income) – to the extent that the tax law ‘net income’ is ‘attributable’ to ‘sources in Australia’.
- to assess the non-resident beneficiary on the same amount, under s98A, which also gives that beneficiary a credit for the s98 tax paid by the trustee.
The regime for beneficiaries ‘specifically entitled’ to the trust’s capital gain
In 2011, Parliament amended the 1936 and 1997 Tax Acts, so that ‘capital gains’ of a trust, could flow through to a ‘specifically entitled’ beneficiary, in a way which reflected the ‘capital gains’ status of trust’s gain – or it did, at least, in part.
The Court summarised the relevant provisions as follows.
- A new Div 6E removed ‘capital gains’, to which any beneficiary was ‘specifically entitled’ from the operation of Div 6. However, Division 6 continued to apply to other Div 6 ‘net income’. [23-25]
- This applies to a ‘net capital gain’ which would otherwise be included in the trust’s Div 6 ‘net income’ (as defined in s95) – see s115-210 of the ITAA97. [26]
- The regime generally involves assessing the relevant taxpayer, on an appropriate share of trust’s s102-5 ‘net capital gain’ – doubling it, if the trust had claimed the 50% general CGT discount.
- The version of this, that applies to a s98 trustee assessment, is to be found in s115-220(2) and s115-225.
- s115-225 specifies the amount fo the trust’s capital gain, which is ‘attributable’ to the taxpayer (in this case: trustee), is the amount of that capital gain multiplied by the percentage of that gain, to which the relevant beneficiary is ‘specifically entitled’ (calculated under s115-227). [29]
- then s115-220(2) adds, to any other s98 assessable income, the capital gain amount ‘attributed’ to this trustee, under s115-225. And the same amount would be added, again (by way of ‘gross-up’), if the trust had claimed the 50% general CGT discount. [27]
- A beneficiary of the trust, who is ‘specifically entitled’ to share of the Trust’s actual gain, will be assessed on that same share of the trust’s tax law ‘net capital gain’, on a similar ‘grossed up’ basis, under s115-215. [32] This is by adding ‘extra capital gains’ – namely a single portion of the trusts capital gain, that is attributed to the beneficiary (under s115-225). Alteratively, it could be double that amount, if the trust claimed one of the general 50% CGT discount, or the Div 152 small business 50% CGT discount. Alternatively, it could be four times this amount, that is added, to its other assessable income, if the trust claimed both of those 50% discounts.
- This section (s115-215) applied to this non-resident beneficiary, when he was assessed under s98A.
- Section 115-215(1) explains that the purpose of this provision is to “ensure that appropriate amounts of the trust estate’s net income attributable to the trust estate’s *capital gains, are treated as a beneficiary’s capital gains when assessing the beneficiary, so (a) the beneficiary can apply *capital losses against gains; and (b) the beneficiary can apply the appropriate *discount percentage (if any) to gains.”
Whether Div 855 could exempt the non-resident beneficiary on the trust’s shares
The taxpayer trustee contended that it was entitled to ‘disregard’ it’s capital gain on selling the shares, under s855-10(1) because these shares were not ‘taxable Australian property and the general regime of Subdiv 115-C was to allow a beneficiary to treat the trust’s capital gain as its own.
Section 855-10(1) provides as follows.
855‑10 Disregarding a capital gain or loss from CGT events
(1) Disregard a *capital gain or *capital loss from a *CGT event if:
(a) you are a foreign resident, or the trustee of a *foreign trust for CGT purposes, just before the CGT event happens; and
(b) the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.
The Trust could not disregard the capital gain, when the trustee sold the shares, for the purposes of calculating its Div 6 ‘net income’. This is because, the Trust was not a ‘foreign trust’ – as required by s855-10(1)(a).
Neither could the trustee disregard its s98 assessable income (under s855-10). This was for several reasons.
- First, the trustee was not trustee of a ‘foreign trust’ (as required by s855-10(1)(a)).
- Second, s115-220 just required an amount to be calculated, and included in the Trust’s s98 assessable income. This amount was not, the Court held, a ‘capital gain’, that could be ‘disregarded’, under s855-10(1).
- Third, the wording of the Act did not support the Taxpayer’s contention that there was no amount, to be added to its s98 assessable income, under s115-220.
- The Taxpayer argued that there was no amount of trust’s capital gain, attributed to him, under s115-225, because his share of the Trust’s income was disregarded (under s855-10(1)). Try as I will, though, I can’t see how the Taxpayer could put this contention.
- Section 115-225 divides capital gains of the Trust, between beneficiaries who are ‘specifically entitled’ to them, and then uses those amounts to feed into three sections: s115-215 for beneficiaries, who are to be assessed on that amount; s115-220 for trustees, assessed under s98; and s115-222, for trustees assessed under s99 or s99A on that amount.
- It is clear that s115-225 works on capital gains of the Trust (and not of the foreign beneficiary).
Mr G was a ‘foreign resident’ but it was not him, who was being assessed.
- Rather, it was the trustee, being assessed, under s98, on the share of the Trust’s capital gain, attributed to Mr. G.
- Rather tellingly, s855-40 allowed non-resident beneficiaries, to claim s855-10 exemption, on capital gains to arise on the assets of a trust, that were not ‘taxable Australian property’ – but this was limited to ‘fixed trusts’ (or chains of ‘fixed trusts’) and this trust was a discretionary trust (not a fixed trust).
And finally, Mr G would have been assessed on a similarly calculated amount, under s98A, based on an underlying capital gain of the Trust (per s115-215).
- But, again, the s855-10(1)(b) requirement, is not met, as it was the not the ‘foreign resident’ beneficiary that sold the shares (it was the Trustee).
- Further, there is no ‘capital gain’, that could be disregarded, but only an amount calculated under s115-215 (even if that was calculated by reference to the Trust’s capital gain).
So the result…
This is hopelessly complicated, but the ‘take away’ is that the Subdiv 115-C regime, for attributing trust capital gains to beneficiaries, is not complete. It is only an arithmetic equivalent, and doesn’t pass through all aspects of the capital gain.
(Peter Greensill Family Co Pty Ltd v CofT [2020] FCA 559, Federal Court, Thawley J, 28 April 2020.)
[LTN 82, 30/4/20]