Trust structures are not uncommon within Australia and are routinely used overseas for investment purposes. This is due to the flexibility available to discretionary trusts in appointing income and/or capital of the trust; however, the Australian tax system has many anti-avoidance tools in its armoury to tax foreign trusts and their distributions made to Australian beneficiaries.
There are numerous issues to consider when you have an overseas trust and have migrated to or are already within Australia. Careful planning may be required to ensure a person’s migration to Australia does not trigger any unforeseen issues for the foreign trust.
Case study
Michael moved to Australia from the UK in 2022 and is a tax resident of Australia. M S Trust was established in a foreign jurisdiction with $1 million in initial capital. Michael is the sole Trustee of the M S Trust (the Trust).
The Trust acquired a property for $1 million back in 1998. The property was sold for $2 million in 2010. The Trust retained the income and included the gain of $1 million in corpus. The Trust put the funds in a bank account that has been accruing interest ever since.
Tax issues that arise for the M S Trust – Australian tax residency
As a starting point, we would need to ascertain the residency status of the M S Trust for Australian tax purposes. Although the M S Trust could be a resident of a foreign jurisdiction, it does not mean it cannot be a tax resident of Australia. Discretionary trusts are residents of Australia if any trustee is a tax resident or its central management and control (CMC) is in Australia at any point during a particular income year.
Therefore, since Michael is a tax resident of Australia, Australia would consider the M S Trust to be a tax resident of Australia. It could have obligations to file tax returns in Australia and could trigger a wide range of capital gains tax and income tax issues for the Trust.
In a situation where a trust is a resident of two countries, you would then need to consider the double tax agreement between the two countries to consider any tie breaker provisions and who maintains taxing rights over the income of the trust. If there is no double tax agreement with the foreign country that the trust has been established, it could create further issues. Careful planning was required prior to Michael’s move to Australia to ensure the Trust remains outside the Australian tax system.
Tax issues that arise for the M S Trust – foreign tax resident
Let’s assume Michael had in fact planned for this and the M S Trust is not an Australian tax resident trust i.e. it is a foreign trust. Another way Australian taxes distributions from foreign trusts is under s99B ITAA1936.
The ATO recently released guidance on the application of s99B and how it approaches it from a risk point of view. S99B acts as an anti-avoidance provision to prevent people from “hoarding” money in overseas trusts and then re-patriating that money without paying any tax in Australia. S99B applies to distributions that are defined very widely, and simply put, can apply to payments and loans made by an overseas trust to an Australian resident shareholder.
Under s99B, an amount is assessable to a beneficiary unless an exclusion applies. One of the most common exclusions is corpus (i.e. capital) of the trust but excludes an amount of corpus that would have been assessable had it been received by a resident of Australia.
For arguments sake, let’s assume the Trust had generated $200,000 in interest income since 2010 and had not made any distributions and included those amounts within trust corpus. If the $200,000 is then paid to an Australian resident individual, the corpus exclusion would not apply since the interest income would have been assessable to a tax resident of Australia had they received directly – remember, this provision is to prevent people from “hoarding” money in overseas trusts and avoiding tax in Australia.
Similarly, if Michael ever receives the payment of $2 million from the overseas trust, from the capital gain in 2010, he would be assessable on part of the gain in Australia that is not sourced from corpus. Arguably, out of the $2 million, Michael could argue that $1 million should be eligible for the corpus exclusion (if he has maintained adequate records) and he should not be assessable to him in Australia. The remaining $1, million, which is not subject to the corpus exclusion, would be assessable to him here and more importantly, he wouldn’t have access to the 50% CGT discount in Australia and would be assessable on the full amount i.e. potentially $470,000.
Other issues
Whenever we consider the word “trust”, we generally only consider the most common types of trusts such as discretionary (or family) trusts and/or unit (or fixed) trusts. Another key issue to bear is mind is that a superannuation fund is also considered a trust. If an individual has a superannuation/pension fund abroad, that would generally be subject to the trust rules (i.e. s99B considered above) unless the fund is considered a foreign superannuation fund. A foreign superannuation fund in simple terms is any foreign superannuation fund that has the same terms of release as an Australian superannuation fund, which is generally retirement or death. If an individual can release amounts from a foreign fund for other reasons (e.g. termination of employment), it would not be considered a foreign superannuation fund, and you would then need to consider whether s99B could potentially apply to the distributed from that trust to the resident individual that could come at a significant cost. Similarly, 99B can also apply to distributions from deceased estates situated overseas.
Another common exemption from tax in Australia is amounts received by way of gifts, gifts are fairly common amongst family members; however, if a gift is sourced from a foreign trust, it could again be subject to s99B and the amount could be assessable in Australia.
Concluding remarks
Like we mentioned earlier, the ATO has recently released guidance on s99B and it is clearly an area of focus over the coming years and they will devote compliance resources to distributions from foreign trusts. It is also important to remember that the ATO has significant data matching capabilities and uses information from AUSTRAC to check transactions coming from outside Australia
It is very important for beneficiaries of foreign trusts and trustees to be aware of these risks but if you would like to discuss this in further detail, contact your Moore Australia advisor today.